A Guest Blog by Philip Whiteley

Note: Philip is one of the co-authors of a forthcoming (2012) book, New Normal, Radical Shift. This is a guest post from the Radical Shift blog.

Here are some highlights of a recent speech on financial services:

‘In 1989 the CEOs of the seven largest banks in the United States earned on average $2.8 million. That was almost 100 times the median US household income. By 2007 … CEO compensation among the largest US banks had risen almost tenfold to £26 million. That was over 500 times the median US household income.’

And yet, the speaker complained, returns for investors were negligible over this period of widening income inequality, and the actions of banks had imposed huge costs on wider society. He added: ‘Temporary support for the global banking system during the crisis peaked at around a quarter of global GDP. The permanent damage to world GDP from the crisis is still being counted, but it is likely to be several multiples of that.’ The problem lies in serious imbalances between privatised returns and socialised risks, he said. ‘This calls for fundamental reform.’

The speaker was not the leader of the Occupy protests, nor a left-wing populist politician, but Andrew Haldane, Executive Director, Financial Stability at the Bank of England, giving the Wincott Annual Memorial Lecture on 24 October. Full text of the speech is available here.

The fact that a senior regulator at the Bank of England broadly agrees with the tented protestors causing such a fuss on the steps of St Paul’s Cathedral in London and in Zuccotti Park in lower Manhattan is an indication that we are entering new territory.

Our politics is struggling to catch up with the scale and the pace of the economic crisis; battle lines often fought on the basis of the ‘old normal’ agenda of public versus private, left versus right and regulation versus deregulation. This will not do. Much fuller understanding comes from understanding vested interests, following the money, and looking at actual behaviour.

A deeper understanding of the current crisis comes in the recent book [amazon_link id=”0691145180″ target=”_blank” ]The Economics of Enough[/amazon_link], by Diane Coyle of this blog. In a single sentence, she summarises our dilemma:

“Alongside the potential impact of climate change, we face a debt crisis, a result of untenable social security arrangements in ageing societies as well as the impact of bailing out the banks that caused the financial crisis; a strong sense of unfairness caused by inequality and the failure of certain groups to benefit much or at all from greater prosperity; and the depletion of social capital against a background of declining trust in authority and institutions.”

(Our review of her book is published here.)

The need for a longer term perspective to governance is pressing; sustainability is for the public sector, as well as corporations. One possibility is for the second chamber of a democracy to be constitutionally devoted to long-term matters such as pensions policy, infrastructure, and higher education. This institution would have power of veto over a government wanting to borrow above a certain percentage of GDP. Members would serve one-term only, but probably for longer than the standard four or five years. There would be no party whips.

Another factor driving short-termism has been the use of technology. Fast computing has combined with over-optimistic faith in efficient markets. City traders often pile into a stock or bond not because they see value in the underlying asset, but because they think the price will rise in the next 48 hours. Some use ultra-fast broadband, and seek to make money in the nano-seconds it takes for price changes to reach other dealers. These activities exacerbate the already destabilising investment bubbles that can create havoc in the real economy. Speculative finance is now out of control, and is increasingly criticised by business leaders as well as trade unionists (see this earlier post).

But one of the problems with making these criticisms is that they are often interpreted as a general attack on all financial services. Many debates descend into sectarianism: Wall Street good/Wall Street bad; global capitalism good/global capitalism bad. This is hopelessly inadequate. We desperately need to move beyond the confines of ‘left/right’ politics.

• ‘Beyond left and right’ is the subject of a chapter in the forthcoming book New Normal, Radical Shift. Excerpt here.

One of of the thriving areas of economics in recent times has been the study of urban economies. This year brought Ed Glaeser’s terrific book, [amazon_link id=”0230709389″ target=”_blank” ]The Triumph of the City[/amazon_link], which serves as an excellent route into the research. Although all work on cities acknowledges the influence of Jane Jacobs, in [amazon_link id=”0679600477″ target=”_blank” ]The Death and Life of Great American Cities[/amazon_link] and [amazon_link id=”0394729110″ target=”_blank” ]Cities and the Wealth of Nations[/amazon_link], he revival of economic geography more generally dates back to work by Paul Krugman in the early 1990s, such as [amazon_link id=”0262610868″ target=”_blank” ]Geography and Trade[/amazon_link] (1991) and [amazon_link id=”1557866988″ target=”_blank” ]The Self-Organizing Economy[/amazon_link] (1996). Fujita, Krugman and Venables captured much of this work in a 1999 textbook, [amazon_link id=”0262561476″ target=”_blank” ]The Spatial Economy[/amazon_link]. This strand of research in economics has entwined fruitfully with the work of urban theorists and economic geographers.

