Caution: Data in use

Data are the lifeblood of analytical research. If it were not for people willing to go out and track the positions of the stars in the sky, the theories of Nicolaus Copernicus would remain unproven and we would be operating on the misconception that the Earth was the centre of the universe. Albert Einstein would just be another clever theorist with some whacky ideas unless people were able to validate his theories by observation and measurement. On a more prosaic level, data matters hugely for modern policy issues as we need some form of benchmark against which to judge whether a policy is working.

As an economist I spend my professional life assessing economic issues on the basis of the evidence in front of me. I may not always be able to foretell the future but I can make a pretty good fist of understanding what is going on based on the data at my disposal. The data may not always be accurate or may be distorted by factors which hide the true message and one of the keys to decision-making is to understand how the evidence is compiled upon which decisions are based. This matters because decisions taken on the basis of faulty data risk making outcomes even worse. Two pieces of evidence released this week highlight the problems inherent in making policy based on uncertain data. 

(i) Covid data

The first instance is the measurement of Covid-19 deaths in England. It is well known that the UK has reported the highest number of deaths in Europe. But what is less well known to the casual observer is the figures assume that once a person is diagnosed as Covid-19 positive, their eventual death will be attributed to Covid-19, irrespective of the manner of their demise and how long after the initial diagnosis. For example, if a person was diagnosed as Covid-19 positive this year but dies a year later as a result of a grand piano landing on their head, they will technically still be classified as a Covid death. The rationale for this approach was that the authorities did not know much about the incubation period of the disease and did not want to be accused of under-reporting mortality figures in the early stages of the pandemic. Incidentally, this explains why, in contrast to many other countries, the UK did not report figures on recoveries. Once you have had the disease, that’s it – you are marked for life.

Obviously this is not particularly sensible. Consequently Public Health England this week imposed a limit of 28 days from diagnosis as the basis for measuring Covid-19 mortality, bringing it into line with Scotland, Wales and Northern Ireland – and indeed the international consensus. This makes a lot of sense: Broadly speaking, if you have not died 28 days after diagnosis, the odds are very much in favour of you remaining alive. This also changes the UK’s position in an international comparison. By my reckoning, the mortality rate is reduced from 70 per 100,000 of population to 62, which is much closer to the figures for Italy, Sweden and Spain. The UK still has the fifth highest global number of deaths but it no longer looks quite the outlier that it did earlier this week. Not that this is to excuse the government’s many failings in the way it handled the Covid pandemic, but by treating the figures on the same basis as other countries we have a more fair picture of how the UK stacks up in an international context.

(ii) Assessing exam data

The second data issue concerns the way in which school leavers’ ‘A’ level results were graded following the cancellation of this year’s exams. For those readers outside the UK, I should point out that the reporting ritual of exam results has become a staple of August news bulletins when there is nothing else for the media to focus on. Until recent years, the cry was that exams were becoming too easy and too many students were achieving top grades. In response to this media outcry, the marking was toughened up. So you can imagine the field day the media have had when it was impossible to hold exams at all.

There was never a satisfactory way to go about assessing what grades students would have achieved in the absence of exams. The starting point was to ask teachers to predict grades, but as Ofqual (The Office of Qualifications and Examinations Regulation) pointed out  teachers tend to offer optimistic predictions of their students’ ability. Teachers were thus also asked to provide “a rank order of students for each grade for each subject” on the basis that empirical evidence suggests people are better at making relative judgements than absolute judgements. Having collated all the evidence, Ofqual concluded that this would “likely to lead to overall national results that were implausibly high.” Accordingly, it had to find a way of normalising the results.

