29 Aug 2012

Keynes Quotes

I follow Stephanie Kelton @deficitowl on Twitter. Lately she posted a series of quotes from Keynes. I liked them very much so here they are with only minimal editing:
"employment...depends on the amount of the proceeds which the entrepreneurs expect to receive.." -JM Keynes. (Expected) Sales create Jobs.

The notion that "supply creates its own demand..still underlies the whole classical theory, which would collapse without it." -JM Keynes

1936 Keynes complained that classical econ treated money as something that could be "introduced perfunctorily in a later chapter" Still does

"workers..are instinctively more reasonable economists than the classical school [b/c] they resist reductions of money-wages.." JM Keynes

"Never in history was there a method devised..for setting each country's advantage at variance with its neighbors' as the inter'l gold std"

Gold bugs champion gold's "inelasticity of supply", but that that is "precisely the characteristic..at the bottom of the trouble" -JM Keynes

"gold-mining is the only pretext for digging holes in the ground which has recommended itself to bankers as sound finance" - JM Keynes, 1936

"It would..be more sensible to build houses and the like; but if there r political..difficulties in the way..[bottles] better than nothing"

"If the Treasury were to fill old bottles with banknotes, bury them..and leave it to private enterprise..to dig [them] up there need be no more unemployment" -JM Keynes

"..digging holes in the ground known as gold-mining..adds nothing whatever to the real wealth of the world.." -JM Keynes

"..the deep divergences of opinion b/w fellow economists..have almost destroyed the practical influence of economic theory.."JM Keynes, 1936

27 Aug 2012

Delusional economics and the economic consequences of Mr Osborne

New Talk From Ann Pettifor

This is a very good summary of what's going wrong from a Keynesian point of view. AP has in common with other commentators who warned of crisis the idea that the problem is private debt, which in turn is a consequence of deregulation.

AP kind of skips over things, and I'd like to see the same talk but with more time.

25 Aug 2012

Error in GDP Numbers is Obscured by the ONS

It's really rather difficult to find information on the statistical errors in GDP figures released by the Office for National Statistics (ONS). Today's release for instance gives no direct information, but only refers the reader to another document: Quality and Methodology Information for Gross Domestic Product. It says:
Validation and quality assurance
The degree of closeness between an estimate and the true value.
There is no simple way of measuring the accuracy of GDP, that is, the extent to which the estimate measures the underlying ‘true’ value of GDP in the UK for a particular period. Blue Book 1 2008 (pp 27-30) provides more information on this.
One dimension of measuring accuracy is reliability, which is measured using evidence from analyses of revisions to assess the closeness of early estimates to subsequently estimated values. The results of revisions analysis are regularly presented in the background notes of GDP Statistical Bulletins and revisions spreadsheets containing the data behind this.

The QMI:GDP document doesn't discuss error generally but does give figures for the revisions. They say that the total revisions are not statistically different from zero for 2011. This might be difficult to accept for those of us used to non-zero revisions, such as the revision from -0.7% to -0.5% for Q2 2012; which is very far from being zero! Indeed in recent years the revisions between the first and the current estimates have been very much non-zero and increasingly volatile. The graph below shows the difference in percentage points per quarter from Q1 1997 to Q2 2012 (not including the most recent revision).

However this document does lead to a third document Accuracy Assessment of National Accounts Statistics (2002). The author of this paper doesn't really come out and say what the margin of error is, but does discuss sources of error and gives some indication of the magnitude of errors. This is partly due to the complexity of the calculation. But let's recall that when we add to uncertain figures the margin of errors are added together as well.

GDP is calculated in different ways and, as best as I can tell from these obscure documents this leads to an error of between 1.5% and 3.5% depending on the method. However this is far from being clear, and the way the figures are stated seems designed to hedge and fudge.

Contrarily we have the document Understanding the quality of early estimates of Gross Domestic Product. This document estimates the change in the estimates of GDP to average around 0.05 percentage points. But of course the data for this claim are in a separate document! The graphs are presented so as to obscure any differences between first estimates and subsequent estimates - which seems to be what this one is about, rather than error margins generally. The conclusion here is that the
"since the mid-1990s, revisions have been smaller than in previous periods. Over maturities up to T+24 [months], when most of the non-methodological changes will have been taken on board, the average revision is only +0.05 percentage points."
However in the graph I show above the average may be 0.05 percentage points but the standard deviation must be large because changes of 1 percentage per quarter (which could be 4 points over a year) are not uncommon.

As far as I can work out--though I have hardly exhausted all of the many OND documents available--the ONS do not supply error margins with their GDP figures.They do supply information on the differences between first estimates and later estimates.

Why Is It So Hard Get a Straight Answer About the Margin of Error?

Flying in the face of all good practice when dealing with statistics, the figures produced are treated as absolute. Not only the media (who probably can't be expected to know better), but the ONS themselves skate over the issue of statistical errors. It is reprehensible of ONS not to indicate the level of confidence they have in these figures at every point. No figure should be quoted without an indication at least of the calculated margin of error.

What this pattern of interlocking documents reminds me of is ISO9000 Quality Control documentation of a process. This in no way defines the quality of the product, but only provides for the process to happen the same each time. That is it guarantees that reports will be produced with figures in them, and the figures will be produced by the same method, but in fact says nothing at all about the quality of those figures.

The GDP guestimate we get from the ONS have a built in margin of error. It's unlikely to be small since it involves compounding errors from a series of other statistical measures. A lot rides on small changes in GDP, but the irony is that the smaller the change the less confidence we can have that it isn't just a statistical blip. 

21 Aug 2012

Putting the Cart Before the Horse

The use of Game Theory in economics have become quite fashionable. Game theory seems to offer an alternative to the Utilitarian ideas that came to nought with the discovery that aggregate demand doesn't follow the Law of Demand.

In particular the theories of John Nash became popular. Nash devised a series of game scenarios in which theoretically rational participants interacted in idea ways. It's thought that this branch of mathematics shows what ideal rational behaviour would look like and has thus been interesting to economists.

But it's all a farce. Human beings are not rational choice making machines. We make decisions using our emotional responses to situations and events. I've written about this elsewhere (Facts and Feelings) based on Antonio Demasio's book Descartes' Error. While no economist seems to be ready to take this on, the advertising profession has increasingly shown sensitivity to this fact in the design of advertising campaigns. Remember when cars were sold on the basis of engine size, fuel efficiency, or special features like limited slip differentials? None of that is relevant any more. Car ads speak directly to our emotions now, bypassing the rational completely: BMW sells "joy".

I wanted to learn a little more about Nash so I checked out a paper supposed to be a 'Classic' hosted on the website of the Proceedings of the National Academy of Sciences of the United States of America (PNAS).

An economist called Robert Weber is cited in this classic: "Nash's theory of noncooperative games should now be recognized as one of the outstanding intellectual advances of the twentieth century" but elsewhere we find it said:
The Nash equilibrium concept does not necessarily predict how people will behave in the real world. Rather, it provides a measure for how purely rational people might behave.

"The Nash equilibrium tells us what we might expect to see in a world where no one does anything wrong," Weber says. 
In fact the Nash equilibrium does not predict how people will behave in the real world except by accident. It creates a particular kind of fantasy about a "rational person". The definition of "rational" is left aside. We know the old Utilitarian definition of rationality as maximising one's own pleasure without regard for other people. This is seen as "rational" because of the conceits of a few Victorian English gentlemen. In fact if we met someone like this we would think they were crazy, a sociopath if not a psychopath.

In Nash's model humans were inherently suspicious of each other, selfish and constantly struggled with other people as competitors. And Nash did actually succumb to paranoid schizophrenia not long after he published these results. "Rational" in other words means inhuman or insane in these models!

But these people are so convinced that their worldview is Truth in an absolute sense that they put the cart before the horse and say things like:
"In some settings, people routinely deviate from the kind of behavior the Nash equilibrium predicts," Weber says. "These deviations have led to the discovery of pervasive psychological phenomena that pull people away from rational behavior." 
The assumption here is that the weird definition of reality included in Nash's models is normal, and that ordinary human beings deviate from that norm. Here I think we have to conclude that Weber is also a lunatic. Human beings have never conformed to the norms that Utilitarianism or Game Theory have sought to impose on them. To turn around and suggest that human beings are deviant for not following the models is madness. I can think of no other discipline which constructs arbitrary models in the abstract and then criticises phenomena which fail to conform.