A very interesting new book, [amazon_link id=”1442611529″ target=”_blank” ]The Evolution of Great World Cities: Urban Wealth and Economic Growth[/amazon_link] by Christopher Kennedy, takes the logical step of connecting the study of the economic growth of cities themselves with the contribution cities make to the growth of the economy. It is – or should be – an obvious point: growth is not abstract, it happens somewhere, and mostly where it happens is in cities. If you want to understand growth, you need to think about making it happen in cities. If the UK economy needs to grow faster, that growth will have to occur in Manchester, Bristol, Edinburgh and Cardiff as well as London. So the question arises as to the transmission mechanisms between the urban economy and national outcomes.

Kennedy argues that successful cities follow a path from commerce to innovation and industry to finance, with the development of key infrastructure as the catalyst for this evolutionary process. Thus for example the investment in the Erie Canal,  widely criticised at the time as a waste of a huge sum of money, was vital for New York City, and decisive in making it, rather than Philadelphia, America’s financial centre and wealthiest city. This emphasis on communications infrastructure chimes with the instincts of everybody involved in city government, but is rather at odds with much economic analysis. Economists tend to be a bit sceptical about the benefit-cost ratio of ambitious transport projects – see for example the eminent Henry Overman of the LSE on the current debate about HS2 – but it is possible that economists’ normal approach under-estimates the size of dynamic (and therefore hard to quantify) benefits – as long as the investment pays off. A thorough assessment of Kennedy’s argument on this point would need to look at why so many big transport infrastructure investments do not transform urban fortunes.

He has a neat point that residential housing wealth is one of two main components of a city’s wealth, because the amount people will pay to live in the city captures most of the external benefits they derive from being in that location rather than another. This means that other assets – town halls, parks, museums, tram lines – need not be counted. The second main component is the financial wealth of the city’s inhabitants. His argument about the links between financial markets and specific urban economies lost me rather, in particular an unconvincing point (on the face of it) that there is a conservation principle when it comes to wealth – if shares go down some people lose out but others will have gained and will put their money in some other asset such as god. Obviously there is a buyer for every seller, and investors face a portfolio of options, but this does not seem to imply an inevitable global ‘waterbed effect’ in asset values unless one defines an ever-expanding set of assets – when it becomes true by definition and not necessarily interesting.

However, the more general point about the role of finance in major cities is an interesting one, and this area would repay further study by economists. It doesn’t feature as strongly as one might expect in the literature.

The book is also a good, fluid read. The argument is made through many historical examples, some familiar, others new to me, all helping keep up the pace and interest. I rather agree with the conclusion that there are two main tasks for urban leaders: direct budgets to the most important big projects; and set out a future vision of the city to co-ordinate the expectations and activities of the millions of people who live there. Kennedy shares the increasingly prevalent view of cities as a more or less organic complex system, with citizens best placed to look out for their own wealth.

[amazon_image id=”1442611529″ link=”true” target=”_blank” size=”medium” ]The Evolution of Great World Cities: Urban Wealth and Economic Growth[/amazon_image]

These are strange times when one rushes to look at the latest news thinking, ‘I must find out how the yield on Italian government bonds has just responded to the Standard & Poors alert.’ However, my focal length was extended a little by reading a marvellous essay by the Princeton economic historian Harold James, The Poetry of The Euro, in which he reminds us of the history and meaning of the European project. The essay ends:

“Jean-Claude Trichet, until recently the president of the European Central Bank, liked to claim that money was like poetry, before adding that both give a sense of stability. That unusual but accurate formulation is reminiscent of General August Neidhardt von Gneisenau’s famous reply to the Prussian King, who dismissed as “nothing more than poetry” von Gneisenau’s patriotic concerns in the early nineteenth century. “Religion, prayer, love of one’s ruler, love of the fatherland, what are these but poetry?” von Gneisenau asked. “Upon poetry is founded the security of the throne.”

Stable money, too, is the foundation of political order. We should not allow ourselves to be so overwhelmed by today’s crisis that we forget that.”

