Is anybody happy?

My original intention in writing this post was to look at the trials and tribulations in British politics as allegations of financial impropriety raise major question marks against the conduct of senior politicians which in turn has stirred a major debate about standards in public life. This is a theme to which I may yet return but I realised that this political split reflects a much deeper social schism and one which is not merely confined to the UK. Ultimately the issue is whether the economic system is working for the majority of voters or is it a system which is rigged in favour of political insiders. Simply put: Are electorates happy, and if not why not?

Measuring the mood

It is very difficult to put one’s finger on the national mood and measure the extent to which society is at peace with itself. Indicators such as consumer sentiment do not really do the trick for although they capture economic well-being, society can still be restive even when the economic indicators appear strong (and vice versa). In the 1970s and 1980s economists popularised the misery index (the sum of the inflation and unemployment rate) to try and provide a link between economic and social well-being but this has fallen out of favour in recent years as both inflation and unemployment have fallen. Ironically the US misery index during Donald Trump’s term of office posted the lowest average of any president in the post-1945 era. But as the Capitol demonstrations indicated in January, US society is far from being at ease with itself.

In recent years, economists and statisticians have attempted to broaden their measurement of well-being beyond looking at GDP growth, unemployment or inflation. One of the limitations of these standard measures is that they take no account of distributive aspects which have become an important agenda item since the GFC of 2008-09 and which were given additional prominence by the work of Thomas Piketty. Indeed, the perception that the benefits of economic recovery over the past decade have accrued to an economic elite (the haves) at the expense of the rest (the have-nots) was one of the driving forces behind the election of populists such as Trump and Bolsonaro, and was very much at play during the Brexit referendum in 2016.

An alternative to using GDP which has become popular in the academic literature is the Genuine Progress Indicator (GPI). This attempts to measure economic welfare and differs from GDP in as much as GPI attempts to distinguish between welfare enhancing and welfare-reducing activities whereas GDP simply assigns a positive monetary value to all activity irrespective of its social welfare impact. GPI starts with the national accounts measure of consumer spending and adjusts for a range of 24 factors including income distribution and environmental costs, and also accounts for negative activities like crime and pollution.

It is far from perfect; for example, it is not a measure of sustainability, therefore activity which adds to social welfare today but which subtracts from it in future is still classified as a positive addition to GPI. Nor does it capture all types of social benefit; for example, it omits factors such as political freedom which can substantially add to social welfare. Nonetheless, it is a useful first attempt to account for welfare issues and is vastly superior in this regard to GDP. One of the great ironies is that a study conducted almost a decade ago[1] concluded that the quality of life in Britain based on the GPI reached a peak in the 1970s – a period which politicians have told generations of voters was actually one of great economic hardship.

Another problem with what we might call indicators of material well-being is that they are not necessarily correlated with quality of life indicators. Precisely because quality of life measures are highly subjective, with different people assigning different weights to the same factor, it is not easy to devise an aggregate measure of well-being. However, the OECD has created a website which allows users to create their own index based on three indicators of material prosperity and eight quality of life measures. The results can be broken down into detailed geographical regions and those based on participants in three global cities are shown in the chart above. It is interesting that the most important factors for Berlin and London are broadly similar, with safety a top priority in both cases but across the Atlantic in Washington DC, survey respondents prioritised income.

Whilst the idea of creating an index on a snazzy, easy to use website may look like a fluffy exercise in optics, the results are far from trivial. If society is to repair some of the divisions which have been allowed to fester over recent years it is important to understand what factors are important to people and how well their objectives are being met. The results of the OECD analysis suggest that a government which places its focus in improving the quality of health outcomes or social safety will do well in Europe but US governments have to prioritise policies which deliver strong incomes.

Energising younger voters will be crucial

All this was brought into focus by an article in the FT by the always excellent Sarah O’Connor who looked at the challenges facing younger people in the wake of the pandemic. The article references a global survey which the FT conducted of those aged under 35 which canvassed the opinions of 1700 people (the results are summarised in the chart below). Two issues particularly stood out from the reader comments: the cost of housing and the burden posed by student debt (a topic I looked at here). One survey respondent noted that “most people my age are paddling so hard just to stay still … and many are losing faith in the system.” Another commented “it feels as if “we are drowning in insecurity with no help in sight.”

