Notes from the Economics Teacher Conference

Here are some great summary notes from the five key-note presentations at the Economics Teacher Conference in London on Monday 24th June. Many thanks to our colleagues from the Royal Grammar School, Guildford for putting together an excellent summary of many of the key points.

Tim Harford - fixing the Economic Machine - starts with an Economic history lesson about Bill Phillips

Bill Phillips - a nervous chain smoker - just failed his Sociology degree, his Dad was a tinkering engineer and Bill was smart. After school he was too young for Uni and the global recession was hitting hard and his parents were struggling. He needed to earn a wage and so mainly he did engineering on a hydro electric dam. He did lots of random jobs and ended up in the air force in Singapore, fighting Japanese dive-bombers. He was captured and went to a POW camp by the Japanese. "The tall guys starved and the little guys made it". He continued to tinker, building an immersion heater and little radios. A very inventive man who weighted seven stone at the end of his time in prison.

Macroeconomics had only just been invented in response to the Great Depression, a time when more than microeconomic price theory was needed. At the same time came the birth of national income accounting, partly to enable war planning but also to investigate what was happening in the economy. Keynes' metaphor was that the economy was suffering from 'magneto failure' which is easy to fix and enables the macro-economy to restart, just like fixing the magneto in a car.

When Bill joined the LSE he started sociology and moved into Economics under James Meade, neither impressed him. He noticed that the differential equations of Economics were the same as his hydro-engineering equations and offered to help Meade develop differential equation solving tools. He invents a machine to do this and shows it off for the first time at the LSE.

This was the first ever computer model of the UK economy. There is one in the science museum and another at Wellington. Alan McRobbie also has a one hour online talk about the machines. Here is a short version with the machine in action

But he is most famous for his Phillips Curve and relationship between money and wages. It became the most cited paper ever and become a very practical policy making tool.

In the 1970's there were headwinds as Milton Friedman and Robert Lucas refuted the Phillips Curve relationship. The Lucas Critique imagined you were playing American Football, with four chances to move forward ten yards, otherwise the other team get the ball. On the fourth down the team almost always kicks because they are just about to lose the ball. Lucas drew parallels with the Phillips curve which he said would advocate abolishing the fourth down, obviously this won't work. E.g. Fort Knox has never been robbed therefore you don't need guards. I.e. the Phillips Curve is not causal it is just empirical and the moment you try and exploit it it will destroy you. Tim Harford says Lucas was in effect arguing for the abolition if macroeconomics and a return to causality rooted in price theory. In addition in the 1970's the data for the Phillips curve collapsed.

In response to this critique Phillips (who never really rated the Phillips Curve and whose colleagues had over-reacted to his empirical correlation relationship, possibly publishing in his name) was very ill. He moved to Melbourne and focused on the Chinese economy before dying in 1975.

Since then Keynesianism is making a comeback, partly due to the inflexibility of classical thought. Complex systems is high in the agenda and the would have appealed to the Engineer in Bill Phillips.

Doyne Farmer is developing at Kings, Cambridge an agent based model of the US economy to try and simulate the economy in a very 'Bill Phillips' style. The Economy is a complex system and it is good to model it, but don't forget that we still need to manage it when it is broken.

Questions

Is the economy less like a machine and more like an Eco-system, far more complex?

Tim agrees and wrote a book (Adapt) about this. Where does that take us? Alan McRobbie is the modern engineer and is considering adaptive systems.

What are the periods that we should be teaching?

Difficult as the lessons aren't always obvious but at the moment lessons from the Great Depression and Japan. Also the Yap, late nineteenth century donuts, 20th century and the price of coke not changing for 76 years - price rigidity. The influx of Spanish Gold and other inflationary moments plus the lessons learned from the Cold War.

Linda Yueh - China's Growth - the making of a superpower - blog is called Linda's Line, her book is called China's Growth

Huge division of opinion between the bulls and the bears, however this is an awkward shorthand. In reality Linda stands in the same analytical place and as the received wisdom changes so does her relative bullish/bearishness. Her books looks forward and Linda has been asked to look forward by the Chinese government to the next stage of development.

Key findings:

What has driven growth of over 10% per annum, doubling every ten years. Even with growth of only 7% it's economy will double in a decade, making it as big as the US is now. However is that growth rate sustainable and do they grow in a sustainable way?

Linda points out at China has a business cycle which is driven by the move from a state owned system and this differs from the demand shock cycle of the West.

She warns that the macro data is not particularly accurate, with bias and uncertainty present, both due to politics but also due to 'grey' economy which is a characteristic of a developing economy in which formal GDP is under measured, so there are upward and downward biases to the stats.

