Archive for the ‘Economy’ Category

Standing up for democracy

That we face immense difficulties economically and otherwise is obvious on the day of Osborne’s autumn statement.  But how many noticed that on its eve a heavyweight commentator on Newsnight suggested, albeit somewhat tentatively, that we might have to consider alternatives to democracy to deal with the problems?

The commentator concerned was Gillian Tett of the Financial Times whose writing I generally like so I wonder how much this was just a loose comment made in the heat of the moment and how much she was reflecting a strand of opinion among the Great and the Good.  The relevent bit of the conversation was as follows (starts at 17: 40, lightly edited)

Tett: “The chief economist of the BIS, the central bank of central banks, gave a devastating speech recently where he pointed out that the real problem is that economic cycles tend to happen in multi-decade periods and governments only last for a few years and you have this fundamental clash right now that you need governments to be able to take a 5 – 10 year view and unfortunately they are looking at 1-2 years at the most – and that’s a real problem”.

Paxman: “Well, there’s no way round that  … not if you believe in democracy”.

Tett: “Not unless you start looking at more technocratic solutions like Mario Monti in Italy or something like that….  Maybe the next decade or two is going to be about people questioning this balance of how democracy works and looking at more technocratic solutions because the economic choices confronting the West right now are so painful that the pressure is not going to evaporate quickly”.

There is certainly a long wave component to economic cycles – that is hardly a new thought.  And the mismatch between political horizons and the longer ones supposedly required for effective long-term management of the economy is nothing new either.  They are certainly issues, but they are hardly the “real problem” – even when combined – so the proposed technocratic solution is predicated on a faulty analysis.

The real problem is (to put it at its simplest) that there is too much debt (not just the government debt that the Coalition obsesses about but also private debt) and that inequality is too high (these are, of course, linked).  Debt and inequality combine to work like a sea anchor on the economy, preventing it from making proper headway so the only answer is to write off some of the debt and reduce inequality.  That would indeed be painful to the 1% who own most of the debt.  But how does that compare with having no job, no home, no hope – and hungry children?

Any democracy, however imperfect, is likely to come down on the side of the 99% eventually even if the entire political establishment has lost the plot as completely as ours has.   And strangely enough, policies crafted for the benefit of the 99% are exactly what is required economically as well as for natural justice.

 

 

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Energy market fail – the case for ordoliberalism

For once David Cameron has done the roughly right thing in restricting the energy companies to only four tariffs although I would have liked to see even fewer.

For years the received wisdom has been that competition – not just in energy, but generally – is a Good Thing; any evidence of that a market isn’t working properly is routinely greeted with calls for more competition.  It’s become so ingrained that almost no-one stops to question why it don’t always work as it’s supposed to.

Unfortunately for market fundamentalists, a growing pile of evidence suggests that their economic theory is wrong because it’s simply not an accurate description of how the real world works and ‘free market’ competition isn’t delivering the goods.  How this has been working (or rather, not working) was discussed on last week’s edition of ‘This Week’  with  guest Martin Lewis of Money Saving Expert (starts at 5:15).  His site has done a survey of its 14 million users and found that 80% don’t want the present system so this is political dynamite.

Martin Lewis pointed out that the energy market works as a regressive tax; affluent, middle class internet users pay the least while those in fuel poverty, disproportionately the poorest and oldest pay more, often substantially more.  He said that, whether or not Cameron really meant to say what he said on the subject recently, what he actually said is exactly what the public want, namely regulated prices.  For consumers competition has failed.

Michael Portillo reflected the uncertainty of many politicians.