Economists try to make people fit their theories, whereas scientists make their theories fit people. And this is fundamentally wrong. In grasping simple theories that give consistent answers, economists typically ignore the disconnect from the real world - the make a series of unwarranted assumptions that hide the implausibility of the theory.

And indeed Nash himself admits that his assumptions about people do not stand up to scrutiny in an interview with Adam Curtis for his film "The Trap".

The Economist anticipated some of my criticisms in 1998 - they say that a. people don't understand how economist use words like rational; and b. "rationality has proved a useful [simplification]." I think I do understand how they are defining rational and my point is that they define it in a way that is aberrant.

I'd have liked them to define "useful" since their models seem to be bloody useless at predicting the economy at present - we keep getting "shock" deviations from predictions these days. These "useful" models failed to predict one of the greatest perturbations of the economy since records began. The failure is on a scale that would render the theory irrelevant in any other discipline. It would be like suddenly observing anti-gravity, or neutrinos that really did travel faster than light. Such a result should signal the end of the old order, and an exciting race to provide the new more complete and accurate paradigm - in economics there are many contenders.

20 Aug 2012

Savings, Debt and the Deficit

Edward Harrison, of the Credit Writedowns blog, makes a very good point in these two blog posts
The first has given me much food for thought and I think will continue to do so. He says that the approach he takes here is "an Austrian-styled interpretation of the origins of the crisis", but it's pretty consistent with what the Post-Keynesians are saying too. The guts of it is this:
"When the government sector runs a deficit, the non-government sector runs a surplus of equivalent size.
The government budget cannot be seen in isolation. It must be seen in the light of private and trade sector balances. If the government runs a deficit or a surplus then we need to think about how that impacts the rest of the economy. At the end of the day the books have to balance. Someone's debt is someone else's asset.

I'd interject here to emphasise that a build up of debt is not neutral - Harrison seems to understand this but it doesn't yet feature strongly in public discourse so I feel I need to keep saying it.

It took me a while to get this, and this is where the Chart of the Day post comes in because it shows the relationship between public sector spending and private sector savings in the Eurozone (the chart is already 3rd hand).

I've looked up the UK savings ratio which is a similar shape:

Source ONS

Savings gradually fell throughout the 1990s and up to beginning of the Great Recession. Savings shot up in 2008 and have been gradually, but not smoothly, falling since 2010. Of course the expectation was that the recession would not last. Austerity measures and inflation, and particularly the very low (below inflation) returns seem to account for the decline in saving, but note that it does not seem to be going into spending - presumably it is going into debt repayments.

In June the Guardian was commenting: "The amount people are saving has increased at the expense of reducing debt levels, with consumers paying back 7p for every pound saved during the first three months of 2011." By July the it was opposite story "Savings fall as Austerity Squeezes Household Budgets."

So, according to Harrison, we can conceive the present problem this way:
The non-government surplus is too large, we need to reduce it now before it gets out of control.
"What we want to do is target the cause of the deficits, insufficient demand which I believe is the result of the overhang of debt after a period of excess private sector credit growth. What you want to do is eliminate that debt overhang by reducing the debt or increasing private sector incomes to support the debt. That’s getting at root causes."
This seems consistent with what others are saying, though not of course in the government or the Bank of England! Harrison does not give his preferred solution to this problem. Mine would be direct debt relief in the form of SK's modern debt jubilee. Other options would be to use QE to directly fund investment in business. An alternate take on this is to specifically fund green business that will lessen our dependence on oil.

Debunking Economics IV: Aggregate Demand

In a previous post I worked through the ideas contained in the first part of chapter 3 of Steve Keen's book Debunking Economics outlining the so-called Law of Demand. This is not an empirical law such as Newton's Laws of Motion, or the Laws of Thermodynamics. That is to say it's not an attempt to explain the real world based on measurement. The Law of Demand is an attempt to create a mathematical model of theory about how the world works which is based on the 19th century Utilitarian philosophy of Jeremy Bentham. As it happens the Law of Demand works OK for one consumer consuming one product.

However as early as 1953 it became apparent that the Law of Demand as stated does not apply to two or more consumers. The first mathematical proof was by a chap called William Moore "Terence" Gorman (wiki) in this journal article:
Gorman, W. M. (1953) 'Community preference fields,' Econometrica, 21(1):63-80. JSTOR.
The abstract of this paper is visible even though the article itself is behind a paywall or tucked away in a university library. What it says is this:
A series of formal relationships between community indifference maps and the utility possibility maps are stated and it is proved that a given system of personal indifference maps yield a unique community indifference map if, and only if, the personal Engel curves are parallel straight lines for different individuals at the same prices. [emphasis in the original]
What Steve Keen does is decode this - he's not saying anything new here, he's just pointing out what was said in 1953 and drawing out the most obvious implications. Having reviewed his chapter to date I can see the obvious implications of this too - and I have zero background in economics.

I covered Engel curves in part II. These are the curves that are constructed by tracing the points of intersection with various individual indifference curves in the indifference map for one commodity vs all other commodities at different levels of income. Engel curves tell us predict how much of a commodity an individual will purchase at any given income level.

Now SK points out that at zero income the consumer will spend zero dollars on zero of all commodities. So all Engel curves pass through the origin (i.e. through the point where the axes of the graph intersect). He further points out that if two lines which share at least one point (in this case the origin) are parallel lines, then they share all their points, they are in fact the same line. So the upshot of Gorman's mathematical proof is that you can only construct what he calls a community indifference map and we are calling an aggregate indifference map if and only if, all consumers are identical.

And recall that the demand curve is constructed from the indifference map at fixed income and fixed price. So what Gorman is saying is that it is only possible for the Law of Demand to apply to aggregate demand curves if, and only if, all the individual demand curves are identical. As Steve Keen says quite often: "you couldn't make it up!" Just to drive the point home let's say it another way the Law of Demand does not hold for the real world if you have more than one consumer.

Something less obvious from the abstract is that the Engel curves have to be a straight line. The implications of this is that the share of the consumers income spent on commodities remains the same no matter what their income - i.e. that all commodities must be homothetic. This means that a if person earning £10k pounds spends £1k, then a person earning £10 million pounds would spend £1 million, and a person earning £10 billion pounds would spend £1 billion pounds. There is no such commodity in existence. The only condition in which this is true is if there is only one commodity and all consumers spend 100% of their income on it.

But economists have accepted these conditions as valid and proceed to use "aggregate" demand curves. Gorman himself concluded "The necessary and sufficient condition quoted above is intuitively reasonable". (quoted in Debunking Economics p.56) And it seems that those who bothered to read Gorman agree with him that it was "intuitively reasonable" to treat the economy as having a single consumer and a single commodity. And indeed today mainstream economists agree at some point in their careers to pretend that there is only one consumer, and that there is only one product in the economy.

You'd have to be a moron wouldn't you? You start to see why Steve Keen is sardonic, and why economists have screwed things up so badly.

But to be fair quite a bit of the remainder of the chapter deals with how textbooks hide this remarkable proof that the Law of Demand is simply false, and how economists gradually have had the wool pulled over their eyes as they go along.

With an education in science we're presented with simplistic models at first. Then at each stage we go back and examine the weaknesses in those models, and either introduce more sophisticated models or completely new models. From age 13 to age 21 I followed the progress of the history of chemistry from the 19th century up to the present. It seems that in economics one takes all the assumptions economists make as read, and at each stage one incorporates simplifying assumptions as one goes. As I progressed in chemistry I gained an increasing sophisticated knowledge of the subject so that at the end I was able to synthesise complex molecules and understand the process from first principles; and I was able to take an unidentified white powder and determine it's chemical structure. The economist however moves gradually away from the real world and becomes an expert on the model. And almost exactly five years ago we saw the biggest economic crisis in modern times hit virtually every country in the world all at once, and none of the mainstream saw it coming. Indeed they claim no one could have. No one, that is, who was using their economic ideas and models. Other economists did. Quite a few non-economists also saw trouble brewing. The fault lies in the models!

Since Gorman himself failed to grasp the import of his own discovery, and since few economists were numerate enough to understand Gorman's paper the result made little impact. It was rediscovered independently however in the 1970's by three researchers and the conditions of Engel curves being straight and parallel are known as the Sonneschein-Mantel-Debreu (SMD) conditions. However even these economists failed to grasp the implications for the Law of Demand, and since their writing and their mathematics was even more abstruse than Gorman's it seems as though very few economists have even heard of the SMD conditions.