Growth drivers

• 2/3rds attributed to adding capital/labour and 1/3rd attributed to increases in total factor productivity and this included a period of industrialisation which explains the growth rate since 1989. The factor accumulation is mostly added capital with a large minority of added labour.
• Over this period China has an ageing population and a very high female participation (70%+) which means there isn't a huge gain to be made from adding workers as Europe did in the post war period.
• Total factor productivity improvements are broken down into 1/3rd from human capital although this is quite low and shows how China needs to improve their tertiary education.
• 1/3rd is reallocative efficiency and the movement of state workers into 'normal' firms with normal expectations gives a huge productivity boost - 10million state firms has reduced into a lot less (I missed exactly how many) and means a huge one-off boost which cannot be factoring into future growth.
• 1/3rd is due to innovation with a split between imitation and innovation and it is hard to judge how innovative China is being. China is the biggest recipient of FDI amongst developing economies and will enable swift catchup as they can import ideas. This means true innovation may be as low as a third of the increase due to 'innovation'.
• If you strip out one-offs and imitation the growth rate is going to slow down, which is why the Chinese government is rebalancing

Re-balancing challenges for China

1. Goal for next 30 years - over-coming the middle income trap of $14,000 at PPP basis. only seventeen countries have managed this including Singapore, South Korea and Greece.
2. Withdrawal of hot money flows will take away Chinese growth method of previous years.
3. Increased reliance on domestic markets - to counter export downturn and become more self-sufficient.
4. Raise consumption which is at 35% and this means addressing the rate of savings (22% for private is normal but firms save huge amounts compared to other nations).
5. Re-balance towards services which are less exportable and more domestic focused. For the first time service sector is larger than Industry but still less than 30% of GDP.
6. Reduce the state sector - 1978- 100% of output and the state sector still counts for 1/3rd of all business. However these state run enterprises are inefficient and take up the most bank credit. They do employ about a quarter of workers and this is why the transition isn't faster, even though the return on assets is very poor. Can China reform this sector? Lots of political issues and this will be a thorny issue.

Signs of innovation - patents are rising as is Real GDP

China going 'Global' - China is investing out of China which will improve their capital technology. However they can't buy the best companies, only the struggling ones which will reduce the effectiveness of the strategy.

Within the next decade China needs to restructure.

• By 2020 they need to restructure their economy.
• By 2030 they need innovation to be the driver of growth
• By 2040 they need to have strong and stable institutional reforms in place.

Questions:

China's growth relies on commodities - how tied is China's success to commodity-exporting economies? Very reliant (40% of world consumption) but the sources are diverse. The problems will be for those countries not for China unless they can turn increased wealth into secondary sector development. However China growing at 7% will not be able to keep commodity prices at current levels.

Why does the Middle Income trap exist? Unless GDP is over 5% GDP per capita growth typically doesn't keep up. Trapped economies rarely come close to the capital frontier and need to grow at over 8% to 'develop'. Linda asks why these countries didn't grow more quickly in the post-war period. Since 1990's capital has flowed to developing economies in the 'Great Doubling'. But can it be sustained with investment pulling back or will we end up with the Asian crisis of the 1980's and reversal.

Wondering why the biggest issue isn't that China's institutional development is the major impediment to development? Linda says 200000 judges have no legal training which is why it will take so long to change institutions. It's going to take a least a generation. To really have proper reform the legal system has to be separate from the state and until this happens the legal institution cannot improve. She warns in the 'Fire Next Time' blog post that China may face a middle class revolt similar to Brazil.

Question on the parallels with the USSR - can reform happen without collapse? Linda says that there are three big unknowns? Can a continent really 'catch up' and will there be enough left? To what extent can China reform without crisis? Is it really possible that China will dodge all bank crises?

Ed Conway (Sky TV) - The Real Economy Blog – author of 50 Economic Ideas You Need To Know

The Best Charts of the Last Few Years.

No Normal Recession - NIESR chart shows how unusual our recession has been. This chart shows how different things are this time round.

Real incomes are falling and are the same as they were in 2003. Quid pro quo is that employment has not fallen significantly

Fiscal Conservatism - shows the scale of the debt and the work that needs to be done - we are the worst after Japan, worse than Greece or Spain.

Fiscal Conservatism - we are just over a third of the way through austerity and the spending cuts are yet to kick in, we've had the tax pain. The government has less and less capacity to control what it does. For the first time in history the controlled spending is lower than uncontrolled spending, which makes it much more difficult to reduce and manage spending in the long run.

Monetary activism - this chart shows that the UK has embarked on the biggest monetary base increase ever (increased by a factor of five). Bigger than the US, Japan or Euro. These bonds can be resold to shrink the balance sheet but reselling this quantity has never been tried before.

What can £375 buy?

