19th December 2016
To finish off in what turned out to be a remarkable year, no year in review in the conventional sense, and no bog-standard, bank-type economic outlook 2017. Rather, and in keeping with the time of year, here is a list of nine economic lessons (but no carols) that we learned. ‘Learn’ may be a bit strong in many cases, so perhaps ‘became more aware’, instead.
1. Financial crises have deep, long-lasting effects
Had there been no financial crisis in 2007/08 with all the consequences that came with it, the economic outcomes – and, therefore, political history – of the last 8 years would have been markedly different. We can talk about globalisation and income inequality until we are blue in the face, but these issues alone don’t explain what’s happening, and anyway, they pre-date the Lehman bust. This year, I think the financial crisis, which upended the world system, has gotten off lightly. The only real surprise was that it took so long for the political backlash to erupt as it has. There’s been no attempt to help people understand the systemic causes of the financial crisis or how we really might act to mitigate the possibility of a repetition. Many people, well off and not, have been left with a perception about collusion between bankers, captains of industry, politicians and other members of the ‘elite’. It’s not well defined, but nonetheless real.
There’s still time to change the way our economics and economic systems work for society but the politics of those with with less benign intentions are knocking on the door.
2. It’s ‘the political economy, stupid’
The mantra of James Carville, Bill Clinton’s campaign strategist 24 years ago, needs a makeover. There clearly are circumstances in which people vote with passion against their fundamental economic interests, or at least, subordinate them to other things.
In the Brexit referendum, there were and still are heated arguments about the economics of leaving. Remain short-term economic forecasts were wrong but three things have been corroborated: the money that was going to be saved for the NHS etc by leaving was a myth; the glacial negative consequences of leaving are starting to build, no matter how many sweet deals the government might strike with the likes of Nissan and so on; we might feel more confident if the government had a strategy to mitigate the corrosive consequences of leaving. Free trade mantras just wont cut the mustard. In the US election, Trump won the votes of people whose living standards will certainly not benefit from big tax cuts for the better off, or the consequences of trade conflicts which will be anti-growth and inflationary.
Economics isn’t everything any more, and to some, not anything, necessarily. Politicians have to appeal to more than pockets.
3. The fallacy of disaggregation.
This is a mirror image of a well-known economic concept, known as the fallacy of aggregation, which emphasises that what’s good for the individual may not always be in everyone’s collective interest. Think saving more as an individual versus everyone doing it and ending up in a demand slump, or you and the joys of car ownership versus everyone and the pain of urban congestion. The fallacy of disaggregation simply means that what’s good for the economy may not always resonate for all individuals.
Even though the post-crisis economic recovery has been slower than normal, GDP is now significantly higher than it was in 2007-08 in the UK and US. But over the entire period, real incomes have flat-lined or fallen for most people. This speaks to now very familiar distributional issues. Employment, the core of total income growth, is at record levels in both countries. In the US, for example, there are 9 million more jobs than the last peak at the end of 2007, according to the Economic Cycle Research Institute, but whites, who account for 78% of the labour force, and 71% of the population in smaller cities, now hold 700,000 fewer jobs than then. Among prime age workers, aged 25-54, white employment is 6.5 million lower, while Hispanics, Blacks and Asians have all done relatively better. There are numerous examples of labour market winers and losers.
Aggregate data can sometimes mask some uncomfortable and disturbing trends for particular demographic groups or cohorts.
4. Walking on 2 policy legs again
2016 probably marks the point at which we came to recognise finally that the sole reliance on quantitative easing and unorthodox forms of monetary policy, developed since the financial crisis, had reached the end of the road. For some time, many people have been resigned to the central role of monetary policy because there was no other serious attempt to influence the economy. But the brief of monetary policy is limited. It can’t boost productivity, provide ubiquitous broadband, raise educational attainment, or address structural economic problems. Now, with political pressure in the ascendant, governments are being forced to review policy-making. Canada and Japan have moved towards greater fiscal activism. The US almost certainly will, and the UK has to a limited extent, according to the recent Autumn Statement. A year from now, QE will no longer preoccupy us as before, including in the UK, Euro Area and Japan, where it is still being pursued but with waning interest.
Fiscal initiatives, ironically urged on governments by the left during the last several years when economic conditions were worse, are now finding favour with the right when they are better.