The key papers are:
  • Debreu, G. (1974) 'Excess demand functions,' Journal of Mathematical Economics. 1(1): 15-21. doi:10.1016/0304-4068(74)90032-9.
  • Mantel, R. (1974). "On the characterization of aggregate excess demand". Journal of Economic Theory 7 (3): 348–353. doi:10.1016/0022-0531(74)90100-8
  • Sonnenschein, Hugo. (1972) 'Market Excess Demand Functions.' Econometrica 40 (3): 549-563. JSTOR.

A nice result that falls out of their work is the statement that an aggregate demand curve can be any shape that can be described by a polynomial - any curvy line with one y value for every x value. For any given price there is not one level of demand, but arbitrarily many.

SK argues that this result completely invalidates Neo-classical economics with it's assumption of equilibrium (we'll get this to) because it requires a single intersection of supply curve with demand curve, and this can only happen when we assume there is a single consumer and a single product.  The assumption of the standardised individual making rational choices is just wrong, but when we attempt to aggregate the behaviour of such theoretical individuals the model goes awry.


Just this result would seem to be a death blow to Neo-classical economics. The theory simply doesn't produce realistic or sensible results, largely because the accumulation of the simplifying (often over-simplifying) assumptions it makes result in unrealistic distortions. But Neo-classical economists have pushed on. S. Abu Turab Rizvi notes:
As the results in SMD theory became well known, for example through Wayne Shafer and Hugo Sonnenschein’s survey (1982), economists began to question the centrality of general equilibrium theory and put forward alternatives to it. Thus in the ten years following the Shafer-Sonnenschein survey, we find a number of new directions in economic theory. It was around this time that rational-choice game theory methods came to be adopted throughout the profession, and they represented a thoroughgoing change in the mode of economic theory. (p.230)

Rizvi. S. Abu Turab . (2006) 'The Sonnenschein-Mantel-Debreu Results after Thirty Years,' History of Political Economy 38 (annual suppl.). doi 10.1215/00182702-2005-024 [pdf]
Now this is interesting because the introduction of game theory, particularly the theories developed by mathematician John Nash feature in Adam Curtis's 2007 documentary The Trap which I discussed in an earlier post. While John Nash is now recovered, at the time he was developing these theories he suffered from paranoid schizophrenia, and it's arguable that the theories reflect this. Indeed Nash in an interview with Curtis admits that the individuals he modelled were not at all like real people. They're like the ideal rational Victorian gentlemen envisaged by the Utilitarians, but utterly selfish and, well, paranoid. These ideas expressed in economic terms began to influence politicians like Margaret Thatcher and Ronald Reagan. A prominent proponent of game theory called Alain Enthoven, who envisaged the "body count" as a way to measure the efficiency of the Vietnam War, was called into the UK in 1984 to restructure the NHS.

I think this illustrates the danger we face. Economic theory is divorced to a large extent from inputs from the real world. The model is all. It takes real world data and interprets it according to this distorted view, and then creates policy by which we order the world. In doing so it appears to strive towards transforming the world to become more like the model, not the other way around.

Another result of the SMD conditions has been the development of Behavioural Economics, but I have not yet looked into this.

There's a lot more material towards the end of the chapter, that I haven't covered here. It's worth reading through but I think most of it is of less general interest - I'm trying to get my head around the basics. Next we'll move on to looking at the other half of the 'iconic supply and demand model' - and since the first section is headed "Why there is no supply curve" I think we can expect a polemical treat.

19 Aug 2012

The Follies of Forecasting

A broad based recovery started in end–2009, but faces significant headwinds during 2011, which can be mitigated by monetary policy remaining supportive. The planned fiscal consolidation is needed to ensure that the fiscal position will be sustainable over time. Nonetheless, it adds to the headwinds from weak real income growth and a fading rebound in global trade. Monetary policy should hence remain expansionary, even if headline inflation is significantly above target, to support the recovery. OECD Report Mar 2011.

The Organisation of Economic Co-operation and Development according to their website the mission of the OECD is "to promote policies that will improve the economic and social well-being of people around the world." No doubt they are sincere in this. But look at what they were saying about the UK in 2011:
  • broad based recovery
  • "headwinds" can be mitigated by monetary policy
  • fiscal consolidation (i.e. cuts in public spending) needed to ensure sustainability

The recovery turned out to be a mirage. Far from being "broad based" the emergence from technical recession was tentative and weak, and now we are back in technical recession with shrinking GDP and declining production. This week we learned that employers have been putting off redundancies so unemployment is likely to rise sharply within a year.

The "headwinds" can not, apparently, be mitigated by monetary policy (low inflation rates & quantitative easing). The base interest rate has been 0.5% for two years now and the best we can say is that it's helping to prevent runaway inflation, but it has not lead to more investment in the real economy. Instead actual lending interest rates remain high due to the high risk, and the amount of lending has stagnated.

If anything fiscal consolidation has stymied demand and growth and is extending the recession.

Here is the graph accompanying the statement, covering the period 2000-2011 (GDP is indexed to 2007)

This is the graph of key indicators that accompanies the statement. It show GDP on a downward trend after a bounce which is not in fact a broad based recovery at all. It shows that the UK's GDP has consistently been at the bottom of the OEDC range. It shows that unemployment is high and possible trending down - though as I say we heard this week that employees have been delaying redundancies, so the downward trend is not going to continue. The graph shows that inflation is very volatile, but with an upward trend and with the base rate at 0.5% there is little the Bank of England can do to help, especially as their QE is a source of inflation. The present downward trend is unlikely to be sustained.

The OECD's most recent forecast is May 2012
The global economic slowdown and uncertainties in the euro area outlook, alongside fiscal retrenchment and private deleveraging, are generating headwinds to growth. Growth will remain weak in the first half of 2012, but should gain momentum thereafter, with private consumption supported by higher real incomes, as inflation slows, and exports and business investment revive with stronger external demand. Unemployment will continue to rise over the projection period, due to job cuts in public administration and weak output growth.

Budget deficit reduction remains on target, fostering fiscal policy credibility and leaving room to let the automatic stabilisers work. Structural reforms to promote fiscal sustainability, strengthen the financial sector and improve educational outcomes should help the necessary rebalancing of the economy from debt-financed private consumption and public spending to exports and investment. OECD.

Note that at least the OECD include private sector deleveraging as a cause of slow grow.  Nothing to be done about it though apparently.

My Non-professional Forecast

GDP shrank in H1 2012, and looks likely to shrink again in 2012, probably by about the same amount to give us -2% for the year. It might actually pick up but over the next 10 year at least nett growth will be zero. Both construction and exports are slowing and there is continuing lack of investment funding. Our markets are suffering the same problems that we are! Private sector deleveraging has only just begun, and won't make much difference for some years to come. Business insolvencies are beginning to rise again as the recession drags on and begins to make inroads into marginally profitable businesses - compare my comments on Travelodge.

So where is the growth going to come from? Burnley Savings & Loans? Answer: it isn't going to come

Unemployment is not rising as predicted, as employers unexpectedly hold back on redundancies, but it will rise sharply when employers finally realise that the recession is going to go on. At some point people will realise that the DWP are shuffling people between categories so many of the people who ought to be counted as unemployed are in government "work schemes" and the like - not sure why they hide this New Deal style policy as creating government funded jobs worked so well for the USA in the Great Depression.

Budget deficit reduction is actually far below the Osborne plan and looks more like the Darling plan (according to my MP). Budget deficit reduction received a blow as the trade deficit ballooned in H1. Also as revenues fell more borrowing was required to sustain even the reduced level of spending - this pattern carries with it a danger of becoming a vicious circle especially as the government seems to be deaf to any suggestion that they're going too fast.

Finally the government will fail to implement any major structural reforms in the finance sector. Their in-house review will grab headlines but not make the kind of changes that would protect us from parasitic financial practices. There will be some public displays of contrition from bankers, and perhaps a few high profile resignations (with full bonuses), and mean it will be business as usual. At best the government will implement the Vicker's Report ring-fencing which will protect savings (but not pension funds) and allow casino banking to carry on unhindered so that it can cause yet another debt bubble and collapse in the near future.

