The long arc of UK productivity

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Nick Crafts has a compact book – based on a series of lectures – about the trajectory of the British economy from the Industrial Revolution to the present. Forging Aahead, Falling Behind and Fighting Back: British Economic Growth from the Industrial Revolution to the Financial Crisis is a very nice and pretty up-to-date summary of the state of knowledge in economic history, combined with Nick’s somewhat idiosyncratic – but highly plausible – view that the seeds of the country’s post-world war 2 relative decline were sown in the institutions that enabled it to perform so well during the 19th century.

The chapters look at successive eras: the 1st Industrial Revolution, the US overtaking in the late 19th century, the Interwar years, the Golden Age, and the recent past. The trends in GDP, labour productivity and total factor productivity growth are set out, comparing Britain to a number of outher countries (mainly the US and Germany). The lens is modern endogenous growth theory, considering the expected returns to innovation and agency problems, and also – importantly for the US part of the story – the importance of market size. The book also makes use of the Hall and Soskice framework of comparative political economy. The argument is that being caught up by other countries was no shame, but being overtaken in absolute income per capita levels by all other comparator countries in the second half of the 20th century reflected significant policy failures.

The policy failures, in Nick’s view, date to the emergence of liberal market economy institutions in the early phases of the Industrial Revolution.  Although understandable at the time – notably the development of equity financing with dispersed shareholdings, rather than bank financing, and decentralized strong craft unions due to the importance of skilled labour for the young technologies – their persistence into the 20th century meant Britain lacked the ‘social capability’ that would have enabled it to take productive advantage of 2nd and 3rd Industrial Revolution technologies. The continental co-ordinated market economies fared better.

The other key policy failure underlined in the book is the weakness of competition policy in the domestic market, combined with the slow removal of barriers to competition from imports due to delayed entry into the European Economic Community (as it was). Postwar British governments protected has-been industries (not growing frontier ones, as some economists would support). And, having long been a leading free trader, this policy leadership was ceded, at least within Europe.

It’s a persuasive account. The one bit of economic history debate I’m aware of that’s not reflected here is the very recent debate between Jane Humphries and Robert Allen about how high real wages actually were during the Industrial Revolution (Allen arguing that high labour costs and cheap coal – ie factor prices – in the UK played a key role at that stage). So the book is a very nice survey of the state of knowledge about productivity and growth. It even ends on a mildly optimistic note that British institutions may be better suited to the distributed digital technologies, albeit pessimism about the prospect of leaving a large scale low barrier competitive market would surely outweigh this. And the bottom line is that the level of productivity and incomes in the UK compared to other leading economies leaves us with plenty of catching up to do.

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Crashed

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Adam Tooze’s much-praised history of global political economy from the period just before the Great Financial Crisis to the present – Crashed: How a Decade of Financial Crises Changed the World – is indeed a terrific read. It’s a detailed (600+ pages) synoptic account of the political forces that enabled a few dozen banks to entwine the world’s economies in an interlinked web of credit at massive scale, and the political reactions to and consequences of the crisis. One might quibble that some parts of the story are sketchier than others, but then it’s always a good sign to be hankering after more of a book rather than less. Making the parts into a convincing whole is a major achievement.

There are several central points the book emphasises. One is the extent to which the dollar underpinned the whole global financial market construct – and consequently the extent to which the Fed bailed out the whole world after the crisis. Another is busting the myth that the crisis was Anglo-Saxon: the continental European banks were in it up to their eyeballs, with equally ineffective regulatory oversight, such that they too had massive maturity mismatches (like the US banks) and also massive currency mismatches (whereas it was all dollars for the US banks). Tooze is also forensically critical of the lack of a coherent European policy response – both the ECB (especially under Trichet) and the German political establishment come in for particular fire. The policy response to the Greek crisis in particular was abysmal – as was clear at the time. It was always apparent, certainly by 2012, that debt restructuring was essential, and that the bailout was for German and French banks more than for Greece.