“I think politicians reaching the point where they are beginning to lose faith in the ability of competition to produce the best deal for consumers but I think that is a big psychological and, kind of, philosophical moment if that’s what you actually conclude because, you know, for the last 20 years it’s been based on the idea that competition was going to give people a deal and in most things in life that’s exactly what happens. If you go to shops, telephones, if you fly on airlines, competition has brought down prices”

Note the positively baroque construction of his opening,“reaching the point where they are beginning to lose faith …“.  You can almost hear the gears shifting.  Whether he realises it or not he is calling the end of the era of neoliberal belief in the infallibility of free markets which Thatcher ushered in with her general election victory of 1979.   The old paradigm still rules by default in the absence of a better replacement but it’s mortally wounded and can’t stagger on much longer.

Portillo still clings to faith that competition reliably delivers in sectors other than energy.   However, here too evidence is piling up that not all is well with the received wisdom although, inevitably, the picture is complicated so no simple statement suffices.  I see at least three main problems (there are others but that would involve a book, not a blog post).

The first is the problem of ‘market failures’ including that markets don’t factor in externalities and that they reflect short-term supply and demand which makes them terrible where the long-term is important like planning for transport infrastructure or energy.  Market fundamentalists typically claim that market failure is rare and exceptional.  Indeed the whole basis of their faith is that ‘free’ markets (i.e. free of any government regulation) deliver optimal outcomes.

In reality, market failure is the norm.  To result in anything like a good outcome that is stable over time requires a long list of tightly specified preconditions which never, or almost never, occur in the real world.  For instance, any business sector with economies of scale (i.e. almost all) will tend towards concentration and oligopoly until the point is reached where competition is no longer effective.  The board game of Monopoly is a familiar example of how an early advantage drives growing concentration of power and inequality until it’s game over.

The second problem is that ‘free’ markets rarely exist – and then only briefly.  It doesn’t take long for oligopolistic businesses to work out how to influence the levers of power.  It helps the influencers that too many politicians are horribly star-struck and easily succumb to the glamour of money.  It can be revolving doors between companies and government, informal understandings with senior regulators and politicians, participation in standards-setting or even writing legislation.  The ways commercial power wins are limited only by human imagination – which is to say almost unlimited.  The result is the emergence of an interconnected elite.

Moreover, power abhors a vacuum so when government is weak the private sector quickly seizes an opportunity to fill the void.  If government decides not to regulate as a matter of either policy or weakness someone else will step in and the ‘law’ becomes whatever the new Mr Big says it is.   The law ran thin on the frontier of 19th century America so the theme of many westerns is the story of a big rancher employing a gang of thugs to enforce his own self-serving version of the law.  Much the same is true of Wall Street today thanks to the gutting of effective regulation as a policy choice.

The third problem is that real full-blooded competition is simply TOO effective for firms to survive it.  They must find ways of reducing the pressure on them.  The easiest way to do this is to merge with or take over rivals until the market is an oligopoly.  Hence the small numbers of serious players (typically 4 – 6) in a whole range of sectors from banking to supermarkets to energy.

It’s not that I’m against competition, far from it, but left to their own devices markets aren’t stable and won’t deliver the public policy goods.  Like advanced fighter planes the trade-off for high performance is that they are unstable.  The solution for planes is fly-by-wire systems that react faster than any human pilot ever could.

The solution for markets is the equivalent.  It’s a constant battle to keep them ‘open’ (subject to challenge) and keep them working for the public good.  This is a very different from what neoliberals advocate.

Equally, because full-blooded competition is ruinous it means that government should arrange things so that it is muted, so that there is a gentle pressure to improve and to innovate but not the imperative to eat the seed-corn to survive until next week.  That in turn means limiting pricing ‘freedom’ (aka anarchy) in sectors like energy.  And that is why I think Cameron, for once, is on the right track except I would like it to be even simpler – allow only one fixed and one variable tariff for each company with premiums and discounts for dual fuel or direct debit etc. expressed as a percentage.

This is ordoliberalsim and is the approach of most German liberals.  It’s worked rather well for them.

