Triumph of the City – Ed Glaeser

This new book celebrates how cities have made civilisation and fostered human endeavour. It is a readable and exciting book and I agree with many of its propositions. But what it has made me reflect on is the concepts of necessary and sufficient. In his book, Glaeser concentrates on the need for skilled citizens and education. He argues convincingly that this is essential for growth and city success. He is surely right.

But there are other necessities too. Not all of these come over clearly enough in my view, although they are certainly present. He writes about the rise of consumer cities, places where the ability to consume a desirable variety of goods and services makes them good places to be and thus generate the contacts which produce innovation and ideas.

In fact, cities started as consumer cities, places where the elite created the opportunity to make and consume luxury goods. What is fascinating is how long they took to create production cities, where this contact made it possible to have ideas and get them to function. The Roman Empire had very successful cities but couldn’t create the Industrial Revolution. This took considerable historical contingency – accidents perhaps in one reading – which came together to create the explosive growth which has reduced infant mortality, raised living standards and lengthened our lives.

Two elements are key to this contingency, communications and harnessing energy. Both are as essential as skills and education. Communications are both short and long range. Short range communication is about creating ideas and how to use them. Long range is about the ability to exploit these ideas and make them work. Small groups can get together and have all kinds of insight. Without longer range communication, nothing will happen. The internet and the world wide web have harnessed ideas in a wider and wider way, and follow on in the long road from printing, from the telegraph and telephone as well as physical communication as ways of communicating and expressing our ideas.

Glaeser tells how New York grew rich on pirating British novels – and indeed Rudyard Kipling complains about such piracy – this is precisely about harnessing ideas effectively.
Energy is the other pre-requisite. Tractors replaces horses in agriculture and transformed agricultural productivity, as indeed horses had done in medieval times. Electricity made elevators possible and the density of occupation in city centres which Glaeser extols. Fossil fuels have a productivity which nothing else has so far matched. All the education in the world will not help us when the lights go out.

The education and communication might help us create the new technologies which could replace such fuel, although we are still a distance from doing so. So we need three things – skills, communication and energy.

Ed Glaeser has focussed on the first of these. I suspect that this is partly because in the US they are still very rich in communications and energy infrastructures. However, in other countries the balance might be different. In the UK, the physical and energy infrastructure needs as much attention as the skills.

Do we want to throw money at reforms without results?

Volterra Consulting's new sister firm, Volterra Health, launched its first report today 'The Medical Arms Race, A New Global Perspective'. It sets out our main critique of common health policy reforms over the last thirty years and warns of the dual costs of running the 'Old Model' in parallel with attempts at the 'New'.

Volterra Health take a global view and show that while behavioural demand drivers of increasing health costs are important - and will become more so - there are basic structural problems preventing cost containment. Most developed countries suffer from an imperative to use the latest technologies and therapies - the so called 'medical arms race'. But some developing countries have shown that they can get better or comparable results for much, much less (see also McKinsey, 2010).

Professor Nick Bosanquet, Bridget Rosewell and Charlotte Alldritt argue that unless we halt this medical arms race and address underlying supply side issues, we'll continue to throw money at 'reforms' which only fail payors and patients. As Charlotte also argues in the Guardian today, healthcare is going to be the issue for 2011. Watch this space!

Gender Pay Gap Widest Amongst the Top Jobs in London

Just before the Christmas festivities got into full swing GLA Economics published its analysis of women in London’s labour market. The GLA’s findings include:

1. Women with children are least likely to be in employment in the capital (53%) compared to the rest of the UK (65%);
2. Women in full time work earn 87p for every £1 earned by men (at the median); and
3. The gender pay gap rises to "a staggering 31%" between men and women at the top of the income spectrum (the ninetieth percentile).

I have argued elsewhere (see, for example, ‘2020 Welfare: Life, Work, Locality’) for a local Living Wage – a principle advocated by the Major of London. While a floor level wage not only creates an effective minimum, it also helps to establish a culture in which work is made to pay. Given that children in families where adults are working are more likely to be in poverty in London than elsewhere, the Living Wage policy is particularly pertinent for the capital.