The book explores the interplay between the financial crisis and geopolitics, particularly the desire of both China and Russia to ensure the transition – already heralded but revealed by the role of the dollar to be exaggerated – from a unipolar to a multipolar world. Above all, it draws the lines from the possibility of the crisis, and the crisis response, to the current political situation: “Though it is hardly a secret that we inhabit a world dominated by business oligopolies, during the crisis and its aftermath this reality and its implications for the priorities of government stood nakedly exposed. It is an unpalatable and explosive truth that democratic politics on both sides of the Atlantic has choked on.”

Quite so. Here in Brexit Britain, those working in the City have by and large continued to draw their large bonuses, retire early, holiday in exotic places, while post-crisis ‘austerity’ due to the way the crisis torpedoed public finances means many fellow citizens need to use food banks and are seeing local services like social care and libraries starved. Whatever you think about the consequences, the anti-establishment protest vote, in the UK and elsewhere, is entirely understandable. I’ve been completely gobsmacked by how little consequence of the crisis there has been for the financial sector and those working in it. The same went for the rest of Europe, creating “the sense that Europe’s welfare state was being subjected to a relentless program of rollback driven by the demands of bankers and bond markets.”

So too in the US. Tooze describes the election of Trump as the “most disorienting event experienced by the American political class in generations.” It seems likely to me to be even more damaging for the United States than Brexit will be for Britain. Disorienting, but really hardly surprising. It isn’t only the lasting, scarring financial, emotional, health costs the crisis inflicted on millions of Americans (“The grief and distress caused by the crisis were forces to be reckoned with”) but also the way the Fed’s crisis response and the Obama administration programs contributed to polarising American politics. This happened elsewhere, too. Inevitably perhaps, during the firefighting technocratic responses took priority over democratic legitimacy. We see the lasting consequences in the (slightly abstract) disdain for ‘experts’.

Nobody comes out of Tooze’s account particularly well, although some fare less badly than others (eg Bernanke vis a vis Trichet). Some readers will disagree with the economic diagnosis – for there are people who believe the austerity was essential, the fiscal bomb having been detonated by the crisis. There is more sympathy for the Syriza government than many of its interlocutors in Brussels, Berlin and Paris would share. There will be too much detail for some readers – it helps to know what haircuts and CDOs and repos are. Nevertheless, ten years on, Crashed is an essential read to understand the state of the world, and a troubling read, thinking ahead to the next ten years.

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The Community of Advantage

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I very much enjoyed reading Robert Sugden’s The Community of Advantage: A Behavioural Economist’s Defence of the Market. It tackles the aspect of behavioural economics that has always troubled me: the presumption that there’s a wise policy-maker who somehow knows better than I do what’s good for me and will act like a government version of Mad Men to non-coercively get me to choose accordingly. In other words, libertarian paternalism is a contradiction in terms, and in reality. In fact, I’m torn because – like many other “experts” –  I do think economists (or doctors, or engineers, or farmers, or nuclear physicists etc) often do know better than most of us what makes for a better outcome. Even in less expert domains, such as the provision of news, it is surely better not to give people exactly what they want, if that’s bias-confirming news rather than impartial and accurate news.

However, Lord Reith and other paternalists didn’t pretend to be ensuring people got what they *really* want, rather than what’s good for them according to the paternalist. As Sugden points out early in this excellent book, most behavioural economics implicitly assumes it’s possible to discern a set of ‘true’ but latent individual preferences, undistorted by the various psychological mechanisms identified in the literature. It addresses policy prescriptions to a benevolent social planner, the policy maker – in other words it takes what’s referred to as “the view from nowhere”, an impartial spectator outside society. This enables a normative assessment of behavioural policies. It’s an appealing idea in many ways, and an admirable effort to take this impartial perspective. But it is of course open to the standard public choice critique and has led (as I argued in my Tanner Lectures some years ago) to bad economic policy choices. Sugden also criticises Sen’s alternative of finding impartiality in the ability of a proposition to withstand reasoned public debate; “I cannot see why I am morally required to justify my private choices by reasoned arguments and to expose those arguments to public scrutiny,” he writes.