The political angle to all this is that western governments have for many years prioritised average income, as represented by GDP, at the expense of distributional issues. In the Anglo Saxon world, governments have slashed taxes for the wealthy over the past four decades, which has allowed the rich to become richer whilst the middle earners have been squeezed and those at the bottom have done extremely badly as the welfare safety net is eroded. The perception of extremely wealthy capitalists rubbing shoulders with politicians at venues like Davos has contributed to the sense – real or imagined – that public service is increasingly a licence to make money. The likes of Tony Blair and Gerhard Schröder, for example, became very wealthy after they left office by taking on a variety of different jobs.

Moreover, it is a well-worn political “fact” that older voters are more likely to head to the polling booths than younger ones. Accordingly the economic and political system is biased towards older voters for it is their votes that keep politicians in office. However today’s younger generation will be tomorrow’s mature voters but it appears they have little incentive to engage with the system as it stands today. Stories of rows amongst government ministers and the chummy relationships between senior politicians and private sector companies do nothing to persuade young voters in particular that the system has anything to offer them. The post-Covid response will demand politicians engage with the electorate in a different way to that of recent decades in order to tackle issues of importance to a new generation of voters, such as climate change and securing long-term prosperity. On the basis of recent events in the UK, politicians seem to be making little headway on this front.

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[1] Kubiszewski, I., R. Costanza, C. Franco, R. Lawn, J. Talberth, T. Jackson, and C. Aylmer (2013) ‘Beyond GDP: Measuring and achieving global genuine progress,’ Ecological Economics, 93, 57-68

 

Some thoughts on the 2018 outlook

One of the anniversaries you may have missed was the bicentenary of the first publication of the novel Frankenstein, which first saw the light of day on January 1 1818 when the author, Mary Shelley, was just 20 years old. As you are no doubt aware, the eponymous title referred to the scientist who created the monster which in popular culture now bears his name. A couple more economically relevant anniversaries will also fall in 2018. Assuming that the US economy does not go into reverse, May 2018 will mark the second longest US economic expansion on record, exceeding the 106 month upswing between February 1961 and December 1969. Perhaps of greater symbolic significance, September will mark the tenth anniversary of the Lehman’s bankruptcy – an event which proved to be a Frankenstein moment for the global economy.

From an economic perspective, global GDP growth this year is predicted to post its strongest rate since 2011 with the IMF forecasting a rate of 3.7%. Indeed, there are increasing signs that the global economy is beginning to match the optimism which has long been a feature of financial markets, with Europe likely to be one of the brighter spots after years of underperformance. But markets appear to be in the late stages of a cycle which will soon enter its tenth year, with concerns about the overvaluation of equities whilst in the credit world spreads remain narrow and covenant-lite issuance is on the rise.

As I noted in my previous post, it was possible to rationalise market movements in 2017 on the basis of accelerating global growth, low inflation and a lax monetary stance on the part of global central banks. But one of the features of the current market cycle is that many investors describe themselves as “reluctant bulls.” This suggests that they may decide to jump off the bandwagon in the event of an event which triggers a change in sentiment. This is not to say that I believe markets will necessarily crash, but it might pay to reduce the degree of risk exposure – perhaps by switching the top 10% of risky assets in the portfolio for something less risky. One curiosity of market moves of late is that the surge in US equities is increasingly reliant on a narrow base of stocks. Indeed, the so-called ‘FANG’ stocks (Facebook, Amazon, Netflix and Alphabet) accounted for roughly 17% of the rise in the S&P500 in 2017: If we add Apple, this figure rises to 25%. A market which is so dependent on tech stocks is clearly vulnerable to a shift in sentiment.

Monetary policy is likely to play a more important role in market thinking in 2018. Whilst the market shrugged off US rate hikes during 2017, it will probably have to contend with another 50-75 bps of monetary tightening this year. In addition, the Fed will continue to run down its balance sheet. Admittedly, an expected reduction of $300 million relative to an overall balance sheet of $4.5 trillion does not represent a huge amount of liquidity withdrawal, but to the extent that more air is being taken out of the monetary balloon than at any time in the past decade, it might point to a market which rallies at a slower pace than we witnessed in 2017. I expect that global stock markets will end the year higher than they began and I’ll stick my neck out by predicting a rise of 5-10% in the major US and European indices.