Unfortunately the model it chose is primarily based “on the historical performance of the school or college in that subject.” Even allowing for numerous tweaks, the system contains built-in discrimination against bright students from schools which in the past may not have delivered great exam results and is particularly biased towards independent schools which have a tendency to deliver above-average results. Ofqual argues there is “no evidence that this year’s process of awarding grades has introduced bias.” The data suggest otherwise: The number of A and A* grades awarded to independent schools increased by 4.7% compared to 2019, whereas the increases awarded to sixth form colleges, which tend to be attended by more disadvantaged students, was just 0.3% (chart). The data also show that the most disadvantaged students were more likely to have their predicted grades marked down: The proportion of pupils achieving a C or above fell by 10.4 percentage points among the most deprived third of pupils, compared to 8.3 percentage points among the wealthiest third. For anyone interested in an expert view of the problem, this series of Tweets is worth a read.

For a government that is trying to level up the life chances of those outside the south east of England (if you recall that was the promise in the 2019 election campaign) the 2020 exam process seems to be an odd way to go about it. Moreover, to the extent that young people’s exam results are one of the benchmarks which determine which university they attend, which in turn has a bearing on their future employment prospects, the importance of their exam results matters. Unfortunately, it is difficult to justify the rationale behind the algorithm which predicts exam grades thus devaluing their usefulness as a predictor of student ability. This in turn means that the data generation process becomes more important than the data which it turns out and is an example of why we should not always take data used to feed into policy decisions at face value.

As for the students, it is hard not to feel sympathy for them. They may or may not have gone on to achieve the grades predicted for them. But had they fallen short during the exams, they would at least have done so on their own terms. As it is, they have had grades imposed upon them by what appears to be a flawed data generation process, and judging by the popular outcry, it is not a decision that has played well with the public.

Taking stock of markets

It may be the dog days of summer but financial markets are still busy as we digest the implications of the dramatic second quarter earnings season. Latest estimates suggest that more than 80% of the S&P500 companies reporting so far have beaten earnings expectations, although this has a lot to do with companies issuing very pessimistic guidance in a bid to ensure a positive surprise and hopefully a boost to equity prices. It is an old trick but it seems to work and one of these days investors will get wise to it. Nonetheless, it has helped equity markets along with the S&P500 now just 1% shy of its mid-February peak.

Regular readers will recall I expressed concerns prior to the March sell-off that equities were overvalued. You might therefore think that the recent rebound is a cause for concern. But I am less concerned about the recent rally than I might once have been. For one thing, although risk indicators such as equity option volatility continue to edge lower, the VIX is still trading above its long-term average. It is notable that the VIX has come off its mid-March high of 83 to current levels of 22 (long-term average: 19.4) far more rapidly than in the wake of the 2008 collapse when it took 13 months to fall from the September 2008 high around 80 to levels around 22. This is one illustration of the impact that central bank liquidity provision has had on markets. In 2009 it took a while before markets realised that central banks were serious about ongoing liquidity provision. A decade on, markets have accepted the message that central banks mean what they say about providing all monetary support necessary and are investing accordingly. With no sign that central banks are about to pull the punchbowl, the liquidity support underpinning markets will be in place for a while.

Indeed whilst it is easy to make a case that prices are out of line with fundamentals, an environment of zero interest rates renders conventional metrics such as price-to-earnings or price-to-book ratios meaningless. This appears to be a market where investors feel they need to be invested in order to get some returns – after all, dividend yields continue to look attractive. It is possible that investor positioning will change once fund managers get back to work after the summer break, which is one reason why we see so many equity crashes in the autumn. But it is difficult to see where else investors can put their funds to work for a better return.

For all that equities might appear excessively valued, estimates of the equity premium are on the rise. The ERP reflects the required excess return over and above the risk free rate and past experience suggests it declines at a time when investors become less discerning about what they buy. On my estimates, which assume long-term dividend growth rate of 3.6%, the UK ERP is running at 820 bps. This is slightly down on the March peak of around 920 bps but is nonetheless high in the context of the past 25 years (chart 1). To a large degree, the rise in the ERP reflects the fall in bond yields whilst investors have not yet adjusted down their required earnings in view of the changed macro environment. Indeed, in a world in which trend GDP growth is lower due to slower population growth and limited productivity growth, and in which the Covid crisis will impact on earnings, so expected equity earnings are likely to adjust downwards. It appears we are in a world where investors expect a return to some form of “normality” as the current crisis passes. But just as the 2008 crash pre-empted a change to a new normal in the equity world, so Covid may be the catalyst for a “new, new normal.” Bottom line: Look for the ERP to edge lower in the medium-term.