But what about women at the top end of the income distribution, for whom regulation by a Living Wage doesn’t apply? In London, females employed in the private sector receive just two thirds of their male counterparts. Astonishingly, the pay gap rises with the level of qualification achieved. This is not just poorly educated women failing to assert their right to equal pay. If they get there (only 5.5 per cent of all executive directors in the FTSE 100, for example, are female) the most articulate and highly qualified women in London’s top jobs are earning significantly less. The GLA show that the picture is worse in London than the rest of the UK and hasn’t changed in the last decade.

Does this mean that we should sit back and wait for norms and behaviours to change? What policy levers might accelerate the current crawl towards greater gender pay equality across the whole of the income spectrum? Two approaches are frequently proposed:

1. Legislation has proved to be only marginally successfully, having slightly narrowed inequalities between male and female pay in the public sector (subject to certain duties by the Equalities Act 2006). Nevertheless, the gender pay gap persists (averaging 16% compared to 21% in the private sector) and the ways in which public sector regulation can influence norms and cultures of the private sector are not clear. Legislative policy levers also take time to change the culture in which they are applied.

2. Greater transparency of comparative salaries between and within organisations might help to speed this process up. Sweden has shown that a policy of open tax returns can work. But the traditional British sense of squeamishness over ‘vulgar’ of talk of money could bolster the privacy lobby.

Set within a wider debate ranging from positive discrimination to Open Government, solving the gender pay gap seems doesn’t seem within our grasp in the short term. Some argue that the recession has delayed progress further. The Equality and Human Rights Commission recently concluded that efforts against the gender pay gap are ‘grinding to a halt’. To kick-start progress, we need a new source of insight. Work by Volterra on the spread of social norms, values and network effects (see N Squared, RSA 2010) offers an alternative approach which could help to combat gender based inequalities that cost our economy much, and our society more.

Posted by Charlotte Alldritt, Senior Consultant Volterra Consulting

Bucket Economics

We would all like to see permanent full employment – a productive job for everyone. When I learnt my economics we thought that the way to achieve this was demand management: if demand in one part of the economy fell, the answer was to raise it in another. As resources drain out of the bucket in one place, then fill it up elsewhere.

This bucket model may look simple but it has been hugely influential (perhaps largely on that account) and has been hailed as the encapsulation of the ideas of John Maynard Keynes. The tidy reformulation of his ideas popularised by John Hicks, himself a Nobel prizewinner, gave weight to the proposition that we could understand equilibrium in the macro-economy and hence manage levels of demand to ensure that it was achieved, balancing monetary demand and unemployment using interest rates and fiscal spending.

Unfortunately, the model left out two crucial aspects, even though both had been noticed by Keynes. One is that public sector activity is not a substitute for the private sector. Keynes saw that it was possible to break out of an underemployment equilibrium with public works, but did not see this as a permanent phenomenon. Yet over time, an increasing role for the public sector has ratcheted up as a result, and each time that cuts are proposed, an immediate defence of ‘our jobs’, understandably, springs up. And the public sector is seen to provide ‘good jobs’ – secure, well pensioned and with good holidays. Much less is made of whether they produce anything at all, certainly whether there are increases in productivity as wages rise. Ratcheting up public sector activity as a proportion in downturns and never reducing it as the economy recovers will never produce any pressure for good economic performance.

The other missing element was any consideration of debt. In rereading Keynes, it essentially comes over that borrowing does not really matter because it reflects a real asset. Recent experience has shown not to be true. Debt has to reflect the ability and willingness both to pay it back and to service the interest due. The failure to do this triggered the debt crisis of 2008 when holders of debt realised they the assets against which the debt was held were essentially worthless. And this crisis morphed into a crisis of sovereign debt when the responsibility for managing this debt passed to governments. It is true that governments can force their citizens to pay – it is called taxation – but if this is difficult then they need to find other governments’ citizens from whom to borrow.

In any of these cases, there are real burdens of interest payments to be carried. The only alternative is to default. This is not that unusual, but it plays merry hell with credit ratings later, as you would expect. It can only be achieved by countries where underlying opportunities are very strong. It is unlikely to work for highly developed nations.

These missing features from the bucket model are dynamic, changing the shape of the bucket as we proceed; they are underweighted by the proponents of continued borrowing to prevent a double dip recession.

Abusing the Future

We all know that we don’t know what the future will hold but we all plan for it anyway. We plan our holidays, our retirement, the sales of a new product and the state of the economy. We pull wool over the eyes of our ignorance because someone, somewhere needs a view.