5. The old normal might just be the new normal
Curiously, the adoption of a more pro-active fiscal policy in the US, for example, coincides with the economy doing reasonably well after a 5 quarter hiatus until the second quarter 2016. By standard measures, it is at more or less full employment. Since the economy’s trend growth rate is probably about 2% and Trump wants to see it growing close to 4% as a matter of course, the implication is that there will some upside bias to inflation. In the UK, the expectations for higher inflation are well entrenched following the fall in Sterling. A strong US dollar, itself the result of Trumponomics expectations, is liable to put upward pressure on other countries’ inflation rates too, including in China. Oil prices are up 45% this year even before the recent OPEC output restraint agreement comes into force. The US Federal Reserve just raised rates for the second time since the financial crisis, and thinks it might have to do 3 more times next year.
This shift in inflation thinking may be important: it is already affecting global bond markets and could spread.
6. Farewell to free or free-er trade
The Brexit and Trump votes showed significantly that large swathes of the population have had it with free trade, and identify it with job losses, unfair competition, excessive migration and so on. We can’t say we haven’t seen it coming. Between 1991 and 2009, there were around 20-40 free trade agreements signed each year, but this plummeted to 10 or less after 2010. World trade which had previously grown twice as fast as global GDP for 30 years, is now struggling to keep pace with it. Deglobalisation of finance, trade and investment is the new trend, and while it looks nowhere as bad as what happened in the 1930s, we have to hope that the stall doesn’t become a slumping that Donald Trump’s anti-free trade bark is louder than his bite.
The liberal trading order that the US has sustained for the last 60 years may now lose its main protector. Emerging markets, which have been the main beneficiaries, should watch out.
7. Wretched robots
Since we are well past peak globalisation, the debate about jobs is moving on quickly to the effects of robotics, and machine intelligence. On the one hand, advanced manufacturing techniques could encourage some companies to stay at home, or repatriate jobs, but on the other new technology isn’t labour-friendly because it lowers the demand for middle-wage paying, middle-skill level occupations. This affects people directly, and whole communities.
For example, big metropolitan areas, with relatively high numbers of migrants, provide a lot of low end, low pay service jobs. It’s certainly not great financially if you work for Deliveroo or Uber. But in thriving and vibrant large cities, you have to have work to get on the ladder and at least believe you can get on. In smaller cities and towns and in the countryside, if you’ve been digitised out of a decent manufacturing job where employment and income are shrinking, your community is at risk.
Encouraging investment in and the development of jobs for people who lack top quartile educational attainment, is going to be one of the most urgent agenda items for politicos and civil servants. Plus regulation on conditions of work for people in the gig economy. We may all have to come to terms with having to pay more for services.
8. Even economic experts have to learn
Thanks Michael Gove for lowering the tone of this particular lesson, which people will hopefully unlearn very quickly. There are several things economists should not be proud of. We taught people too much maths and modelling over the years, and not enough economic history and economic thought. Most economists didn’t spot the biggest financial crisis since the 1930s. And many can’t shed the economic themes and structures that arose in the 1980s. Taking the whole period from 2010 to date, and incorporating the Eurozone crises, much economic thinking, espoused by political leaders, has been drivel and or positively harmful. The blind belief in the powers of monetary policy alone to nurse a return to economic health in the wake of the crisis beggars belief.
And yet….economists are experts in how economic systems function and respond under given conditions. If we didn’t have them, we’d have to invent them. It doesn’t mean the shibboleths that ruled before the financial crisis are as good, or any good, now. Economists are always going to get things wrong, but make them ask the right questions and get them to specify the conditions in their answers, and you’ll find we are quite a user-friendly group.
9. The world economy is sort of ok at the moment
Finally, let’s be upbeat-ish. With the S&P and FTSE breaking records, the 2017 economic outlook doesn’t look so bad. The US economy is finishing this year on a bit of a roll, after a long soft patch of weak inventories and capital spending. Now Trump wants to rev it up some more. China is stable and doesn’t want anything untoward to impact the all-important 19th Party Congress at the end of 2017. It will pay a major price later, but probably not next year. The Eurozone is growing modestly: it could implode if the French or probable Italian elections bring populists into power, but right now, it’s doing alright. In the UK, manufacturers are ending the year with decent order books, and consumer confidence is high. For the moment, flaws and all, the global economy doesn’t look like it’s about to go into a deep dive at all.
Ok, sour note after all: we are in very unfamiliar political territory (unless you’re a baby-boomer or older) and living with high unpredictability. How will Trump, Putin and Xi set about re-arranging Europe and Asia, and to what effect for NATO and other global institutions? Will European elections end up destroying the EU and producing one of the biggest economic and geopolitical shocks since 1945? Will Brexit then become the equivalent of a rounding error?
More lessons, one imagines, for this time next year.