Greek forecast fail

Here’s one simple graph that reveals an awful lot about the mess in Greece.  It shows how Greek GDP has changed over the last few years and how well the experts of the European Commission, the European Central Bank and the International Monetary Fund (collectively the ‘Troika’) have forecast it since the start of the crisis.

It’s not too easy to read but the black line is the actual change in Greek GDP (expressed as the percentage change on the previous year) and goes from a little over 3.5% in 2007 to around -7% in 2011.  The dotted red lines are successive annual forecasts from 2008 to 2012  (H/T Zero Hedge/Follow the Money).

Obviously, the Troika is totally and consistently incompetent at forecasting.  To be so reliably bad it must be sticking to a wholly wrong theory of how an economy works.  It’ as bad a series of misses as you would expect if NASA was trying to send a probe to Mars while remaining unshakably convinced of the Ptolemaic theory that the Sun and other planets go round the Earth.

The only other reason I can think of is that these were never intended to be serious forecasts at all; that they were just a way of dressing up a real strategy that dare not speak its name – for instance that it was a way for those calling the shots (i.e. largely France and Germany) to save their banks from bankruptcy by buying time for them to get their money out of Greece and dump the losses onto unsuspecting Eurozone taxpayers.

The two explanations are not mutually exclusive so could both be true.  That would be my bet but either way how much longer can it go on?  The new Chinese leadership is apparently reading de Toqueville on the causes of the French Revolution.  EU leaders should join them.

Retail rip-off – what the milk market should teach us about regulating the marketplace

Dairy farmers are back in the news; the processors who buy their production to sell on to supermarkets and food manufacturers want to push through a substantial price reduction that will see most farmers getting paid well below their cost of production.   Clearly this is not sustainable; if the processors succeed many farmers will be forced out of business, inter alia increasing our trade deficit in dairy products despite our having one of the world’s best climates for it.

To the extent that imports are involved I would bet a substantial amount that they are driven by lower welfare standards overseas and/or devious transfer pricing schemes whereby most of the profit ‘just happens’ (/sarc) to arise in subsidiary companies based in tax havens that provide a ‘service’ but never actually handle the milk at all.   Clearly, this is enormously beneficial to those involved but, equally clearly, it’s not in the public interest.

The problem is not that milk is ‘too cheap’.  Rather it is because well over 100% of the profit in the industry that should be equitably spread through the supply chain has been appropriated by the buyers.  (It’s over 100% since the farmers’ loss adds to the buyers’ profits).   They are able to do this because the supermarkets at the top of the food chain have the power to dictate terms so forming an effective oligopsony as described in an earlier post.   This has enabled them to pump up gross margins year by year; they rip off consumers while pretending to be their friend.

On the figures provided by the BBC adjusted to a single litre (and which are consistent with the time series included in my earlier post – see above link) supermarket make a gross profit of around 15 pence/litre which is nearly 30% of the selling price.   The BBC lamely ducks the issue of how much of this makes it to the bottom line as net profit but we can make a reasonable guess.  Logistics, store overheads etc. will all be minimal as it’s handled in bulk and sales are predictable.  Also we know (earlier post) that in the mid 1990s supermarkets got by on gross margins of only 1 or 2 pence.  So we can be very sure that the vast majority of the gross profit translates into net profit meaning that the supermarkets are achieving a ‘economic rent’ (roughly the excess profit above what they would get in a genuinely free market) of at least 12 pence per litre or around 25% of the selling price.

That is HUGE; if the margins on other goods are broadly similar (and I think many are) then this is a big part of the cost of living – especially for those on limited incomes.

So what is to be done?  If you are a plutocrat then nothing; for everyone else reducing prices raised by oligopoly is an even bigger prize than increasing personal allowances for the low paid.   Getting retail right also has a very direct bearing on other issues including Clone Towns and Mary Portas’ Review of the future of high streets.  But what can be done?