The Euro-zone can't hold, and Greece, Italy, Spain and probably Ireland will need to leave it. They're mad if they don't as it's destroying their economies. Even if Germany offers to take on their debts, they need to have a weaker currency to begin to rebalance their economies. Germany and France will take other countries with them, but with more stringent rules on budgets which Germany will eventually control (not that they were fiscally responsible according to the Maastrich Treaty).

OK. Let's come back to this early next year and compare my predictions to the OECDs.

18 Aug 2012

Travelodge Goes to Creditors

A couple of days ago I mentioned that Travelodge seemed to typify the problems with the UK economy. I also mentioned that Travelodge was a profitable company which saw a 16% increase in profit last year.

Travelodge was bought out in a highly leveraged deal in 2006. Dubai International Capital (aptly acronymed DIC). Though DIC borrowed the money, Travelodge got saddled with the debt - if anyone can explain that to me I'd be happy to hear from you. DIC borrowed £478 million. The result is that Travelodge pays £100 million per year in interest payments.

Now we find that Travelodge has been handed over to it's creditors: Goldman Sachs and two hedge Funds. Once again we find that banks have loaned a stupid amount of money and have wrecked a perfectly good company in the process.

The creditors are writing off 40% (£235 million) of the debt. This is an important fact. As Steve Keen has said, we just have to decide how not to pay back these debts. This is what needs to happen much more broadly - debt write off, the modern debt jubilee.

17 Aug 2012

Past, Present and Future of GDP Growth in the UK.

This post was inspired by one by Mark Thomas: Does This Ease Your Worries?: US GDP from 1870-2008 where he shows that USA is getting back on trend for GDP growth. In the UK things look very different and so no, it doesn't ease my worries.

The Guardian conveniently provide a spread sheet of all the GDP figures from 1955--Q2 2012. Below is a plain graph of quarterly GDP figures with an exponential trend line courtesy of Excel.

What the graph shows however is that the trend overall is exponential growth - a shallow exponential curve, but with an R2 value of 0.9917 the fit of the line is very good. There were ups and downs but basically we got back to trend until the global economic crisis. If we graph from 1955-1997 an exponential line is still the best fit, though the R2 value is less at 0.9873.

Thatcher (1979-1990) inherited a recession and a period of below trend growth from Callaghan (1976-79) though the problem probably dates from earlier - witness the hiccough in 1973 that was followed by several years of stagnation. When Thatcher handed on to Major (1990-1997) things were picking up, but recession and below trend growth followed. And as Blair took over in 1997 growth had  returned to trend and growth was about 1% per quarter. It had been a turbulent few years since the early seventies and the collapse of the Gold Standard, the end of the Bretton Woods agreement, and the UK's Competition & Credit Control Act. Now things seemed to be looking up.

After 1997 growth in GDP began to accelerate, rising above trend at an increasing rate. However growth in this period is more accurately described as linear (R2 = 0.9974) rather than exponential (R2 = 0.9965). Clearly we got a long way ahead of the trend of the previous 43 years, further ahead than any previous period. This was Gordon Brown's economic miracle.

In fact the period of above trend growth (1997-2008) is the debt bubble caused by New Labour's deregulation of the finance industry. It caused a sustained period of GDP growth which Gordon Brown called "the end of boom and bust". It was part of a global phenomenon. In the USA they called it "the Great Moderation".

However in 2008 it all came tumbling down.

With GDP still shrinking we are unlikely to ever get back to the pre-crash trend. Having risen about 6% or £25 billion above the trend by 2008, today, four years later we are about 12% or £47 billion below trend (and remembering that these are quarterly figures). In pre-1997 terms we've lost 35 quarters or nearly 9 years of growth and counting.

I actually lean to the left in politics and I think the present Chancellor is a moron. His legacy will be the extension of the worst recession in modern times as the graph from the NYT shows. The UK has been mismanaged. The USA is about to head back down unfortunately and German is likely to be devastated by the breakup of the Euro if they don't act soon. That said our part in the global financial crisis was facilitated by the New Labour government with Gordon Brown as chancellor. He didn't end boom and bust, he increased it by an order of magnitude!

There are a couple of key differences between the USA and UK trends. In the UK we had no great perturbation of GDP in the Great Depression. For the UK the post-World War One recession was much worse. And whereas we see in the graph above the USA returning to growth, albeit possibly weakening, in the UK we started up and faltered. We're now so far off trend that we probably will never get back.

When economists say that this recession is different they do mean that it is both qualitatively and quantitatively different. What is happening now is unique in the post-War period and we're unlikely ever to make up those nine years. In previous recessions the economy has always bounced back and got back on track. Not this time.

Below is Japan's GDP Curve (from http://professorpinch.wordpress.com/).

This is going to be the shape our the UK's GDP curve now. Basically an extended period of stagnation at best. All those predictions of a return to growth? Just forget it. The game has changed. And the difference is levels of private debt.The USA and Germany are further ahead because they have half the level of private debt that the UK has.

In political terms I don't see anyone really getting to grips with this, so we'll just have to ride it out. A lots decade looks optimistic given our political leadership at present.

That Lack of Growth in the UK is Starting to Tell.

The UK economy is trending more like Spain and Italy than like the USA or Germany. But on the face of it we are in a much better position that Spain or Italy. By the measures that feature in most public discourse: Employment, Public Debt, etc we should be much stronger than Spain. 

Obviously the austerity needlessly imposed on the UK by an ideologically driven and economically illiterate government have not helped. But actually we were doing badly before the current crop of idiots.

China's Housing Bubble fit to burst

Writing in Prospect Magazine (8.8.2012) Mark Kitto gives a vivid description of life in modern China. It seems the Chinese have caught afluenza. The name of the game for many is making money. Sixty years of communism and thirty of the one child policy have resulted in disconnected individualists who understand their worth in monetary terms and show it through conspicuous consumption.

Having bought all the symbols of status and success, what to do with the excess?  One has to be careful because as you get old you have to pay your own medical bills in China - so a safe investment with a reasonable return would be ideal. However Kitto tells us "The stock markets are rigged, the banks operate in a way that is non-commercial, and the yuan is still strictly non-convertible." While the very rich are able to squirrel their money offshore the remainder really only have one option: property. As in the UK house prices have become highly inflated, and new buyers cannot afford to get onto the ladder. Indeed Kitto remarks that "If you own a property you are more than likely to own at least three."
"The result is the biggest property bubble in history, which when it pops will sound like a thousand firework accidents."
Meanwhile on the Wall Street Journal's Market Watch website Andy Xie says "China’s land market will experience a dramatic adjustment ahead. In most cities, land prices may fall by 80%." He also notes that the one child policy will begin to have dramatic negative effects on the demand for property as population begins to fall. This is similar to the problem we have in the west with the decline of the Baby Boomer generation (See Role of Demographics).

Kitto fears what will happen when the bubbles bursts because so much of people's savings for old age is tied up in property. A large number of people stand to lose everything. And there is no social welfare and one child per family means. The new middle class are very vulnerable. Kitto envisages large social unrest.

16 Aug 2012

Labour Market Statistics (Again)

In her recent reiteration of surprise at employment figures the BBC's  Stephanie Flanders expressed the general confusion on the small downward movement in unemployment reported in the ONS August Labour Market Stats
"The unemployment rate was 8.0 per cent of the economically active population, down 0.2 on the quarter. There were 2.56 million unemployed people, down 46,000 on the quarter." (ONS)
According to convention economic theory when GDP is shrinking employment should also shrink. Why is it not? Flanders proposes several possible reasons without much conviction that they explain the situation.

  • GDP estimates might be wrong
  • Rise in part-time work
  • Rise in self-employment
  • Pay not keeping pace with inflation (i.e. lower real wages)
  • Retention of staff
  • Olympics
"Finally we're left with the explanation favoured by Britain's finest economic detectives at the moment (not to mention senior policy makers): it's a mixture of all of these possible factors, plus, maybe "something else"."
Some members of the public, commenting on this story provide further insights:
"We're replacing full-time jobs with 2 or 3 part-time jobs or zero-hour contracts."

"The answer is simple. Having worked in the welfare to work sector as a manager for many years I eventually walked out in disgust at the manipulation of the unemployment figures by pushing the unemployed through training courses, work experience programs and by backdating and projecting the period of training. The real unemployment figures are much higher than stated, it's all smoke and mirrors."

