What Liam Fox and the Brexiteers get wrong on exports

Not long ago there was an official Government target for UK exports.

“We want to double our nation’s exports to £1 trillion this decade,” the former Chancellor, George Osborne, proclaimed in his 2012 Budget speech. Many said at the time that it was a foolishly unrealistic target. But ministers insisted it really could be done. Comparing it to Maoist pledges of a great leap in steel production was unduly cynical, we were told. So, five years on, are we nearly there yet? Not exactly.

Alongside Philip Hammond’s Autumn Budget last week, the Office for Budget Responsibility released its latest UK exports forecasts. The total value of overseas sales in 2017 is projected to be only £549bn, up just 16 per cent on the £473bn in 2012. And the forecast for 2020, the date when we were supposed to hit the magic £1 trillion number? £575bn. So a miss by a mere £425bn. Not exactly the kind of sum one finds down the back of the sofa.

It’s a safe bet that Osborne would blame the 2016 vote for Brexit, which he strenuously argued against, and the decision by Theresa May to yank us out of the EU single market and customs union in 2019 for this failure (although the reality is that we were well adrift long before the referendum vote).

But what about Liam Fox, the International Trade Secretary? This leading Brexiteer can hardly blame leaving the EU for Britain’s export underperformance relative to those 2012 targets, set by a government of which he was a senior member.

In February, Fox told a parliamentary committee that disappointing global growth was the reason we would not get there. Yet global growth is now picking up rather strongly, just as Britain slows down sharply due to the negative impact of higher inflation and an apparent investment freeze by many nervous UK firms.

True, British export values are up 15 per cent since the referendum vote. But this is actually pretty disappointing given the tailwind of a record plunge in the value of sterling, which instantly makes our goods and services more competitive overseas.

Brexit itself can’t possibly be the problem for its champions, so other culprits have been identified by Liam Fox. “I can agree as many trade agreements as I like, but if British business doesn’t want to export, then that doesn’t do us any good,” he said in an interview last week.

This was essentially a more sanitised version of his comments last September, when he was caught on tape accusing British exporters of letting the country down by being too “fat and lazy”.

“We’ve got to change the culture in our country,” he ranted. “People have got to stop thinking about exporting as an opportunity and start thinking about it as a duty – companies who could be contributing to our national prosperity but choose not to because it might be too difficult or too time-consuming or because they can’t play golf on a Friday afternoon.”

Leaving aside the aching hypocrisy, the flawed economic worldview such comments betray is notable. Fox seems to see strong export-growth as something that relies, fundamentally, on vigour and patriotism from firms. In fact, the evidence suggests it requires a dense framework of state support from above and below.

Dig around for the roots of the exporting prowess of Germany’s famed small and medium-capacity “Mittelstand” companies and one finds an active state-owned local banking system. It’s a system in which bankers actually encourage their corporate customers to venture into overseas markets, happily extending credit for the purpose.

It’s a far cry from here, where small firms’ trust in their banks is chronically low. Nothing that the Government is fiddling around with – on new export-credit guarantees and the like for firms – comes close to trying to emulate this German ecosystem of truly community-embedded, corporate-relationship banking.

The state trade support from above comes in the form of harmonised regulation. The evidence shows that joining the EU in the 1970s gave the UK’s exports a substantial boost. Part of this was the end of tariffs. But a larger ingredient was the harmonisation of product regulation and the licensing rules of what would eventually become the single market. Such licensing is especially important for services, which is the reason why pulling out of the single market promises to be so damaging for our service exporters.

These are the benefits of EU membership that the Brexiteers, with their 19th-century mental image of trade as merely the shipping of finished manufactures and raw commodities, refuse to acknowledge. In the 21st century, regulation is not the enemy of free trade; rather it helps create the market. As Sir Ivan Rogers, our former top Brussels diplomat, put it: “Contrary to the beliefs of some, free trade does not just happen when it is not thwarted by authorities.”