Any solution must start from the fact that the core issue is an imbalance of power.  So, for instance, suggestions that producers should differentiate their product miss the point – some limited differentiation around the edges may be possible but milk is fundamentally a commodity product.  Ditto an ombudsman or Food Market Regulator: having someone looking over the supermarkets shoulder, so to speak, may lead to limited interventions but it leaves the bad dynamics in place.

The first thing to say is that size is a problem in itself.  Retailing is a complex and demanding business but not exactly rocket science.  Nor does it require global companies with the resources required to design a new jetliner or get a new drug to market.   But it does benefit from economies of scale – largely (though not entirely) because the bigger you are the easier it is to bully producers – which means that the big get bigger and the small go extinct unless they can hang on in some niche.   Therefore left to its own devices a retail sector will evolve into an oligopoly where a small handful of large firms, all with similar cost structures, dominates the market.  In effect, regulation of the marketplace becomes privatised for the benefit of the biggest participants and freedom to evolve without limit in response to the market’s internal dynamics eventually ends in a market that is neither free nor fair.

So, the first conclusion is that the size of retailers should be limited.  This could be done in several ways, for instance by legislating that retailers must divest operations above a market share of, say, 20% in any one local authority area or 5% nationally.

The other way that retailing has traditionally been regulated is by mandating an equal price at either the wholesale level (US practice) or the retail level (UK practice).

The US Robinson-Patman Act  (and see also here) prohibited price discrimination by, in simple terms, requiring that the same price and other terms be given to all purchasers of goods for resale except insofar as the cost of supply is genuinely different.  The effect is to put all retailers on a level playing field with respect to their purchases.   The most obvious consequence is that large and small retailers can coexist which means that they are all kept honest by competitive pressure; many corner stores would think themselves in heaven to get ADSA’s margins and would gladly undercut them to increase sales – provided they could buy competitively!  A less obvious consequence is that producers who depend in large part on selling to retailers are not under the bully pressure that has characterised the UK in recent years; there is no particular advantage for a strong retailer to beat them into the ground as the retailer gets no advantage from so doing – any lower cost they negotiate has to be given equally to other retailers.  Another result is that it helps maintain a reservoir of small firms – and small firms are almost always the most innovative.

One of Reagan’s first actions on becoming President was to eviscerate enforcement of antitrust (i.e. anti monopoly) legislation to allow brute force to rule in the marketplace.   The fallout from this has been one of the biggest drivers in the subsequent growth of inequality.

In the UK regulation was accomplished by Retail Price Maintenance (RPM) until the 1964 Resale Prices Act which made most such agreements illegal.  (Libertarians ought to – but mostly don’t as far as I know – object to the RPA’s  flouting of privity of contract.)   RPM put the onus on producers to set competitive prices vis-a-vis their rivals while helping preserve a diverse retail scene but large retailers can still get better terms.  Absent RPM producers have no control over price which compromises their marketing and puts most on the back foot.   Interestingly, RPM survived for books until 1995 since when its demise has helped drive a huge concentration in retailing matched by a corresponding defensive concentration in publishing despite which most publishers are over a barrel, held to ransom by the few surviving retailers.

So, we face a stark choice; if we want a competitive market in goods we have to legislate to create and maintain a competitive marketplace.  If we don’t restore effective competition in the marketplace we can’t have a properly functioning market in goods.

 

Zombie theory stalks the railways

Justine Greening, Secretary of State for Transport, has announced that the government plans to accept many of the recommendations of Sir Roy McNulty’s report on the railways and that she wants to see efficiency savings of £3.5 billion per annum.   Much of the media coverage has been dominated by the proposed introduction of smart card ticketing and job cuts.  Unions fear that 12,000 jobs may go.

There is clearly a problem.  As McNulty puts it in the forward to the report,

“However, there is widespread recognition that the industry has problems in terms of efficiency and costs.  Unit costs per passenger kilometer have not improved since the mid 1990s.”