One of the interesting developments to watch in 2018 will be the course of bitcoin prices. There are numerous unknowns regarding the nature of the first digital currency to capture public imagination, notably who holds it. Despite the establishment of a bitcoin futures contract last month, this is unlikely to increase the depth and liquidity of the market so long as institutional investors remain on the sidelines. I still believe bitcoin is a bubble waiting to burst – it is after all currently trading 23% below its mid-December high (chart) – but predicting the future course of events is a mug’s game, as anyone who tried predicting its course last year discovered. I will, however, be that willing mug and predict that the price will end the year lower than where it started.

Politics in the Anglo Saxon world will continue to feel the aftershocks of the great 2016 populist revolt. US mid-term elections will be held in November where attention will focus on whether the Democrats can win back control of the House. Last month’s Alabama Senate election, in which Democrat Doug Jones pulled off a stunning win over his Republican opponent, Roy Moore, is an indication that there are limits to the electorate‘s tolerance of the nastier elements of Republican politics. Moreover, the parties of first-term presidents have in recent years tended to lose seats in the mid-terms, suggesting that there is a chance that the Democrats can mount a political comeback. Whilst I would not put money on it, it does raise a risk that 2018 might be the year in which political gridlock returns to Washington.

On this side of the Atlantic, the Brexit soap opera will continue to play out. In twelve months’ time the UK will be staring Brexit in the face, so it is imperative that progress is made with regard to setting out the terms of the subsequent relationship between the UK and EU. Nothing that we saw in 2017 gives me much hope that the UK government is up to the task. Such progress as we have seen has been dependent on the goodwill of the EU, such as accepting the Irish border fudge as a sign of genuine progress (it isn’t). There is also evidence to suggest that questions are being raised amongst voters regarding the Brexit process and whilst this will not mean that the UK government changes its position, it may be forced to soften it. Undoubtedly, this is a theme to which I will return.

Other things I have been asked about of late include whether I believe the Italian elections due in March are a big deal (no); whether there will be a war on the Korean peninsula (doubtful) and whether Donald Trump will be impeached (no). Unfortunately my clairvoyant abilities do not extend to giving definitive answers to these questions, so let us just say that I would assign a probability of less than 50% to any of them. Of course, the big question of 2018 is who will win the World Cup? I can respond with much more certainty than to any of the issues above: Not Italy.

GDP: A question of input and output

The focus on headline GDP growth is a highly misleading macroeconomic indicator and is routinely used and abused by politicians, journalists and (some) economists. It is an aggregate measure of all output, income and expenditure activity and has numerous shortcomings, as I have discussed in previous posts (here, for example).

Precisely because it is an aggregate measure, the more rapid the growth in factor inputs, the more rapid is growth in headline GDP. Thus, for example, the more labour we allocate towards productive output, the more quickly will GDP grow. In the early stages of its expansion, the extraordinary rates of growth in China were due to rapid rates of population expansion which, between 1980 and 2000, boosted economic output by more than 20%. Strictly speaking, of course, we should use employment or labour force growth rather than headline population, but this is a decent proxy and in any case is easier to obtain on a cross-country basis. This methodology essentially gives a rough measure of the extent to which growth is driven by productivity and how much is simply attributable to labour expansion.

In a 1994 book, Paul Krugman noted that “productivity isn’t everything, but in the long run it is almost everything.  A country’s ability to improve its standard of living over time depends almost entirely on its ability to raise its output per worker.” So it is perhaps surprising to note that in the US between 1980 and 2007 fully one quarter of the increase in GDP was the result of an expansion of labour input, just as in China (see chart). This may go a long way towards explaining why although the US economy appeared to be growing rapidly and creating huge numbers of jobs, it never created the prosperity that politicians claimed.  By contrast, over the period 1980 to 2007, the UK experienced an average real GDP growth rate of 2.7% with GDP per capita growing at 2.4%. Thus, population accounted for just 9% of the rise in UK output over that period.

What is remarkable is how much of a change we seen across many industrialised economies since 2008. US GDP per head has slowed from 2.1% over the period 1980-2007 to 0.7% between 2008 and 2016. The corresponding figures for Germany are 1.7% to 0.9% and in the UK 2.4% and 0.4%. This is the much-discussed productivity puzzle which has exercised many fine minds over recent years. Nobody has a convincing explanation for such a slowdown, let alone how to resolve it, but a slowdown there has definitely been. If we accept Krugman’s view, the western economies appear to have a substantial problem in boosting living standards at the same pace as they did prior to the recession. And it is perhaps no surprise that people are unhappy with their economic circumstances with the result that we saw electorates vote for Brexit and Trump.