Reading Harold James sent me back to a brilliant book by the late Tony Judt, [amazon_link id=”009954203X” target=”_blank” ]Postwar[/amazon_link]. For those who have never read it, it would be a timely moment to do so. The context Judt gives us is the centuries-long history of conflict between different parts of Europe. Towards the end of the book, he quotes Alfonse Verplaetse, Governor of the Belgian National Bank, in 1996: “Europeans want to be sure that there is no adventure in the future. They have had too much of that.”

The real fear about this life-or-death struggle for the Euro is that it might presage an unwelcome return to the days of adventure. The crisis certainly signals that the moment of unaffordability of the European Social Model has arrived: so many members of the Eurozone could not afford the system that has been in place through the postwar era. But can the leaders shape, in the heat of the crisis, an alternative model? As Judt concludes: “Legitimacy is a function of capacity.” He was an optimist – he thought the 21st century would be the European century. Looking at the minute-by-minute headlines, it is hard to be optimistic today. I just hope Mrs Merkel and Mr Sarkozy are taking the time to think about poetry.

[amazon_image id=”009954203X” link=”true” target=”_blank” size=”medium” ]Postwar: A History of Europe Since 1945[/amazon_image]

Following my recent books of the year post, some people have asked if I read anything other than economics books, & the answer is yes, especially on holiday. So here are my books of the year in this more frivolous category (in no special order), even including some fiction – although my reading of literary fiction was a bit sparse this year. I did finish the marvellous Javier Marias trilogy, [amazon_link id=”0099461994″ target=”_blank” ]Your Face Tomorrow[/amazon_link], but have omitted it here as I read most of it in 2010.

Other people’s suggestions are welcome, with the Christmas holiday coming up!

[amazon_link id=”1861975961″ target=”_blank” ]Pompeii[/amazon_link] by Mary Beard

[amazon_link id=”0571243037″ target=”_blank” ]Different Drummer: The Life of Kenneth Macmillan[/amazon_link] by Jann Parry

[amazon_link id=”0747568766″ target=”_blank” ]Just Kids[/amazon_link] by Patti Smith

[amazon_link id=”1846683564″ target=”_blank” ]An Optimist’s Tour of the Future[/amazon_link] by Mark Stevenson

[amazon_link id=”0340898534″ target=”_blank” ]A Case of Two Cities[/amazon_link] by Qiu Xiaoling

[amazon_link id=”0805086641″ target=”_blank” ]Chinese Lessons[/amazon_link] by John Pomfret

[amazon_link id=”0340953586″ target=”_blank” ]Blood Safari[/amazon_link] by Deon Meyer

[amazon_link id=”0091918324″ target=”_blank” ]Shark’s Fin and Sichuan Pepper[/amazon_link] by Fuschia Dunlop

[amazon_link id=”1841957453″ target=”_blank” ]A Field Guide to Getting Lost[/amazon_link] by Rebecca Solnit

[amazon_link id=”0340995742″ target=”_blank” ]The Attenbury Emeralds [/amazon_link]by Jill Paton Walsh

[amazon_link id=”1843549220″ target=”_blank” ]Hitch 22[/amazon_link] by Christopher Hitchens

[amazon_link id=”0141019468″ target=”_blank” ]Changing My Mind[/amazon_link] by Zadie Smith

[amazon_link id=”0330492322″ target=”_blank” ]Kraken[/amazon_link] by China Mieville

[amazon_link id=”0773674616″ target=”_blank” ]Paris Notebooks[/amazon_link] by Mavis Gallant

[amazon_link id=”0571222862″ target=”_blank” ]The Strangest Man: The Life of Paul Dirac[/amazon_link] by Graham Farmelo

[amazon_image id=”0747568766″ link=”true” target=”_blank” size=”medium” ]Just Kids[/amazon_image]

Here’s the latest in my occasional series showing anybody who’s interested my ‘pending’ pile of books. Good thing there are some quieter weeks over Christmas and the New Year for me to work through some of these.

Meanwhile, I’m reading Philip Coggan’s [amazon_link id=”1846145104″ target=”_blank” ]Paper Promises[/amazon_link] to review it for The Independent, and Christopher Kennedy’s [amazon_link id=”1442611529″ target=”_blank” ]The Evolution of Great World Cities[/amazon_link] for this blog.

[amazon_image id=”1442611529″ link=”true” target=”_blank” size=”medium” ]The Evolution of Great World Cities: Urban Wealth and Economic Growth[/amazon_image]