Hmmm.  The ‘mid 1990s’ was when the railways were privatised (progressively between 1994 and 1997 in fact).   Yet a business with a high but fixed cost base should see efficiency soar when passenger numbers increase.  And passenger numbers have gone through the roof as long-suffering travellers know – up by about two-thirds over the same period according to the report.  Clearly something has gone badly wrong.

McNulty goes on to list some of the causes,

“The causes of GB rail’s excessively high costs are many and complex.  The Study was asked to examine “barriers to efficiency” and we have identified that among the principal barriers are fragmentation of structures and interfaces, the ways in which the role of Government and industry have evolved , ineffective and misaligned incentives, a franchising system that does not encourage cost reductions sufficiently, management approaches that fall short of best-practice in a number of areas that are key cost drivers, and a railway culture which is not conductive to the partnership and continuous improvement approaches required for effective cost reduction”.

In other words its structure too fragmented and byzantine to work properly.  Someone forgot the KISS rule.

On R4’s Today Sir Roy said that British passengers are paying about 30% more than their counterparts in other countries.  John Humphrys suggested that the ‘big opportunity’ is to reunite the fragmented parts and rail expert Christian Wolmar agreed adding that since privatisation public subsidies have increased from about £1.5 billion to £4 billion in real terms – i.e. over and above inflation.  Elsewhere, Bob Crow of RMT contributed the fascinating factoid that Network rail has 300 solicitors who spend their time suing the Train Operating Companies (TOCs) and the TOCs have another 300 who spend their time responding.  It’s a hell of a way to run a railway.

So, the government’s solution is to ignore the elephant in the room – that the structure of the railways is all wrong – and go for a combination of fare increases (disguised as smart ticketing) and substantial job cuts (even allowing that the unions may be a scaremongering a little).  Why would Ms Greening do that?  She could just blame it all on Labour as usual.

The answer is that too many in government still believe the neoliberal nonsense that markets have god-like powers and magically always deliver optimal solutions despite massive evidence to the contrary and a theoretical base that can’t stand up to scrutiny.  They are locked into a failed paradigm by bad theory and cemented in for good measure by the vested interests that are doing very nicely from the arrangement.  That 30% excess of costs is someone’s income and is quite big enough for some to be spared for a generous contribution to party funds.

As for hopes that a re-structuring of incentives and the like within the existing structure will solve the railway’s problems – forget it.  These are features of the system, not mere bugs.  Like all centrally mandated targets they will always be gamed by the industry players for their own advantage; if the incentives are changed the game will simply continue under the new rules.

 

Cameron’s 2% nuclear deal

The Prime Minister has just been to Paris to sign a deal with France to, as the BBC puts it, “strengthen co-operation in the development of civil nuclear energy” with much happy talk of, “our shared commitment to the future of civil nuclear power, setting out a shared long-term vision of safe, secure, sustainable and affordable energy, that supports growth and helps to deliver our emission reductions targets“.

Translation: we have agreed a deal to buy a number of nuclear reactors from the French nuclear company Areva.

And this is a BIG deal.  According to Radio 4’s Today, the first four reactors will cost a total of £20 billion and will create 1,500 UK jobs.

But enquire a little and it doesn’t start to look too clever.  Interviewed by Evan Davis on Today, the boss of ‘New Build’ for Areva in the UK, was gushing about the potential, “the UK is the most exciting new build opportunity in Europe; it’s one of the most exciting in the world….”   He explained (above link) that, “Rolls-Royce will become our prime manufacturing partner to supply some £100m of key critical components of the reactor for each EPR [next generation nuclear power plant] that’s constructed in the UK“.   Apparently Rolls Royce will build a factory in Rotherham to fill orders flowing from the deal and this will include supplying equipment for orders in other countries.

Uh!

Do the numbers.  Rolls Royce is to get £100 million out of £5 billion per reactor – that’s just 2%.  Other companies will be involved but the Rolls Royce deal alone accounts for 80% of the £500 million identified so far.  And, according to their website, Rolls Royce already supplies “safety-critical instrumentation and control systems to all 58 operating nuclear power facilities in France …”  so it’s not clear how much of this work is actually extra.