However, we cannot afford to be complacent. Mounting fears of a second Covid spike, which could impact on the economy, and rising geopolitical tensions are good reasons for investors to raise the weight of safe assets in their portfolios. Nowhere is the flight to safety more evident than in gold where the price has established a new record in recent weeks above $2000/oz. I do have some concerns about how much further it can go. According to the World Gold Council, there were record flows into exchange traded funds over the first half of the year. To the extent that ETFs represent shadow demand for gold, and to the extent that a change in risk perception could see a sharp reversal of investor positions, there is a nagging sense that we are operating in elevated territory. That said, as with equities, there are no good reasons to expect an imminent downturn. After all, one of the conventional arguments against holding gold is that it is a non-interest bearing asset. But so, too, is cash these days. If the opportunity cost of holding gold is effectively zero it makes sense to overweight it in these turbulent times.

As a final thought, I have read a lot recently suggesting that investors’ fear of inflation as a consequence of recent central bank liquidity provision is one of factors driving gold higher. But evidence in support of the view is lacking. The break-even yield on 5-year Gilts, which reflects the difference between yields on conventional and index-linked bonds is currently running in negative territory at -8bps versus 60 bps at the start of the year (chart 2). Even the 10-year breakeven is trading at just 13 bps. To the extent that the breakeven rate reflects expected inflation over the lifetime of the bond, the data suggests that investors currently fear the current crisis will be disinflationary – or even outright deflationary – rather than adding to price pressures. In my view, the gold price surge reflects ongoing global uncertainty. It makes sense after all – an unprecedentedly high gold price reflecting unprecedentedly uncertain times.

Is the tide turning?

One of the mounting concerns over the last four years has been the extent to which policy is being conducted on the basis of belief rather than evidence – particularly in the Anglo-Saxon world. The danger was always that at some point those who ignored the evidence would start to come unstuck. We appear to be reaching this point. The question is whether voters are beginning to see through the bluster.

This was exemplified by two items that surfaced on Twitter yesterday from people who are not known for their adherence to evidence-based analysis. The first example was provided by the current occupant of the White House whose TV interview on Covid cases in the US was a car crash of epic proportions. Amongst other things, Trump failed to appreciate the importance of normalising the number of cases and deaths to account for differences in the size of population and appeared not to understand the argument that the journalist from Axios was putting to him. As much as anything, it showed up Trump’s inability (or maybe unwillingness) to engage in intellectual debate. It was far worse than anything I remember four years ago during the presidential campaign. Having recently watched the outstanding film Hillary by Nanette Burstein, I could not help wondering why the US public hated Mrs Clinton so much that they chose a reality TV star in preference to her as president (if you are interested in recent US politics, the film is a must-see). 

The second item was as bad, if not worse in its own way. This series of Tweets by former leader of the Tory party and Brexit hardliner MP Iain Duncan Smith, explaining why the EU Withdrawal Agreement was such a bad deal for the UK, was incredible. IDS argues that the EU wants “our money and they want to stop us being a competitor.” As if that were not enough, the following statement was both wrong and a masterclass in irony: “To avoid their own budget black hole, the EU gets £39billion as a “divorce payment” from us, reflecting our share of the current EU budget. But it gets worse. Buried in the fine print, unnoticed by many, is the fact we remain hooked into the EU’s loan book.” 

It is wrong because it fails to differentiate between the liabilities incurred by the UK which it must meet on its departure and some kind of exit payment. The UK is not somehow filling in holes in the EU budget. It agreed to undertake certain projects whilst it was a member of the EU and agreed that it must pay its share of the liabilities incurred. But the supreme irony is in the phrase “Buried in the fine print, unnoticed by many.” It is the job of MPs to scrutinise legislation. The text of the Agreement was published in October 2019. It then went through the UK parliament, where bills are debated three times by the House of Commons before being passed into law precisely to avoid any hidden items from sneaking through. So what precisely had he and his colleagues been doing prior to January 2020 when they voted by 330 to 231 to pass the Withdrawal Bill? 