• A third of the gilt market - the BoE has bought almost all gilts over the last few years.
• Every single automobile in Britain (£185bn) and still have enough to buy everyone a car.
• It could have bought every property in Scotland and Northern Ireland
• A stack of pennies which would reach Mars.
• Every household in the UK could have been given £14400.

Undertaking QE was an enormous effect and to reverse it will be even more of an enormous undertaking.

Results:

• Distribution of Income - vast majority had fallen to the richest households who own the assets that are being pumped up by the QE
• UK housing market - still over-valued and yet still more housing stimulus is being pumped in - 'Help to Buy'.
• Cost of education has risen by a factor of four.
• Massive divergence in terms of geography - London never really suffered from the recession whilst the lowest regions have diverged most compared to other Euro nations.
• No global re-balancing - National current accounts are not rebalancing.
• No Euro re-balancing 1 - Eurozone countries have not reduced their labour costs significantly. The problem is really Germany as it is the outlier compared to other Eurozone countries.
• No Euro re-balancing 2 - beer prices show the Unit Labour Cost differences. We use beer because there is no Big Mc Index for Europe. The Eurozone (excluding Germany) needs a devaluation

It is malfunctions in the world's trade system that are driving these problems

Historic Current account Balances analysis - when did it work best? Bretton Woods was the best period for current account imbalances 1948-72

1. Bretton Woods compared 1 - world growth was very good, inflation manageable
2. Bretton Woods compared 2 - recessions were fewer and less significant
3. Bretton Woods compared 3 - sovereign defaults were lower too.

Ed says that we need to learn lessons from Bretton Woods and is writing a book explaining what happened. Although there are extenuating circumstances Bretton Woods led to the most stable period of time ever in international monetary terms

But the future is brighter says the OECD - we are going to grow faster than all other G7 counties - partly due to population changes, supply-side reforms - Ed's not sure if he entirely agrees.

Questions

What will happen with QE? Can we just cancel the debt?

It's possible, it's been talked about. A lot of people suspect that this will happen in due course after a significant period of time. Problem is that this is monetization of the deficit and this is Zimbabwe and Weimar Republic-like. It may happen but so much is gestural and about maintaining a responsible attitude to central bank and the Bank if England's independence. Don't expect anyone to talk about soon, and Mervyn King has explicitly ruled it out. But these are unprecedented times.

To what extent is currency speculation a cause or result of the crisis?

For better or worse the absence of Bretton Woods style capital controls increase instability, imposing capital controls doesn't reduce growth (at least within the Bretton Woods timeframe). Floating exchange rates used to be anathema and now they are standard. The problem is we aren't going to get a new Bretton Woods (we'd need a world war to go with the recession) so we aren't going to be rewriting the monetary rules anytime soon.

Is the press a malign influence e.g. immigration?

Ed says he has had no editorial pressure, non-economists may have pressure but economics specialists are left alone within the press sphere. A lot of the time there is morbidity about news but that reflects the publics desire to be part of a narrative which they can relate too, the causal driver of this is unclear.

Vince Cable - is borrowing money cheaply to fix the macroeconomy and the housing market supply issues a no-brainer?

London has become an international market separate from the UK economy. We do need more housing but it takes time, effort, changes to the planning restrictions. Difficulty is that existing householders oare so powerful anyone who crosses them will get voted out. Some might say that 'Help to buy' is a bribe to Tory voters.

Stephen D King - When the Money Runs Out.

Well money can't run out as central banks can print more, but we are considering this from a day to day perspective

Income growth

After 50 years i.e. Stephens lifetime

• 1st decade - real incomes see a massive increase
• 2nd decade - much lower real income growth of 13%
• 3rd decade - 26% back to 'normal'
• 4th decade - 30% 'normal again'
• Last decade - 4% increase this is incredibly low and unexpected compared to his first 40 years.

However China (130%) and India (80%) have seen strong growth. Surely this must be good for us as our exports markets will increase? Unfortunately this hasn't happened and not just because of the financial crises. Is this a return to more normal growth rates more similar to the first half of the twentieth century? Was it technology that drove the sixty years of growth? Yes says Stephen, but there are other factors.

Drivers of growth during Stephen' lifetime:

• The opening up of world trade - firstly between the OECD, then between the East and West (Germany and Russian, China and the US). Next are the South South connections, Asia downwards and South America - not so much Western Europe or North America
• Women in the workforce - big change in the last sixty years
• Consumer credit - really important for generating economies of scale as consumer consume tomorrow's savings today. This is unlikely to be able to continue.
• Education - number of Uni grads has grown enormously, this is a one-off big increase, however there is more competition now for the top jobs.

This added up to sixty years of really impressive growth, which is unlikely to be sustained. Is there a combination of magical monetary policy which can restore growth? Nope says Stephen.