And yet we have it straight from Areva’s senior man that this is “the one of the most exciting [opportunities] in the world“.  With that much buying power 2%, is a truly pathetic result.  The percentage will inevitably rise during the construction phase but much of that will be the modern equivalent of navvies.   The strong implication is that most of the high-tech value-added bits are coming from France.

This looks very much like a replay of the trains affair where a £1.4 billion contract was awarded to Siemens with one crucial difference.   This time as a result of years of dithering and confusion in Whitehall there is no domestic competitor;  we built the world’s first commercial reactor but no longer have a fully capable civil nuclear supply industry because the UK simply doesn’t provide a suitable ‘habitat’ for complex, technology companies headquartered here (Rolls Royce is a very rare exception).

£20 billion (and that’s just for the first phase of a bigger programme) is enough to make a big difference to the economy as any Keynesians would point out – indeed that new energy investment would do just that has been the constant refrain from governments over many years (although they normally prefer to talk more of renewables than nuclear).   The trouble is that the economic boost in this case is going largely to France.

Politicians have been grandstanding about how the latest technology was going to ‘jump start the economy’ since Harold Wilson’s “white heat of technology” speech (and probably long before that) but we are slowly and steadily going backwards.   It’s a good idea in principle but they just don’t know how to do it.

And yet the how of it is perfectly discoverable; any number of Asian countries, starting with Japan and later South Korea, Taiwan and others have worked out how to do it.   We could too – I don’t even think it’s terribly difficult – but first we would have to start asking the right questions and as far as I can see no political party is yet doing that.  Why not?

 

 

Crime decriminalised

What have the Occupy protesters got to complain about?  Why don’t they just go home and leave things to the properly elected politicians?

Well, it turns out that they have a point.  As a new report shows, despite an epidemic of financial crime federal prosecutions in the US have fallen to under half their level of a decade ago.   The downward trend became firmly established in the presidency of G W Bush and has continued under Obama. The chart shows federal prosecutions each year for the last two decades and four presidents.

The FBI warned as long ago as 2002 that an epidemic of financial fraud was building yet nothing was done in the face of willful blindness on the part of bank executives, regulators and politicians.    Policing and regulation (which in this context are much the same thing) completely failed leading to the wave of subprime fraud which eventually broke in 2007 precipitating the world into Depression.

But the subprime meltdown would not have been nearly as serious as it was unless the system was already in a fragile state because so many banks and other institutions had long been exploiting the near absence of any regulation to make hay in ways that history shows inevitably lead to a meltdown.  So subprime was only the trigger.  Dozy regulators are one thing; remaining fast asleep after 2007 is quite another yet, as the chart shows, that’s exactly what has happened; prosecutions have fallen because, whatever the law say (and it says plenty) there had been a de facto decision to decriminalise … well, crime.

Obama came to power amid much hope that he would take control and sort things out.  But nothing; he reappointed Bush’s economic team and did nothing to prosecute offenders despite abundant evidence.  Which is to say that he, and his appointees like Attorney General Eric Holder have made being blind a matter of deliberate policy.   Obama might have chosen to clean out the frauds saying of the inevitable reaction, “I welcome their hatred” as FDR, who understood the score, said when faced with epidemic levels of fraud in the Great Depression.  Instead he chose to try to reconstruct the economy with the criminals in place – a policy that has failed.

Not surprisingly the country is seething and Occupy is the response.

Fortunately the situation is nowhere near as bad in the UK  but there is no room for complacency either.  Almost all the bailout has gone to the bankers and very little to the real economy – a point which last night’s Question Time audience clearly understood.  With the bankers likely to need another bailout very soon, the politics of this are going to get interesting; any party on the wrong side of events is going to be history.