Markets won’t save humanity

In his series of books (Banking Across Boundaries, Rentier Capitalism, The New Enclosure, Our Lives in Their Portfolios) Brett Christophers has provided a forensic analysis of the fundamental plumbing of the global and (especially) UK economy. For example, the first of these identified the statistical construct of ‘financial intermediation services indirectly measured’ (FISIM) as an artefact inflating the apparent contribution of the financial sector to the economy and thus enhancing its political lobbying power. He was the first researcher to point out this consequence (and is cited in my GDP book). Our Lives in Their Portfolios assembles evidence on the scale and scope of private equity ownership of assets in the US and UK, and the adverse consequences for the ability of key infrastructure to provide continuing services.

He continues this grand project of analytically dissecting the neoliberal economic order (even before it has entirely died) – at its most extreme in the UK – in his new book, The Price is Wrong: Why Capitalism Won’t Save the Planet. The book is a persuasive assault on the idea that renewable energy generation has become cheap enough that capitalist self-interest will ensure the green transition without continuing government subsidy and regulation. The analysis has three key points.

First, as the legacy industry fossil fuel generation has high sunk costs and low investment needs, whereas renewables need upfront financial investment as high fixed and low marginal cost generators. Second, the once vertically-integrated electricity business now has a separate wholesale market into which generators sell power, so investors in renewables need to earn their return from selling electricity to the grid. Third, the habit (it seems to be no more) of pricing wholesale electricity at the highest marginal cost makes the potential return to renewables investment dependent on highly volatile prices. Without either feed-in-tariffs or contracts-for-difference to reduce the volatility, a more important purpose than subsidising the renewables generators, it is hard for the rate of return calculation to stack up.

The book has a lot of fascinating detail about the structure of electricity markets, in India China and elsewhere as well as the US, UK and EU. Other design details matter. For example, it matters who bears the cost of connecting new generators to the grid – if it is they themselves rather than spreading the cost over the industry, that is another obstacle to investors earning an adequate return on wind or solar. For wind and solar farms are generally located where land is cheap and the power has to get to where people live, but land is expensive.

All these factors mean that the data point underlying the claim that renewable energy is cheap enough for the market to deliver the energy transition is misleading. This is the ‘levellized cost of energy’ (LCOE) or average net present cost of electricity generation for a generator over its lifetime. Although their zero marginal cost (because the fuel is free) makes renewables attractive on this measure, it ignores the hurdle of the initial and separate calculation of the expected rate of return on the investment in generating capacity. A wind turbine is cheap to operate but costly to install – so how will the developer doing the installation make a profit?

The message I take away is the need to be super-careful about market design in energy. These are state-organised markets (as indeed are all, but even more so in this case). The detail sometimes swamps the thread of the argument, but I’d commend The Price is Wrong to anybody interested in energy transition, and in more broadly in the dysfunctions of modern capitalism.

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Financial geopolitics & economic statecraft

Sovereign Funds: How the Communist Party of China Finances Its Global Ambitions by Zongyuan Zoe Liu is a rather detailed book but a fascinating insight into the evolution of China’s financial policy and its strategic investments using leveraged foreign exchange reserves. The book argues that China has created a new type of fund, Sovereign Leverage Funds, created through the use of complicated debt instruments. Unlike Sovreeign Wealth Funds, they do not require a stream of profits from an activity such as the export of commodities. “SLFs are a political-economic innovation because they are the product of the state leveraging its political and financial resources to make it possible to capitalize a fund,” which can then be invested overseas for startegic geopolitical purposes – the BRI. The SLFs can influence their portfolio investments through the use of voting rights – or a threat of disinvestment.

The first part of the book traces the origins of the arrangements in CHina’s historic opening up and accumulation of massice foreign exchange reserves. The Asian Financial crisis of 1997 was a key moment in determining the leadership to ensure China built up massive reserves: “Awakened by the severity of the crisis, CPC leaders realised dor the first time that national security could not be narrowly defined only by military competences … but must also include financial security.” (I was in Hong Kong as a journalist for the IMF/World Bank meetings held there in September 1997 – an amazing experience.) The 2008 crisis was another key moment. The existence of the SLFs has allso given China’s state owned enterprises a ready source of finance for overseas acquisitions and infrastructure investment, putting them at an advantage compared to their competitors.