Just occasionally, there is the potential to have more than one view. Most of us find this quite hard. We are not programmed to believe several impossible things before breakfast. We are happy to talk about risks, but these are merely up and down (usually down) divergences from that ‘view’. It is often described as a central view but this is not often really the case; it is very unusual when a commentator has as many risks on the upside as on the down.

These views are stories. Stories have coherence and rationality. They tell why this will happen as a result of that. They give comfort of an evening that we can make sense of the world we live in. Scenarios both increase and decrease this comfort. Once, long ago, when I still engaged with large macroeconomic models we set up a scenarios club. With our clients, we proposed to develop scenarios of alternative futures of the world economy. (My macro model was so large that it covered the whole world!) The club sat down to envisage the scenario. We talked of oil shocks and market shocks – it was 1987 – and the future of international agreements. Every scenario that we imagined was run through the model and presented to the club. And then the reactions would set in.

Each participant imagined the policy reaction to the shocks. And when we ran these through the models, we got swiftly back to the business as usual which was our baseline forecast. A world in which things go on pretty much as they have done before. Our scenario club, perhaps not surprisingly, did not last long. I didn’t last long either. I quickly came to the conclusion that these models were a waste of time and money and told me nothing I could not write on the back of an envelope or fag packet (I was still smoking in those days).

Moreover of course we utterly missed the real scenario of the rise of new economies and the spread of globalised markets. Nor could our model have handled this, since it had no data on China and India and very little on Brazil or Russia.

This shows how hard it is to imagine alternative futures, in which the world is really different. And even if we can imagine the causes of these, the outcomes are utterly unpredictable. Not so much stories as fairy stories. So why bother?

One reason to bother is that it might help to be ready when things change. The story of Shell’s success in reacting to rising oil prices in 1973 is supposed to reflect how it had considered this scenario in advance. And this is certainly why the military play war games: when things move fast it helps to have figured out your reaction in advance rather than trying to do the analysis in real time.

On the other hand, playing war games convinced some highly intelligent analysts during the Cold War that pre-emptive strike was the best solution. Fortunately more cautious counsel prevailed. So scenarios are not an unmixed blessing. In this case, they were being used to counsel extreme reaction. A similar use, potentially similarly by vested interests, has been provided by some climate scientists. A scenario based on the risk of greenhouse gas increases, subsequent temperature rises, sea level increases and tipping points of various physical relationships has been used to create a scare which at one level induces the desire to play hard because it is all too late to save the planet.

At other levels, the scenario is simply a story. Facts are uncertain, their implications still more so. Our reactions can stabilise or destabilise and to be frank in the current state of knowledge either could be the case. One reaction to this is to look for probabilities. With enough history we can estimate the probability distribution of any variable in which we are interested. In this case, upside and downside risks are much more likely to be balanced and human tendencies to be either gloomy or optimistic might be minimised. But probabilities are not stories. They carry no freight of rationality or causation, nor of policy reaction implications. The Bank of England has carried probability ranges of inflation and output outcomes for some years now. They are not very wide (not nearly as wide as the data suggests) and in any case have not succeeded in getting much traction. People prefer stories.

An important reason for this is a sense that we face uncertainty. Uncertainty means we cannot attach probabilities to any given outcome. We simply do not know what is most likely. So it is not irrational to prefer the story. Choosing stories to tell and writing stories helps us learn about possibilities. It may help us react to events as they unfold. But it does not help us know what will actually happen. That is much more about defining a probability distribution and considering whether it is possible to do this.

Bridget Rosewell

Making Climate Change win-win

This is the theme of the conference of the European Climate Forum www.european-climate-forum.net this year. Listening to the speeches I am struck by the parallels in analysis between thinking about the impact of climate change and that of infrastructure.

First, we have the scientists. Climate modellers talked about the difficulty of building models that properly incorporated short term natural cycles in order to identify the longer term effects as well as the challenge of separating out local climate effects which are also distinct from large scale impacts. This debate is entirely similar to that about the effectiveness of models of the economy. Most macroeconomic models are concentrated on identifying the prospects for the next five years, and are based on data only since the Second World War. Yet at the same time they are based on equilibrium behaviour which is highly unlikely to be observed in the short term (possibly also the long term but that is the next paragraph). Like climate models, they are imperfect, and like climate models, the pressure to provide the policy outputs militates against model development and strongly against admitting imperfection, data problems or errors.