"They move you from one set of statistics to another: I was on JSA, got moved to an outside Agency (responsible for me for the next two years) and was persuaded to become self employed. Instead of income support I now get tax credits."
My own doubts go the margin of error in these figures which are obtained by sampling and statistical manipulation. Such figures should always be stated with a margin of error, but they never are, not even by the ONS. I have written to ask about the margin of error on these figures in particular and will publish the result. All of these government statistics are estimates with built in error from sampling and statistical method, the magnitude of which we don't know. The statistics have an historical accuracy that is not stated. They're quoted to one decimal place but we have no idea if this reflects the precision or is simply rounded up or down. Most of these estimates are subsequently revised over the longer term. The message is that we can't really treat these figures as absolute in the way that commentators do.More caution is required.

I don't go in for conspiracy theories, but it does seem credible that Job Centre staff under considerable pressure from Whitehall are scrambling to find creative ways to meet their targets. This is what bureaucrats do when faced with impossible demands. Remember when hospitals cancelled all operations and made patients reschedule to achieve their waiting list targets? (Not every one remembers that the man who came up with waiting list targets, Alain Enthoven, is also credited with the 'body count' as an efficiency measure for the Vietnam war).

Many employers do see staff merely as a cost on the bottom line; a cost to be minimised. They look for ways around labour protection laws, ways not to pay overtime, sick and annual leave, etc. The zero hour contract is how employers get around laws intended to prevent the casualization of the workforce.

What's also interesting is that the fall is not even. Unemployment in the North is rising, not falling. This lends credence to the Olympics as a significant factor mainly being felt in London. It will be interesting to see what happens to the figures after Christmas. In the mean time business will be hiring in preparation for the Christmas rush (let's not forget that wholesalers and suppliers have to crank up their operations a few months ahead of the retail Christmas).

UPDATE: Just seen another view from the Prime think tank: UK economy: there is no puzzle – just more work on lower pay.


15 Aug 2012

Debunking Economics III: Assumptions

I wanted to present as a list all of the assumptions which I have noted in economics. I'll update as I go.
  • a rational individual maximises their pleasure to achieve happiness
  • maximisation of pleasure is assumed to be achieved through consumption of goods. 
  •  a util is assumed to be in a constant ratio to units of consumption. 
  •  the util ratio is assumed to apply to all goods. 
  • It is assumed that we would always want more of a good, but that the amount satisfaction we get from each new unit of consumption produces less utility.
  • all consumers spend all their income.
  • price changes do not affect income. 

14 Aug 2012

Is Travelodge Typical?

The FT* today ran a profile of Travelodge. They're quite a big outfit with 500 hotels in the UK, Ireland and Spain ad they employ about 6000 people. Revenue in the last year was up 16% to £370 million, and profit was up 20% to £55 million. That's a margin of 14% which is pretty damn good.

But Travelodge is struggling to pay the rent. This is because they have £500 million in debt. This is 10x their profit levels! Interest payments are £100 million which is 27% of revenue. Why does Travelodge have so much debt? It is because the business was bought on tick by DIC. In 2006 they paid £675 million, of which 478 million pounds was borrowed. This is precise the problem of cheap credit available to speculators. As a result of high interest payments they have delayed refurbishments - which is serious for a hotel. In fact late last year Travelodge breached the conditions of those loans. (Reuters)

They also committed to paying high rents during the boom. And of course high rents was one of the man outcomes of the debt fuelled boom in property prices.

As such Travelodge are looking to renegotiate rents as part of a broad restructuring program. But they're also looking to renegotiate their debts via a company voluntary arrangement, which is a formal way of letting creditors know that a business needs help or it will go bust.

To me Travelodge seems to embody the problems faced by the private sector. They are over-burdened with debt taken on during the boom they believed would never end, because economists created this fantasy that ignored the build up of private sector debt.

It will be interesting to see how long it takes for Travelodge to turn around, or indeed if they manage to.

Update 18 Aug 2012: Travelodge Goes to Creditors

* I read the FT at my local public library. As I don't have a subscription I can't link to them online because of their paywall. 

Lord Lawson calls Nonsense - Is he Right?

Worse than the 1930s? Nonsense

From Lord Lawson
     Sir, It is being said in some quarters that the present UK recession is even worse than the slump of the 1930s.
     That is nonsense. It is certainly the worst since then, but it does not compare with the 1930s. In 1932 (the year of my birth, as it happens) UK unemployment was in excess of 22 per cent, and gross domestic product was was 25% down on 1930.
     Enough said.

-- Letters, Financial Times. 13 Aug 2012.

Dear Lord Lawson (Baron of Blaby),

The comparison of the Great Depression and the Great Recession is instructive. The underlying conditions of the current recession are indeed much worse than they were in the 1930s. Private debt levels, the primary driver of the asset bubble and subsequent collapse that caused the recession, are very much higher than in the 1930s. Professor Steve Keen has calculated that in the USA private debt levels peaked at 176% higher than the highest level in the lead up to the crash of 1929.

However the response to the crisis has been very different. The biggest single difference is that in the 1930s banks went to the wall. In the 2000's we spent a great deal of tax payers money to prop up the banks: in July 2011 the Audit Office estimated the amount peaked at over £1 trillion pounds, though in Mar 2011 we're owed about £450 billion (about 30% of GDP). In Oct 2008 the USA government gave $700 billion to bailout the banks. And so on. Does anyone really know the total cost around the globe of rescuing the firms that causes the crisis?

With the bursting of the bubble in the 1930s the government stepped aside and let the private sector take the brunt - leading to the levels of unemployment you refer to. However it meant that those who were going to bankrupt did so quite quickly and then the economy started to recover. In the UK the Labour government slashed spending and raised taxes causing deflation. However unemployment was very much lower in London and the Southeast - comparable to your time as Chancellor in fact. The UK recovered slowly and was helped by withdrawal from the gold standard, a devaluation, and the lowering of interest rates to 1%. While the USA with it's New Deal policies recovered more quickly and more strongly once the initial agony was over. Interestingly the USA is also recovering more quickly from this crisis.

In the 2000s insolvent banks have been propped up by the government - many people have pointed out that is is ideologically communist (or even national socialist) rather than capitalist but that's an aside. Although lending to the real economy has dropped to very low levels (contributing to the extended recession) there have been no runs on banks. People did lose their pension funds, but on the whole not their ordinary savings. As in the 1930s government policy has harmed rather than helped the recovery, producing a slow down that is already longer that the 1930s and shows no signs of recovery.  At present government revenue is falling so that they have to borrow more despite cutting spending by billions of pounds.

In the 1930s rearmament and WWII intervened. And after the war huge injections of capital from the US left the UK more or less on it's feet but with debts of more than 250% of GDP. But this was followed by a period of economic stability due to Keysian style economic policies and the Bretton Woods Agreement. This period of stability lasted into the 1970s. Our circumstances today are very different. The whole world, and most importantly our trading partners, are all experiencing the effects of this recession. The example of Japan suggests that 15 years of recession might by realistic. However Japan never faced the self-destruction of their major trading partner, as we watch Europe teeter on the brink of collapse. Greece must cash out, probably Italy as well, and most like Spain and Ireland. The cost to the UK and Europe is at present incalculable.

According to the present government's 2011 Budget Report tell us that private sector debt was 450% then. A McKinsey Report from Jan 2012 says "deleveraging has just begun", and indeed from their graph it seems UK total debt might be on the increase. And looking at this graph remember that in 2011 private debt was 450% of GDP - i.e. it accounted for at least 5/6ths of the total debt in the UK.

Note that our debt levels are considerably higher than Japan's in 1990. Indeed the UK is the most indebted country in the industrialised world.

Another major difference is that the world pulled together in the post-war years and implemented measures to protect the world's economies from rapacious bankers. Since the 1970's successive chancellor's but particular you and Gordon Brown, Lord Lawson, have dismantled those protections and left us vulnerable to the same kind of problems. Only this time the Neo-Liberals are so much more in control, so much more integrated into the system, into economic education and into government itself, that we are unlikely to walk away with the protections that Bretton Woods gave us for a time. What is far more likely is that the finance sector will be free to carry on and create yet another crisis before too long. We'll see token measures with lots of media coverage and claims from the incumbent in No.11 that everything will be different, but it won't be. Before long debt will fuel another speculative bubble and that too will collapse with disastrous consequences.