The book then sets out a detailed account of the SLFs and their evolution through to the post-Covid period. It argues that liberal market economies should follow China’s example and set up their own SLFs to “act as white knight investors to defend strategic industries from unwanted foreign takeovers.” Challenges like investing in the green transition will require leverage, it argues. Such funds are institutions between state and market and “can be powerful tools for the practice of financial statecraft.”

There are loads of interesting details. For instance I had never realised that many of the cities authorised to be new economic zones after April 1990 were former treaty ports: “From the perspective of the Party, its revivial of China’s former treaty ports conveyed a message to the Chineses people: only the Party was capable of leading China’s broader economic revivial and redeeming the country from its prior century of humiliation.”

I know far too little about either international finance or Chinese politics to evaluate the book’s argument, but it seems reasonable. It also seems to be a rosy perspective, given what one reads about over-leverage domestically and problems with some BRI investments. As ever, the capacity of the CPC to take a strategic view is striking¬† – especially in a country that sometimes seems governed from tweet to tweet. I’ve argued in a recent article for the use of long-term vehicles like soveriegn funds or investment banks to institutionalise learning in economic policy. I found the book fascinating and will look forward to reading some reviews by readers who do have the right expertise.

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Who owns Kent?

Brett Christophers has become the leading expert on the role the financial sector has played in shaping the UK economy – for better or worse, usually the latter. I first came across his 2013 Banking Across Boundaries, where he was the first person to point out the pernicious effect of the ‘FISIM’ (financial intermediation services indirectly measured) construct in flattering the contribution of finance to the economy – a point later taken up by others. Subsequent books have looked at UK land ownership (The New Enclosure) and rentiership (Rentier Capitalism).

His new book, Our Lives In Their Portfolios: Why asset managers own the world, lives up to the high expectations established by the earlier ones. The subject is the scale and scope of the ownership of physical infrastructure – mainly in the UK but with examples from the US and Australia too – by large and generally little-known asset managers. Take Kent for example: water and wastewater infrastructure is controlled by Macquarie and Morrison, while the gas network is owned by Global Infrastucture Partners and Brookfield. Blackstone, Harrison Street and Safanad own much housing. EQT Partners owns the charging stations for electric vehicles. And so on.

In short, a group of global asset management companies act for investors such as pension funds and companies, creating funds that invest in real assets and buy in services to operate them. However, while the investors have long term horizons and look for steady returns (such as rents or fee income), and the infrastructure itself is long-lived, the funds set up by the asset managers coming in between are short term – a few years at most. Ownership of the assets by different managers churns frequently, and the managers have every incentive to cut maintenance costs and raise charges or rents. As all the operational aspects are contracted out to service companies, the asset managers are neither energy or water companies, nor investors in such companies: they are pure rentiers. The risks are borne entirely by others – and particularly the people experiencing crumbling homes or essential services.

Despite the large impact this subterranean ownership structure therefore has on people’s lives – through lack of maintenance and repairs and rising costs – there is scant public information. One of the major contributions of the book is the evidently huge amount of work that has gone into stitching together what information is available: “Researching and writing about asset-manager society is sometimes much more like detective work than it should be.” There is a shout-out here to the FT’s Jonathan Ford, who has done some excellent reporting on various UK rentiership scandals. The book organises the material by considering the asset classes (housing, energy, farm land, transport), the geography (where are the investments mainly located – US, UK –¬† and where do the asset managers headquarter), and who are the major commercial players.