Indeed, although UK per capita GDP growth has slowed sharply since 2008, to the point that it took until 2015 for output per head to recoup the losses suffered during the recession, the slowdown in measured GDP has been less dramatic. What this implies, as the economist Simon Wren-Lewis has pointed out, is that immigration into the UK has helped to support measured GDP growth in recent years. Moreover, if immigration is curbed as a result of Brexit, an absence of any pickup in productivity suggests that UK measured GDP will also slow. With the UK government possibly poised to trigger Article 50 proceedings as early as next week, this is a message worth taking on board.

It also suggests that we should beware the pronouncements of politicians who extol the virtues of rapid GDP growth, as UK Chancellors are wont to do. An economy’s output performance depends on the quality of its inputs. GDP is not necessarily a measure of living standards: It just means that we produce more, but if there are more of us that is what we should expect – as anyone who regularly battles London commuter traffic will know only too well.

Lies, damned lies and GDP: Part 2

Andy Haldane, the BoE’s chief economist, always produces speeches which are worth a read and his latest, entitled Whose Recovery? is no exception.  Although the UK has been one of the fastest growing G7 economies over the past couple of years, Haldane makes the point that not everyone has felt the benefit of these apparent gains and that “aggregate activity measures are sometimes a poor proxy for the average person’s income.“ Indeed, since GDP measures the sum of all activity in the economy, its performance is boosted by a rise in labour input. Depending how we measure it, GDP per head in 2015 was either 0.1% higher than its 2007 peak (based on total population) or 3.5% higher (based on economically active people aged 16-64). Either way, both illustrate a sharp slowdown in income (output) per head relative to pre-crisis growth rates. The simple GDP per head of population measure posted average annual growth of 2.4% over the period 1980-2007 whilst the age-adjusted activity measure grew at a 2.0% annual rate.

This clearly illustrates that productivity growth must have slowed, and we will leave a discussion of this for another time, but it demonstrates why productivity is so important in generating a rise in living standards and why GDP figures can be misleading. Moreover, the aggregate picture glosses over significant regional differences in output per head, and as Haldane notes “only in London and the South-East is GDP per head in 2015 estimated to be above its pre-crisis peak.” You will need no reminding that London voted overwhelmingly in favour of remaining in the EU on 23 June (although the rest of the south east did not). Perhaps this is one reason why the narrative of a strong UK recovery which would be jeopardised by Brexit did not wash in large parts of the country, as many people asked themselves the same question posed by Andy Haldane: Whose recovery?

It is thus evident that another in the long list of problems with GDP as a measure of wellbeing is that it is an aggregative measure which takes no account of distributive factors. Ironically, much of the evidence on income distribution suggests that the greatest widening of inequality took place in the second half of the 1980s, with a further leg up over 1997-2002, but it has since remained stable and actually come down a little in the past five years. But obviously not enough for a large section of the population to feel that they are getting a big enough slice of the pie.

As I noted in my previous post, GDP is a much used and much abused statistic. There is definitely something wrong with GDP as a measure of welfare if it assigns a positive value to pollution-emitting activities today whilst efforts to clear it up tomorrow will similarly be assigned a positive value. Surely a better measure of net social benefit would be to offset the two. It is for reasons such as this that statistical authorities are placing more emphasis on measuring things such as national wellbeing, which is an area where the ONS in the UK has done a lot of work lately. There is clearly a strong argument for economists to raise their eyes to a wider horizon. But the fact remains that it is still so much easier to measure the physical output of things, and to pretend that we have a handle on the output of services, which is why we continue to focus our attention on GDP statistics.

When discussing the use and abuse of economic statistics I am reminded of the old story of the drunken man who is found by a policeman scrabbling under a streetlight. “What are you doing down there?” asks the policeman. “I am looking for my keys,” says the drunk. After five minutes fruitless searching the puzzled policeman asks, “Are you sure you lost your keys here?” “No,” replies the drunk pointing to the darkness on the other side of the street, “I lost them over there, but the light is so much better here.” I suppose the moral of the story for economists is always carry a decent torch capable of shining a light on the statistics.