Sugden advocates instead a contractarian approach, so rather than asking is aggregate welfare maximized, the question is: “is it in the interest of each individual to accept the rules of that institution, on the condition that everyone else does the same”. The behavioural challenge is devising economic institutions satisfying this condition with respect to individuals who do not know what their preferences are. To translate this into a normative criterion useful for policy, Sugden proposes that: “It is in each individual’s interest to have more opportunity rather than less.” In other words, there is an an analogue to the invisible hand theorem: “The guiding idea is that a well-ordered economy is an institutional framework that allows individuals to co-operate with one another in the pursuit of what they perceive as their common interests.” He traces the approach to Hume’s view of good institutions in a well-ordered society as self-reproducing and self-enforcing conventions – self-enforcing because of mutual advantage, albeit emerging in an evolutionary way in society. Moral reasoning is addressed to individuals rather than a nebulous ‘policymaker’ outside of society.

A couple of technical chapters demonstrate that the contractarian approach is a generalisation of the usual welfare theorems in an exchange economy. The book then turns to policy questions: what kind of regulation can be justified in normative terms if the criterion is expanding individual opportunity (rather than satisfying their ‘true’ latent preferences)? For example, what about someone choosing how much to save for their retirement, a well-known behavioural policy example. Sugden suggests: “Behavioural economists’ propensity to interpret context-dependent preferences [like the opt-out/in pattern] as evidence of self-control problems may be a side-effect of their commitment to the model of the inner rational agent.” He argues that the policy drive to increase personal retirement savings is driven by policy regimes in which pensions are privately provided – so the behavioural policy is there to serve the regime rather than the individual. “A contractarian solution to this problem may require some form of compulsory saving.” In short, the nudge is a fig leaf and the better policy (increasing individuals’ opportunity sets) would be a straightforward regulated contribution.

The term ‘community of advantage’ comes from Mill. Sugden is making an ardent liberal case, while recognising the realities of human psychology. I remain somewhat torn. To go back to Lord Reith, British TV viewers, when asked, are very clear that they prefer watching sport, comedy, movies and soap operas, but they also definitely want their licence fee to support the provision of impartial news, children’s programmes, educational material and other wholemeal stuff. Those preferences are not latent, but rather acknowledge explicitly the mutual as well as the individual benefit. However, Sugden’s approach is very attractive & I’d say The Community of Advantage is a must-read for those interested in behavioural and welfare economics.

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Who benefits from research and innovation?

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I’ve been pondering a report written by my friend and Industrial Strategy Commission colleague Richard Jones (with James Wilsdon), The Biomedical Bubble. The report calls for a rethinking of the high priority given to biomedical research in the allocation of research funding, and arguing for more attention to be paid to the “social, environmental, digital and behavioural determinants of health”. It also calls for health innovation to be considered in the context of industrial strategy – after all, in the NHS the UK has a unique potential market for healthcare innovations. It points out the there are fewer ill people in the places where most biomedical and pharmaceutical research is carried out, thanks the the UK’sregional imbalances. It also points out that, despite all the brilliant past discoveries, the sector’s productivity is declining:

“In the 1960s, by some measures a golden age of drug discovery, developing a successful
drug cost US$100 million on average. Since then, the number of new drugs developed per
billion (inflation adjusted) dollars has halved every nine years. Around 2000, the cost per
new drug passed the US$1 billion dollar milestone, and R&D productivity has since fallen
for another decade.”

All of this seems well worth debating, for all its provocation to the status quo – and this is a courageous argument given how warm and cuddly we all feel about new medicines. I firmly believe more attention should be paid to the whole system from basic research to final use that determines the distribution of the benefits of innovation, rather than – as we do now – treating the direction of research and innovation as somehow exogenous and worrying about the distributional consequences. This goes for digital, or finance, say, as well as pharma. What determines whether there are widely-shared benefits – or not?