The sheer absurdity of the ultra-Brexiteer position is difficult to understate. They clearly seek absolute autonomy over every aspect of the UK’s legal and economic framework without ever once acknowledging that no country in the world – not even the superpowers – have that kind of control. This handy little guide gives an overview of all the areas where the Centre for Brexit Policy think tank believes the UK should simply rip up any agreements with the EU in order to obtain absolute sovereignty. The people who believe this stuff are simply zealots who have no regard for how the international economy works. I have been calling them out for the past seven years but like cockroaches their arguments just won’t die, irrespective of how much logic you apply to them. 

They share with Trump a desire to break down the status quo without giving any real thought to what might come in its place. Their various projects run on finding grievances in order to stay relevant by tapping into the perennially dissatisfied. In a way, the worst thing that could happen to them is that we give in to their fantasies because then they would become irrelevant, having nothing to protest against. But that way madness lies, so we won’t go there.

All this begs the question whether voters think differently now compared to four years ago? In the US, Trump has had worse net approval ratings over the last three years than he is polling today but you have to go all the way back to summer 2017 to find them (chart). It is not a good look just three months before a presidential election. Nor do the polls find much support for Brexit (at least not in the form proposed by the British government over recent months). According to the European Social Survey, just 35% of Brits supported Brexit, with 57% wanting to rejoin the European Union. It is just one survey and we have learned not to trust the polls but this is consistent with the message coming from a number of polling sources in recent years. There is no appetite for the hard Brexit which the UK government says it is prepared to deliver. 

The collective cries of rage on both sides of the Atlantic were hailed in many quarters as the full throated roar of a population willing to take back control and make their respective countries great again. But after giving the electorate just four months to consider the immensely complex topic of Brexit, which was decided by the narrowest of majorities, politicians have had four years to implement it and now its leading protagonists do not appear to like what they voted for. In the US, such was Donald Trump’s popularity that he actually polled far fewer votes than Hillary Clinton. Indeed the vote deficit was the largest in history of anyone going on to be declared president (almost 2.9 million). There was no huge majority in favour of the populist policies on offer. And now that they are proving difficult – if not impossible – to live up to, maybe the sound you hear is that of the tide turning.

House of Sad

Every now and then I like to go off-piste and look at issues in the world of football, partly because it interests me but also because it is an area ripe for economic analysis (bear with me on this, there is some economics in here). A couple of years ago, I looked at the financial position of Newcastle United, the club I support. I reluctantly concluded that although the financial model adopted by the owner Mike Ashley was condemning the club to mediocrity, this was consistent with a strategy in which the owner had no incentive to spend huge sums of money for no guaranteed reward. However, this was inconsistent with the demands of fans who want to see the club spend money in order to challenge for trophies, rather than simply making up the numbers. Perhaps the relationship between owner and fans can be seen as a principal-agent problem in which the owners’ actions on behalf of the club impact directly on the fans. 

The news earlier this year that a Saudi Arabian consortium was interested in buying the club was welcomed by fans who hoped that it would allow Newcastle to challenge for trophies on the domestic, and perhaps even European, stage. The group included Saudi Arabia's sovereign wealth fund PIF thus making a direct link to the Saudi government whose record on human rights is, to say the least, questionable. This posed an ethical dilemma for me. Obviously I want my club to be successful which would have been enabled by the funds PIF has at its disposal. Against that I am uncomfortable with the links to a government deemed by Amnesty International as repressive. As it happens, the dilemma was resolved yesterday when the consortium withdrew its bid for the club.