So is the current recession worse than the 1930s? Well, it's not over yet. I think we will have to wait until after the present recession is finished before passing judgement. It's clear that the present Great Recession is shallower than the Great Depression of the 1930s, but it may well last very much longer and do more cumulative damage to the UK economy over the long run.

It's simply too soon to say "Enough said."

Yours sincerely

13 Aug 2012


Reading something today it struck me that we talk about "goods and services". "Goods" would seem to be a utilitarian concept - material commodities are what we accumulate in order to experience happiness (in this theory) and so a commodity is "good".

However the usage dates back to the 13th century, and the word has the same sense in Old English where it means the same. The singular adjectival form good in Old English meant: 'virtuous; desirable; valid; considerable'.  The Proto-Indo-European (PIE) root is ghedh 'to unite, join, fit'. So good is cognate with gather and  together. In Old English we also find gæd 'fellowship' and other words relating to togetherness with people. Similar sounding words with the same range of meaning occur throughout the Germanic languages, including the Scandinavian branch; and cognate words are found in Slavic and Indic with slight different emphasis in meaning. (Indo European Lexicon).

I presume that the application to commodities derives from agriculture - one's wealth was gathered in autumn with the harvest. Though perhaps it refers to all one's possessions gathered together in a homestead. In any case the application to commodities predates Utilitarianism by a millennia or more.

Unemployment & the Recession

Today we get a better explanation of why, in the face of falling production & shrinking GDP, that unemployment has been going down. Employers, like the government, have been unable to believe that the recession will continue for much longer. They are holding onto staff. As the BBC reports it today:
"Chartered Institute of Personnel and Development (CIPD) showed that a third of private sector employers had kept on more staff than they needed to avoid losing skills."

Business don't see the causes of the recession--mainly private sector debt--so they don't understand the dynamics of the situation. The whole of the mainstream of the economics profession is treating this like a blip rather than a major economic crisis. After five years of forecasting a return to business as usual, the Bank of England is just now seeing that something is terribly wrong. What's wrong is that the mega-debt built up by a frenzy of reckless lending and financial speculation is going to take time to dissipate. More especially so since no one is attending to it. Debt to the tune of 450% of GDP does not get paid off in a year or two in a time of shrinking incomes.

In Neo-classical Economics Land recessions simply don't last 5 years. Unless of course we look at the Japanese recession 1990-2005. But contrary to everything they tell us, this recession is not over by a long shot. As James Mackintosh said in the FT over the weekend: "The world is halfway through a lost decade".

However at the time that Japan was turning things around it did not have it's major trading partners going through exactly the same process, and making all the same mistakes. And Europe was not about to implode with many of the member states insolvent. So it seems that a lost decade could well be an optimistic view.

Meanwhile the private sector is busy trying to pay down debt. Banks are lending at very high rates of interest, while they themselves borrow at almost no interest, and pay less than inflation on savings. Without the ability to invest on a large scale the economy is stalling. Demand will remain low while private debt remains high. There is an employment bubble that will burst soon, and bankruptcies are creeping up. Meanwhile government policy remains focussed on austerity spending cuts which exacerbate everything.

We run the risk of being caught in a vicious cycle. So far no one in government (or in opposition I might add) shows any signs at all of understanding this or moving to address it.

Note 14 Aug: The latest stats from ONS show that real wages fell by 1.7% over last year, while jobs increased 0.8% - so slightly more jobs for slightly less money. Meanwhile RPI is +3.2% so less money going less far. GDP shrinkage is only part of the story.

12 Aug 2012

Debunking Economics II: The Law of Demand.

Key Terms

diminishing marginal utility
indifference curves
budget line
demand curve
income effect
substitution effect
Law of Demand
Hicksian Compensated Demand Curve
Engel curves
homothetic goods 
I studied chemistry at university. I loved the way that things tallied up and the way the implied order in the universe. When you learn chemistry as a subject you typically get the theory first, and then do an experiment in which the observations confirm the theory. I think this confuses a lot of people about the progress of scientific knowledge. At the cutting edge the theory makes predictions and one doesn't know whether they will be right or not. Experiments are designed to allow observations which are then compared to the prediction. These results add to a body of observations against which theory is checked. Theories are models of reality. Their usefulness is in their predictions of reality. If these predictions are inaccurate the theory is not useful.

Economics has never worked this way. At the beginning of economics was a worldview in which the individual was something like the ideal Victorian English Gentleman: rational and alone against the world. This idealisation was combined with assumptions about how the world functions into a model of consumer behaviour that has never really been updated. Steve Keen's explanation of the demand curve shows how this works.

In my first instalment of Debunking Economics notes, I wrote about the Utilitarian view of the individual and the pursuit of happiness through maximising pleasure. In economic Utilitarianism the maximisation of pleasure is assumed to be achieved through consumption of goods. This assumption helped to link happiness to a measurable quantity since consumption is easy to measure. The unit of Happiness or satisfaction is a util, which is assumed to be in a constant ratio to units of consumption. This is assumed to apply to all goods. 

Now we can graph the amount of satisfaction (i.e. the number of utils) received from consuming x amount of good A. Economic theory assumes here that we would always want more of a good, but that the amount satisfaction we get from each new unit of consumption produces less utility. This is knows as diminishing marginal utility. If we imagine a system of two commodities then our maximum satisfaction will be having infinite amounts of both. However there are constraints on how much we can consume, chief of these being our income. At a given level of income, then, various combinations of quantities of each are able to maximise our satisfaction.

2D Indifference Curves
If we lay out the quantities of the goods on the x & y axes of a Cartesian graph with utils on the 3rd z axis then we will see points at which satisfaction are equal. We can join these points into a curve. Since each point on the line presents an equal of utils the individual is indifferent to the different combinations: hence it is called an indifference curve. For any combination of commodities the consumer has a range of indifference curves.
But it's more convenient to use two dimensions and what economists use is a series of indifference curves stacked up as per the image right. A term I picked up from another book is to refer to this diagram as an indifference map.

In 1948 Paul Samuelson worked out what properties indifference curves would have if consumers were like the idealised Victorian Gentlemen - i.e. if they really were rational. There are four of these:
  • Completeness: choice between any combination of commodities is possible
  • Transitivity: so if a combination of products A is preferable to B i.e. A > B & B > C then A > C
  • Non-satiation: more always preferred to less
  • Convexity: marginal utility is always positive and diminishing but never zero.

Now in this narrative the "rational" consumer tries to maximise their utility by consuming the combination of commodities which provide the highest satisfaction, and this point is where a budget line just touches a single indifference curve. The budget line is a line drawn between two points, one on each axis representing spending all income on one product.

Yet another assumption the theory makes is that all consumers spend all their income. Even savings are just delayed consumption. So for a consumer at fixed income and fixed prices the indifference curves allow us to construct a demand curve. A demand curve is a series of points where the budget line (representing income) intersects the series of indifference curves at constant income and changing prices. It normally slopes down (if the price goes up the demand goes down), and it works OK for one consumer and one commodity. The demand curve shows us how many units of commodity will be consumed at a given price.

A further assumption, and one that simply doesn't hold and must be adjusted for is that price changes do not affect income. But in fact if a commodity that we buy becomes cheaper, then we effectively do have more income. And this is an issue when we consider more than one commodity, because a change in the price of one commodity might change how many we buy of both commodities.

But the demand curve can slop upwards under some circumstances. Imagine we usually buy one jar of instant coffee per week. Then due to a large drop in price of another product we decide we can afford to buy real coffee even though it's more expensive - we therefore spend more on coffee.

Another situation in which demand and price might not be connected in the standard way is if we buy a staple food. Keen uses the example of potatoes in Ireland during the potato famine. We might also use the more recent example of the cost of rice in Asia. In a place like India, for example, consumers might not buy less rice because of the price rise, and may be less of other products instead.

Classic Simple Demand Curve
We now have the classic economic demand curve which is a plain straight line (as unlikely as that seems). This shows that as prices go up that demand goes down. This is called the Law of Demand. This seems reasonable at first glance, but there is one more trick that we need to perform to deal with this problem where it can have a positive slope. And this is the bit I don't understand so well. So I'll quote Steve:
"This increase in overall well-being due to the price of a commodity falling is known as the 'income effect'... The pure impact of a fall in price for a commodity is known as the 'substitution effect'." (p.48)
Now for this demand curve to be useful there can only be one price at which demand equals supply (the next chapter is on supply curves). But the upwards slope stuffs this up because a bendy demand curve might present two or more places at which a supply curve crosses it. (This bit is important later). So economists muck about with the indifference curves to make sure the line is straight.