Second, we have the impact analysts. Many speakers focussed on the distinction between mitigation and adaptation. This raises a debate about economic dynamics which is pretty much absent from the models. A reliance on equilibrium focussed models lies behind the kind of analysis provided by Stern, which shows a long term steady state growth of the world economy which happens anyway and thus gives a small cost to investment in climate change mitigation. In other words, the economy grows and investment happens regardless. The same approach lies behind the difficulty in showing that infrastructure projects generate real additional growth – since the models also show that growth happens anyway. In both infrastructure and climate change models there are too few linkages between investment choices, technologies and growth rates. Thus the baselines have too many assumptions built into them which mean that the real impacts of either cannot be properly evaluated.

Third, this leads to the question of project and investment finance. Finance is the elephant in the room in both topics. In climate change, investments either to mitigate or adapt are seen as a cost. Yet analysis of, for example, the coastal cities, shows that creating flood defences has a significant payback in protecting growth prospects, when the dynamics are separately considered. A dynamic analysis of renewable power projects in Germany shows that it creates added value and added jobs – and thus an ability to raise the funds to create the investment. Finance for investment has to be raised from somewhere. It can come from the taxpayer, whose ability to insist on a payback is rather limited, but whose ability to pay is also in the end limited. Or it can come from savers through the investment funds and pension funds where this money is put. Savers need to get something back for what they put in and they need to be sure that the money will be there. In large regulated investments, which is what infrastructure and climate change projects generally are, this means that government must allocate the returns from these investments to the projects, rather than seeing the returns as coming from the general activity of the economy.

In the UK, it is government practice to ask whether an activity creates additionality or not. The stronger the belief in the underlying equilibrium growth or the economy, the harder it is to show that anything will be additional. This applies both to an infrastructure project and to climate change mitigation projects. Both require spending – transport systems, power systems for example – and both have payback in fares, fees and economic growth. That economic growth needs to be better recognised if we are to raise the funds to make these investments.

Large projects have implications which change the terms on which the economy operates. Such projects are those which drive economic growth and those which are largely exogenous to models – even those which purport to make technical change endogenous. They change the structure of relative prices, and work through the networks of connections by which innovation can occur. Understanding this is key to deciding on investments and needs to be better appreciated by those who are still captured by a now out of date of economic model.

Bridget Rosewell

To Borrow or not to Borrow?

The ICAEW (the accountants) had a conference on securing public finances on Tuesday. They published a document including my contribution in Securing the Public Finances. It is comforting that a consensus is emerging that we need to develop a new approach to public services with much better transparency and accountability that we presently have. Whether within government or for citizens, there is inadequate accounting and financial management and too few ways in which citizens can understand or contribute to what is going on.

Jonty Oliff-Cooper from Demos was particularly interesting in talking about new ways in which we need to open up to new ideas and citizens’ input. Clare Tickell also described the work that we have been doing at PST2020.

The consensus of the professionals engaged in delivery and of those actually managing the money contrasts with the approach taken by some economists. I hear there is a petition out there arguing that it is essential to keep borrowing ‘until the economy recovers’. They call upon the ghost of Keynes in supporting additional borrowing in a crisis.

I think this is misguided. Firstly, we have absolutely followed the Keynesian advice to borrow in a crisis to keep the economy going. That is why borrowing is now reaching 12 per cent of GDP. This does not mean that even more borrowing is thus justified.

Now that the economy has turned the corner we need to give the private sector space to recover. This will not be achieved by continuing to fill the bucket with more public borrowing which will crowd out other investment, raise interest rates, and damage our international standing.

It is very unfortunate that economists live in a static world in which the ideas that recovery takes time and needs confidence fails to fit the models. The confidence of investors appears often in Keynes’ writing but in the subsequent models has been lost in favour of a simplistic view that somehow government and private spending can just be switched on and off.

The crisis has created the best chance we have in a generation to get some focus on the size and deliverability of public services. On the previous path, there was a lack of control and trends in demand for health and on aging which cannot be met. I think it is essential that we debate this and decide what a new model of public services might look like.

Bridget Rosewell