Serendipitously, I happened to read a couple of related articles in the past few days, although both concerning the US. One was this BLS report on multi-factor productivity, which highlights pharma as a sectors making one of the biggest contributions to the US productivity slowdown (see figure 3). And this very interesting Aeon essay about the impact of financial incentives on US pharma research. It speaks to my interest in understanding the whole system effects of research in this domain. Given that this landscape in terms of both research and commerce is US-dominated, this surely makes the question of how the UK spends its own research money all the more relevant? As The Biomedical Bubble asks:

“[T]he importance of the biotechnology sector has been an article of faith for UK
governments for more than 20 years, even when any notion of industrial strategy in other
sectors was derided. So the failure of the UK to develop a thriving biotechnology sector
at anything like the scale anticipated should prompt reflection on our assumptions about
how technology transfer from the science base occurs. The most dominant of these is that
biomedical science would be brought to market through IP-based, venture capital funded
spin-outs. This approach has largely failed, and we are yet to find an alternative.”
For it seems the model is no longer serving the US all that well either – not economy-wide innovation and productivity, and not the American population, which has worth health outcomes at higher cost that any other developed economy. There are some challenging questions here, fundamentally: who benefits from research and innovation, how should the public good being funded by taxpayers be defined and assessed, and what funding and regulatory structures would actually ensure the gains are widely shared?
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Made by Humans: the AI condition is very human indeed

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A guest review by Benjamin Mitra-Kahn, Chief Economist, IP Australia

There is a lot of press about the coming – or going – of artificial intelligence, and in Made By Humans: The AI Condition  Ellen Broad has written a short but comprehensive account of the state-of-play which deserves to be read by anyone wanting to know what is happening in AI today, certainly if you want to get in on the conversation.

The book is very contemporary, and if you haven’t had the time to attend every conference and workshop on AI since 2015, then you’re in luck. Broad has been to them all, and this book will catch you up on all the developments. The book also offers a series of insights into the challenges that AI and big data present – because it is about both – and the questions we should ask ourselves. These are not the humdrum questions such as who a self-driving car should choose to crash into (although a randomized element is suggested), but some bigger and much more interesting questions about whether we need to be able to inspect the algorithm that made the decision. Does the algorithm need to be open source or does it need to be exposed to expert review to ensure best practice, and should the data that trained the algorithm be openly accessible or available for peer-review. Using every example about data and AI from the last three years, Broad steps through the issues under the hood that are only now being thought about.

This naturally brings up the question of government regulation. This is something Broad has changed her mind about, which she discusses openly in a book that moves between a technology story, personal discovery and ethical discussions. There is a role for regulation says Broad, and the fact that we don’t yet know what that regulation could be, or should be, is handled with some elegance. Technology is not a nirvana , computer code sometimes held together with “peanut butter and goblins” and written by people who are busy, under-funded or just average. Simply aiming to ‘regulate AI’ however is akin to wanting to regulate medicine: It is complex, dependent on who you impact, their ability to engage, and the risks as well as the situation. It is a human-to-human decision ultimately. Not perhaps the argument one expects in a book on AI by the ex-director of policy for the Open Data Institute and previous head of the Australian Digital Alliance. But it is about humans, and the AI condition is about humanity – about fairness, intelligibility, openness and diversity according to Broad.

The book finishes with US Senators questioning Facebook about Cambridge Analytica, and the recent implementation of the GDPR (data governance, not a new measure of GDP), which quickly dates the book, but that is a choice the author makes explicitly. This book is about the current conversation on big data and AI, and it is about participating in that conversation. It is not about the last 50 years of ethics and the history of computers. There is an urgency to the writing, and as someone interested in this, I found myself updated in places, and challenged in others. Reading this book will allow anyone to particpate in the AI debate, knowing what Rahimi’s warning about Alchemy and AI is, being able to discuss the problems around the COMPAS sentencing software, or seeing why Volkswagen’s pollution scandal was a data and software scandal first. If this is a conversation you want to engage with, Broad’s book is an excellent starting point and update.

 

 

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