If prices fall while income is fixed the consumer still enjoys more satisfaction. In this model they go to a higher indifference curve just as though they did have more income. So they artificially hold the consumer on the same indifference curve and "rotate the budget constraint to reflect the new relative price regime" [I think there's some unclarity here in the book]. Anyway the trick is named after the guy who invented it: Hicksian Compensated Demand Curve.

So we now have created a model, without reference to the real world, in which the Law of Demand holds for a single imaginary rational consumer. This is technically micro-economics, but it forms the basis of Neo-Classical macro so we need to get to grips with it. SK admits this stuff is really boring and urges his readers to drink copious amounts of coffee to stay awake.

We have one more subject to cover in this section which is Engel Curves, and these are important later. Engel curves are constructed by changing the amount on income and tracing the intersections with the lines in the indifference map. These curves can have a variety of shapes and broadly there are four categories:
  • necessities or inferior goods - take up a diminishing share of budget as income rises
  • Giffen goods - consumption declines as income rises
  • luxuries or superior goods - take up an increasing share of budget as income rises
  • neutral or homothetic goods - share of budget remains constant as income rises
And as SK notes there are no real world examples of homothetic goods - there is no commodity that a consumer will spend a constant share of their income on as income rises.

So now we have all the information we need to look at how macro-economists use individual demand curves to construct aggregate or market demand curves. I plan to create a list of all the various assumptions as a separate post.

11 Aug 2012

IMF on UK Debt

There's a very nice little blog on an IMF report from 2011 on the Touchstone website. And it illustrates a good point about where we get our information from and to what extent we can trust the government and the media to keep us well informed.

Back in Oct 2011 the IMF were saying that if growth slows that austerity cuts would need to slow down. The said the same thing in their most recent report: the BBC reported it like this: "The government should slow the pace of budget cuts next year if UK growth does not recover, the International Monetary Fund (IMF) has said." So it seems the IMF is consistently telling the government to on cut public spending if there is sufficient growth. This is the lesson that Japan learned the hard way in the 1990s. The government on the other hand take the IMF report as a confirmation that austerity is the right thing to do.

Back to Oct 2011 there is another story in the IMF report which was not picked up on by the media and flatly contradicted by the government. And it relates to a graph.

All credit to Duncan Weldon for spotting this and telling us what it means. As the title says this graphs shows us what caused public debt increases post 2007 when the credit crunch hit - 5 years ago this week. All the figures are as a percentage of GDP. I won't talk about Italy because Italy is clearly in a class of it's own.

The red block is fiscal stimulus and the graph shows that compared to France and Germany the UK spend less on fiscal stimulus. Note that Germany spent much more on fiscal stimulus and now has a much healthier economy than most of the rest of Europe. These two facts are intimately connected.

The yellow line is amount spent supporting the financial sector, and here again Germany spend a great deal more.

The grey line is basically interest payments which went up either because of more debt or higher interest rates, or both in Italy's case. Clearly this is the primary driver for Italy.

Finally the blue line is revenue loss attributable to the economic downturn - the loss of production. Note that Germany which proportionally spent a great deal more bailing it's economy out, now has a negative contribution from loss of production - i.e. they gained revenue over this period. In France and Germany revenue loss was the major driver of borrowing.

As we know the government's austerity plan is resulting in increased borrowing, and projections are that it will continue to increase. And the IMF are telling us that the main driver of this is revenue loss. As we've heard this week the UK economy is still shrinking: growth was -1% for H1. While the Bank of England are forecasting +1% for H2, we also saw this week that construction is down 6% for the ytd, and "The main driver in this decline was the fall in new public works, which fell by 22% across the three months, reflecting the impact of government spending cuts." BBC. [my italics]

So, as Duncan Weldon points out, the major driver of government borrowing since 2007 has been revenue loss, not profligacy. And the reason the IMF have warned the UK government two years running to beware of cutting while growth is weak would seem to be because without growth the cuts will set up a vicious cycle:

10 Aug 2012

Bernie Sanders: There's a War Going On.

Their greed has no end...

Senator Bernie Sanders, Speech to the US Senate, November 30, 2010. Transcript on the senator's website.

8 Aug 2012

Debunking Economics I - Utilitarianism

My inspiration for starting this blog as hearing Steve Keen on the radio in April 2012. I've just now got around to reading his book Debunking Economics. It's all quite complicated and so in order to help myself understand it, I'm going to try to explain the ideas here in a series of posts.

So let's begin with Bentham. Jeremy Bentham was a philosopher around the turn of the 19th century. He is very influential in economics amongst other fields. Steve Keen (SK henceforth) identifies his ideas about utility as being particularly influential. Bentham characterised human experience in terms of pleasure and pain. This is actually similar in some respects to Buddhism. However unlike the Buddha Bentham characterised happiness as maximum pleasure and minimum pain. Seeking happiness, in this view is synonymous with seeking pleasure. Indeed Bentham the seeking of pleasure and avoidance of pain became the primary motivating factors of all human beings. In this view even altruism is seen as pleasure seeking. Bentham thought that actions which produce happiness had "utility". And utility could be measured.

Collectively the community is simply a collection of individuals - a view echoed by Margaret Thatcher when she said "there is no such thing as society". And that individual is a kind of idealised Victorian gentleman: who always acts rationally to seek their own best interests, usually in a benign sort of way. The best interest of the community is served by the serving the interests of the individual (this is all sounding familiar, right?); and any action which increases the aggregate happiness of the individuals was useful to the community.

Economics is fundamentally a utilitarian discipline, in that it accepts Bentham's axioms about utility. The task that early economists set themselves was to express utility mathematically, and to use this mathematics to demonstrate the Bentham's ideas were a reflection of how societies function. And this project still lurks at the heart of economics.

As a result economists--despite vast leaps of progress since Bentham--still see the individuals as fundamentally self-serving and rational.


Economists recognise three factors of production: labour, capital, and land. Labour earns wages, capital earns profit, and land earns rent. Members of society tend to be split according to whether their main income is from wages, or whether it is from profit and rent. In an economic utilitarian view (presumably) happiness is found in the maximisation of wages, or profit and rent.

However we cannot both maximise profit and wages, since from the firms point of view wages are a cost. So the firm seeks to maximise profit, but it also seeks to minimise wages. And actually in Bentham's view this must be evil since it necessitates a struggle between labour capitalists. Which is presumably what Marx was talking about? As I understand it, one of the ways to prevent this clash was for labour to won the means of production (the factories in Marx's day). This is actually used in practice in a very few firms, such as John Lewis, which give shares in the company to employees so that they share in profits and well as receiving wages. Workers don't exactly own the means of production, but they do have a share in it.

In general what happens is that maximisation of profit takes precedence. Ironically this is especially so under governments more strongly influenced by Utilitarianism, i.e. conservatives, probably because the people in such governments invest capital and own land.

Modern law treats the firm as an individual with the same rights and obligations as a person. But the typical firm does not behave like a person. The typical firm maximises profit without regard to the consequences for the environment or the community. People are naturally gregarious whereas firms are naturally individualistic. People natural cooperate, firms naturally dominate. Indeed if we psycho-analysed many firms it's apparent that their behaviour is consistent various forms of psychopathology that would get a person locked up and treated against their will.

There has been a great deal of study of the dynamics of societies in the intervening years, but very little of this progress in knowledge has made an impact on economics. Fundamentally the 19th century worldview still informs mainstream economics. Neither have advances in mathematics, such as chaos theory, been incorporated into economics. And you have to wonder why economics is such an intellectual cul-de-sac?

Incidentally Bentham is apparently the source of the views of Ayn Rand as well, though she herself  acknowledged no debt to any philosopher except Aristotle. There is really no difference between Rand's Objectivism, and Bentham's Utilitarianism: a society composed of rational individual seeking their own self-interest with no reference to other. The only acceptable limits being that one should not harm others in the process. Rand did take this to an extreme, e.g. describing altruism as slavery to the desires of others, but in essence she is spouting Bentham.