Huge amounts of monetary and fiscal stimulant in 2001/02, low interest rates, fiscal stimulus (Bush Tax cuts) - these were justified in that growth was supposed to return to trend. However if you look at US growth post 2002 the average growth was 2.5% which does not correspond with the 80s/90s 3% growth that everyone expected.

There is a real challenge for the public sector which assumed growth of nearly 3% - especially now when the growth is much lower. Public spending as a share of GDP is now much higher as a share of GDP compared to historic trends - nearly 50% of GDP.

The quality of the spending is also an issue - an ONS study into NHS productivity concluded that over five estimates of productivity two showed progress, one static, two declined. It was proved very hard to measure and to pull out the gains from innovative pharma as opposed to health care.

Infrastructure can be interesting e.g. Spain has had lots of wonderful infra development but this has not lead to growth.

The private sector is also a concern - CEO pay in USA 38x average in 1980 and in today's data it is 380x average earnings.

Adam Smith describes three states of a nation:

Progressive states: no absolute losers, everyone is getting better off even if inequality increased.

Dull states: a stagnation

Melancholy state: recessions.

These last two are zero sum games and lead to a loss of trust and as people are are fearful and risk averse they tend to lose their entrepreneurial spirit. The way we usually try to deal with these states is to bounce back as policy makers like to believe it is a cyclical swing while it may in fact this time be a structural problem.

Stephen quotes from Freud - "the future of illusion" - why was it that people believe in God. Freud said that a world without God is empty and miserable so you are better off believing in God, belief is an illusion and not dissimilar to what Economic forecasters are doing now, especially if the issues are structural and cannot be solved. So we naturally assume a faster growth to escape the Dull and Melancholy states.

Surely if we did more monetary and fiscal stimulus it will be better - Krugman's analysis. Krugman wants a New Deal Roosevelt style

History is important here says King, he looked at 1930's data

US GDP fell 30%, prices fell 20%, Unemployment 25%. Roosevelt offered a huge fiscal stimulant, he inherited a 2pc deficit and loosened to 9pc. He also had a major regime change and improved flexibility by taking dollar off the Gold standard. We cannot do these things and we've already depreciated our currency.

Roosevelt also promised higher inflation - saying that it was wrong that debtors should pay back real debts as it was unfair on them since deflation had increased their real debt. He said it was important that prices return to normal levels to make debt repayment possible. But our prices have never fallen, and this argument isn't valid.

King argues it was a 1930's style crisis in 2007 and the responses were very good, however we have made promises that we cannot keep including health care, public sector spending, house prices and CEO pay and we cannot expect to meet these unrealistic goals.

King looked at history for Dull and Melancholic States

Argentina was one of the richest countries in the world in 1900 - same as Germany and now only half as good. Argentina was unusually dependent on foreign savings which dried up in the Great Depression. Argentina choose e narrative of protectionism and isolation and cut themselves off from the flows of money that could grow their economy., money left the country and political class atrophied and it all become a very bad story. This is the situation that the US and UK could find themselves in now.

Other examples of when the major narrative changes:

Peasants revolt - result of the Black Death on working population plus the squeeze on pay to fund wars with the French.

French Revolution - explained by the fact France saw surges in living standards which created high expectations before France it an economic brick wall and he economy shrank, the income inequality issue created a atmosphere of revolution.

UK in the 20s and 30s - Britain adopted a currency union (gold standard) in 1925 at an overvalued level and saw a period of continuous austerity until 1931. Creditors would be reimbursed and the UK would repay its debts. It was clear that Brtain would stay on e Old Standard, ten days later they left the Gold Standard. UK lost the support of the military due to solider pay cuts and the public mood shifted, then the policies moved.

Point is that when the environment changes policies are forced to change. T draw a parallel with re-revolutionary arrange is that the Debtors (Southern Europe) will eventually shift the burden of debt to the credit (Northern Europe)

Distopia - extending the French and Argentinian story, what happens if we return to isolation and nationalism. This is plausible and we are seeing shifts in Greece and Spain. Some parties even move to take advantage of the conditions to promote extremism. This leads to some very strongly reactionary policies e.g. Japan could adopt a hyperinflation plan.

What can be done?

Global imbalances - worry about the current account surpluses as well as the deficits. E.g. Germany, Japan and China. Savers create distortions too.

In Eurozone there may need to be fiscal union and one-off fiscal restructuring.

For the US and UK austerity needs to be replaced with a commitment to reducing deficits except when there is a recession. Bram Hollings Act

Something to look after the young instead of the old, choices must be made and decisions must be made for the future not just the short term.

Nominal GDP targeting- because it safeguards the value of contracts.

Banking needs to have some sort of consequences - fines, hypocritical oath and being imprisoned and struck off.

A pure focus on models within a poor data set was totally and utterly wrong. Many lessons were there to be learned but we seem to have ignored or forgotten them.