It appears that the Premier League (PL) had dragged its feet in applying the “fit and proper person” test to the prospective owners and 17 weeks after the bid was submitted, the consortium simply lost patience. Quite rightly the PL wanted to determine the precise links between the consortium and the Saudi government. It needed assurances about who would have control (who is the beneficial owner), where funding would come from and who would appoint the board. In the absence of clarification, the PL’s rules prevented it from sanctioning the deal. On the surface, you might think that this was a case of good governance in action. But the PL – and indeed the English Football League, which governs lower leagues in England – has a murky record. Consider these examples:

1. In 2003 the PL welcomed Roman Abramovich's takeover of Chelsea FC with open arms. Not once did they publicly ask how he obtained his money. Nor did they raise the issue of money laundering, despite the fact that any business funded by funds of dubious provenance is a classic money laundering risk.
2. In 2005 the PL was quite happy to allow the Glazers to purchase Man Utd, despite the fact they loaded the club with huge debts in the process. Those debts are currently valued at £0.5bn – almost 0.8% of the annual gross value added generated in Manchester.
3. The PL welcomed Thaksin Shinawatra as the buyer of Man City in 2007. Thaksin, being a former PM of Thailand who was deposed in a coup, is the sort of politically exposed person whom people in finance are warned to treat carefully in any financial dealings. Thaksin then sold the club to the Abu Dhabi Investment Group, owned by a member of their royal family. The club was recently charged with breaching UEFA's financial fair play regulations (and dubiously acquitted), yet we did not hear anything from the PL on the issue.
4. If it is Saudi involvement the PL is concerned about, there seem to be no worries that Sheffield United are owned by a Saudi prince who recently won a court ruling that he could purchase a 50% stake in a club reputedly worth £100m for just £5m. 
5. Lower down the leagues, the football authorities claim to have a 'fit and proper' person test. Yet Wigan Athletic was last month declared bankrupt just four weeks after it was sold to a Hong Kong based consortium.
6. The travails of recently-promoted Leeds Utd can partly be laid at the PL's door. They raised no eyebrows when in the early-2000s the owner borrowed against future revenues to load up the club with debt, predicated on the basis it would regularly qualify for the Champions League. It didn’t and predictably Leeds went bankrupt. It then went through a series of owners which culminated in the farce whereby Massimo Cellino took control in 2014 only after winning a challenge to the Football League's attempt to block him. Cellino was later banned for financial irregularities before being allowed to return to his post. You almost couldn’t make it up.

I could go on. Fans of football clubs with long pedigrees such as Blackpool and Portsmouth can tell similar tales of woe in which unscrupulous owners managed to take over clubs before subsequently ruining them. On the basis of their past record of "anything goes" there are calls for the PL to be more open about why they put obstacles in the way of the Saudi takeover, without ever explicitly saying they failed the ownership test. Has it discovered a moral conscience, in which case I fully expect that this won't be the last occasion that club takeovers are blocked? Or is it because the Saudis have blocked the PL from taking legal action against the broadcaster beoutQ for illegally streaming matches whilst simultaneously blocking the PL’s licensed broadcaster in the Middle East?

In effect, football is being run along casino capitalism lines: The very behaviour which voters condemned banks for undertaking prior to the Lehman’s bust is alive and well in football. It has been well established in finance that self-regulation does not work – there is always an incentive for someone to game the system to their advantage. The same is true in football club ownership. To the extent the owner is running a business, there needs to be a systematic set of rules which proscribe what owners can do and penalties which are consistently applied in the event they are broken. Football’s regulators could do worse than learn from the financial regulators, which have been open and transparent about what institutions can and cannot do, and which crack down hard on miscreants. There should also be a separation of the financial incentives of the PL and those of the top clubs. Regulators are there to regulate, not to get rich on the back of those they are meant to oversee.

My favourite quote from the book by Simon Kuper and Stefan Szymanski Why England Lose … (aka Soccernomics) is “just as oil is part of the oil business, stupidity is part of the football business.” But it should not be this way. If football people want to be treated as the professionals they say they are, the sport needs to be regulated properly. Not run in the capricious manner which benefits the rich owner at the expense of the less well-off fan.