Regarding the decision making process I have written about this on my Buddhist blog in a post called Facts and Feelings. Decisions always involve emotions, since we experience the value of information as an emotional response to it. This is always true even in apparently rational people. Certain types of brain damage impair this ability and render the victim incapable of weighing up options (this is one of the subjects of Antonio Damasio's book Descartes' Error).

They Haven't Got Clue

Watching the press releases from the Bank of England one can't help but wonder why they bother. They really don't understand the situation. On the 2nd of August they announced (as reported by the BBC)
Its rate-setting Monetary Policy Committee (MPC) has voted to maintain rates at the historic low of 0.5%.

It also decided not to increase its programme of quantitative easing (QE), having lifted it by £50bn last month.

Now (8 August) it appears that this action was based on an overly optimistic view of the economy:
The Bank Of England is expected to cut growth forecasts close to zero from the 0.8% predicted in May as the double-dip recession intensifies.

The quarterly inflation report is likely to indicate no growth for 2012 compared with 2% predicted a year ago.

Why do they get things so wrong? Steve Keen has said that their models don't include banks, money or debt, so they can't predict a crisis caused by banks and money and debt. But it also means that they don't understand why the crisis continues, and why, as Richard Koo says the kinds of measures that have worked before are not working now. It's quite sobering to realise that the head of the Bank of England and the Chancellor of the Exchequer, and their staffs and advisers, don't understand the economy.

7 Aug 2012

Silver Lining?

The Financial Times is reporting today that the repayments from mis-sold payment protection insurance (PPI) is acting as a fiscal stimulus by putting money into people's hands. The amounts are considerable with £4.8 billion paid out to May 2012, and £9 billion set aside. Since the money, amounting to about 1% of GDP was likely to be spent it amounts to increase in demand that may have an appreciable effect on GDP. Though I would add a note of caution that the economy is actually still shrinking at present, so the effect is not a magic cure.

As the FT says "The government’s own schemes to stimulate demand, meanwhile, have yet to have any demonstrable effect." The obvious problem with the government's plan is that they are giving money to the banks who have used it to deleverage (improve their debt to asset ratios) rather than investing in the real economy. Banks continue to be skittish about lending money in an environment they polluted to the point of toxicity with easy credit. But more than this as Richard Koo says, everyone is busy minimising debt rather than maximising profit, so demand will be low.

I think this helps to make the case for debt relief, for Steve Keen's modern debt jubilee. We need to stimulate demand by putting money into the pockets of people. But we should not do this randomly (as with the PPI pay outs) and we should avoid punishing the prudent who saved money. By giving money to everyone and requiring them to pay off debts first we'd get a lasting stimulus to demand because not only would people spend the handout, but there would be less debt to service and more disposable income over the longer term. There are 50 million adults in the UK.
£1 per person = £50 million
£10 pp = £500 million
£100 pp = £5000 million or £5 billion
£1,000 pp = £50 billion (the most recent round of QE was £50bn)
£10,000 pp = £500 billion (a bit more than all of QE to date)

The more QE we do the higher the risk of inflation, and with interest rates already at 0.5% there is little more the Bank of England can do to deal with inflation. It also hurts import businesses as the money they use to buy overseas goods is worth a little less. This might not be a bad thing for the economy though since we need to stimulate demand for local goods and services. Though on the down side we buy most of our oil abroad and quite a lot of our food and prices of both are high and rising because of factors beyond our control.

I think on balance I'd opt for giving every adult in the UK £2000 with the proviso that it be used to pay off debts if people have debts. Administering it might be a nightmare, and costly, but I'm sure the civil service can come up with something.

No doubt the Chancellor reads the FT. But he's so ideologically blinkered that he's unlikely to see the value in the PPI payout stimulus, or that his own measures have achieved nothing. But maybe members of the next government will be paying attention?

6 Aug 2012

Analysis of the European Debt Crisis

Some of the Economists I follow on Twitter pointed me towards this article.
Philip R. Lane. 'The European Sovereign Debt Crisis.'
Journal of Economic Perspectives. 26 (3). Summer 2012: 49–68.

Lane analyses the causes of the European sovereign debt crisis. I think he shows that except in the case of Greece, and perhaps Italy, the crisis did not begin in the public sector. As for the UK, the problem began in the private sector. Government borrowing did not start in earnest until the 2007 credit crunch. The exceptions are Italy and Greece which were already approaching debts of +90% of GDP by the end of the 1980s.

Indeed Ireland's and Spain's government debt were the lowest of the countries in the study and trending downwards. As Lane says Ireland  and Spain were not net borrowers from 2003 to 2007. At the same time private credit was rising exponentially partly because when they joined the Euro banks in these countries could suddenly source loans in Euros from outside their national borders.

This is the same pattern as we see across the first world. Private debt sky-rockets up leading to the credit crunch. Lane does not understand how credit grew so fast:
"A complete explanation for the timing of this second, more intense phase
of current account deficits and credit booms is still lacking."

But actually I think we do have an explanation of this. Deregulation of the finance sector allowed banks to create huge amounts of money, and lend far more than would have been wise. At the same time the loose regulatory environment encouraged banks to gamble on derivatives, and to pursue more and more risky, and ultimately illegal, practices in pursuit of higher and higher profits. That Lane doesn't understand this is obvious in later comments such as:
"Rather, households were the primary borrowers in Ireland and corporations in Spain, with the property boom fueling debt accumulation in both countries."
If I understand Steve Keen's arguments about this then the effect was precisely the opposite, i.e. debt fuelled a property boom, not the other way around. Debt did not simply accumulate which makes it sound passive, but the banks were actively creating debt and pursuing customers to become debtors and go deeper into debt. Especially in the USA mortgage brokers were disconnected from the consequences of bad loans - hence the sub-prime mortgage market was centred in the USA. Vast numbers of loans were issued which could not realistically be paid back in a boom, let alone a slump.

During this period rating agencies, paid by financial institutions, were giving junk derivatives AAA gilt ratings so that pension funds could 'invest' in them. Goldman Sachs in particular used the AAA rating to continue selling what they knew to be a junk product as gilt, and to take advantage of low insurance rates to create hedges on loans they knew would default. The effects of this were felt worldwide. Especially when the market collapsed.

Lane points to a failure of fiscal policy in the period 2003-2007. But during this period, which Ben Bernanke dubbed the Great Moderation, economists who were, and remain, blind to the problems of private debt, convinced themselves and western governments that growth would continue for ever. They were saying so right up to the eve of the credit crunch. The failure of governments during this period was not fiscal but regulatory. During this period an increasing number of economists began to warn about the growing private debt, but were ignored by deluded governments.

Lane also sees large current account deficits as contributory to the problem. [I need to work on understanding this a bit more so no comment yet from me]

Ultimate Lane blames the crisis on the design of the Euro beginning in 1999, though I'm not convinced this is the answer because we see the same kind of crisis in the UK, and the USA. I'm more inclined, following Steve Keen and Ann Pettifor, to see private debt as the central problem. Certainly the Euro design has hampered all efforts to deal with the crisis, but then none of these countries has even acknowledge that they have a private debt problem caused by deregulation of finance. And as such the regulatory environment remains unchanged, and banks are still pumping money into casino investments rather than the real economy.

Until banks and other financial institutions are properly regulated and policed there is little hope of recovery, and every danger of it happening all over again. Indeed those foresighted economists who predicted the crisis on the basis of private debt problems have predicted a further major credit crunch in the near future. In the short term some kind of debt relief program--Keen's modern debt jubilee--will help to kick start growth, but ultimately the finance industry must be properly regulated.

Lane concludes on a cautiously pessimistic note:
However, the alternative scenario in which the single European currency implodes is no longer unthinkable, even if it would unleash the “mother of all financial crises”
(Eichengreen 2010).
I think those of us not bound by the formalistic conventions of academic publishing can be far more boldly pessimistic. There is every likelihood of another global credit crunch. The Euro cannot stand as it is because it's foundations are insubstantial, the mechanisms they have to deal with the problem won't work, and they have yet to acknowledge the underlying problems regarding financial institutions and endogenous money creation. One or more countries--certainly Greece, but probably Italy, Ireland and Spain--will be forced out of the Euro. Finland may go as well. What's left of the Eurozone will, like the UK and the USA, remain stagnant for a decade or more, like Japan in the 1990s.


The BBC provided some very good background info-graphics to the Eurozone crisis earlier in the year.

If it's all too miserable then John Finnemore explains it in a humorous way here.