PFI projects clearly boosted the asset manager business no end, and there are continuing pressures for the government to bring more private long term investment into infrastructure, given that the state has seemingly abdicated from such investments in the country’s future. While I don’t have a problem with the idea of private money coming into infrastructure investment, there is a clear incentive issue: as Avner Offer’s excellent recent (2022) book Understanding the Private-Public Divide set out, private money will always require pay-back faster than a major piece of infrastructure can deliver, so there are challenges in structuring the investment and governance. And the lack of transparency and failures of governance over the maintenance and operation of infrastructure and housing, resulting from the financialized structure of the investment through asset managers, are shocking. I defy anyone to read this book without being at least a bit scandalized about the blatant disregard for the people using these essential services.

What to do about it? Not clear, but the first step is clearly the disinfectant of light. Our Lives in Their Portfolios is an essential start. The book is out in late April.


What a spectacle

The subtitle of Alex Preda’s The Spectacle of Expertise is ‘why financial analysts perform in the media.’ I was interested because the everyday perception many people have of economists is shaped by seeing City economists talking about markets up, exchange rates down, inflation either up or down…. whereas of course most economists don’t do financial or macroeconomics. Yet the financial markets and commentary on them define the subject for so many.

Anyway, the book is rather interesting. It’s a sociology or ethnography largely based on fieldwork in Hong Kong, where there are many, many more financial programmes to be filled with expert commentary, and it seems that for many people working in the markets there is pretty much a full time career phase of going around the studios performing. The best known even get hired to advertise other products – a new hair conditioner being a ‘good investment’ for instance.

Prada describes the whole spectacle (yes, Debord, hello), a performance requiring a team – the expert talking head but also their research assistants back on the trading floor, the programme anchor, the producer and their team, the make-up artists and sound technicicans. All in the interest of selling more finance products and growing the sector. In the financial realm of exchanging digitised symbols, the embodied reality of a persuasive talker with good make-up and a Bloomberg screen accessible on their phone is central.


Future uncertain

I’m late to Radical Uncertainty by John Kay and Mervyn King, which was published last year. It took me a while to get into the book but I’ve enjoyed it and found much to agree with. The basic hypothesis is well known: that the kinds of models and methods useful for understanding what the authors call ‘small world’ or well defined problems are not useful for dealing with the contexts of many actual economic challenges. In these cases, from innovation or financial stability to climate change, ‘radical uncertainty’ demands a less narrowly formal approach. The term the book uses is that we should be asking ‘what is going on here?’ By radical uncertainty they go beyond Taleb’s famous black swans, or events in the fat tails of distributions. Rather, they mean there is no stable underlying probability distribution at all. This is the territory of unknowable futures. Is the Earth’s climate going to change irreversibly in the years ahead and if so how? There’s no probability to read off for this.

Some of the analysis is familiar. For instance the idea of reflexivity (from Popper via Soros among others) undermines the stationarity of probability distributions. In other words, one source of radical uncertainty is that we humans respond to events in ways that can be self-fulfilling or self-averting (see Chapter One of my Cogs and Monsters!) Kay and King also emphasise the important role of narratives, increasingly recognised (and btw we have a terrific Bennett Institute event on this coming up). I strongly agree with their scepticism about the scope for replacing humans with machine learning systems to get ‘better’ outcomes – as they put it, justice should be admininstered in an individual, not a statistical, manner. Otherwise we’re in the nightmare world of Minority Report. Human intelligence is accumulated collective intelligence, and co-ordination and institutions are all-important.

The book is full of examples of where policies go wrong by assuming a small world problem in a context of radical uncertainty. The UK pensions regime for example, applying technical valuations of the worth of pensions schemes which assume a stationary distribution of future returns – something belied by the evidence. Future risk can’t be eliminated so what’s needed is a future risk-sharing mechanism, rather than raising contributions now to unaffordable and unnecessary levels. (See for instance this excellent article about the UK’s USS scheme.)

As you would expect given the authors, the book is wide-ranging and beautifully written. There’s a tacit acknowledgement that these two eminent economists have changed their minds about the applicability of much of mainstream economics, for Mervyn King at least held an important role at the heart of mainstream policy. Good for them, though – so have I. As well as reading Radical Uncertainty on its own merits, it offers an interesting insight into the tides of change within economics, about which I’ve also written.