Sir Ivan’s candour was not welcomed by ministers and he resigned in January. Perhaps what they wanted to hear was that, thanks to Brexit, hitting the elusive £1 trillion export target will be a piece of cake.

This article was originally published in The Independent on 26/11/17

Why the economic forecasts for Britain are so apocalyptic – and how much Brexit is to blame

The economic headlines of the past 48 hours have been thoroughly miserable, if not apocalyptic.

So what’s going on?

Has the UK’s economic outlook really suddenly become very much worse – or has this reckoning been coming for some time?

To what extent is Brexit to blame?

And is there any way out of this mess?

Below we explain what’s going on with the British economy behind the headlines.

The key is something called productivity….

The fundamental reason for those awful economic projections in the Budget is a severe downgrade in the Office for Budget Responsibility’s view of the UK’s potential productivity growth over the next five years.

Productivity is the amount of output the UK workforce as a whole can produce per hour of work. It’s essentially a measure of the efficiency with which the British people are working.

Productivity may sound like an abstract “economicky” concept, but it is fundamentally important for a host of more tangible economic data that households really do care about such as wages, interest rates and public spending.

From the Second World War until the global financial crisis in 2008 the UK’s productivity reliably grew by around 2-2.5 per cent a year on average. There were recessions and crises over that time, but the overall economy always sooner or later got back to trend productivity growth, which means that wage and GDP growth etc, always eventually bounced back too.

But then the financial crisis hit and productivity has pretty much flatlined ever since. The Resolution Foundation has calculated that the past decade has actually been the worst for the UK’s productivity growth since 1812.

…and the Office for Budget Responsibility has become less optimistic about it…

The independent OBR has been the Treasury’s official forecaster since 2010. And a key feature of all its forecasts since 2010 has been its assumption that the 2 per cent plus post-war trend rate of productivity growth would always return by the end of its five-year forecast period.

But having seen all its previous forecasts prove woefully over-optimistic, it chose this week to break the habit. It now thinks UK productivity will only be growing an annual rate of just 1.3 per cent in 2022.

…so growth, wages and incomes are all expected to suffer…

Because the productivity outlook forms the basic building block of all GDP forecasts, the productivity downgrade is the reason why the OBR turned in the most miserable set of GDP growth forecasts for the UK since it was established seven years ago on Wednesday, with output growth never rising above 2 per cent over its five-year outlook.

Productivity is also the key determinant of wage growth. Many economists (although not all) take the view that if wages grow considerably faster than productivity the result is a surge of damaging inflation, which means that in inflation-adjusted terms, wages don’t actually grow at all.

Average real wages in the UK are still around 6 per cent below where they were in 2008, with the blame being put on the fact that productivity has not grown over that time.

And because the OBR has severely downgraded its view of productivity growth over the next five years, that means it has also downgraded its forecast for UK wage growth.

Put the latest weak wage growth forecast from the OBR over the next five years together with the realised weak wage growth over the past decade and you have the shocking calculation from the Resolution Foundation: that wages are not projected to recover back to their 2008 level until 2025 – essentially 17 lost years for workers.

…and public services and welfare spending too…

The size of the economy has a profound influence on how much money the Government receives in taxes to spend on things like schools, hospitals, the police, the military and also cash transfers such as tax credits and other benefits etc.

Weak productivity growth leads to weak GDP growth which means pressure on public spending.

After the deficit shot up to 10 per cent of GDP in the 2008-09 recession the previous Chancellor, George Osborne, imposed severe austerity policies to curb state borrowing. He originally expected the job of reining in the Government’s deficit to be done by 2015.

But the economy has massively underperformed expectations, which means the deficit did not fall as planned and ministers have responded by prolonging the squeeze on public spending and benefits.

The budgets of some Whitehall departments are due to be cut by almost 50 per cent on 2010 levels by the end of the decade.

Real-terms UK departmental budget changes, 2010–11 to 2019–20, IFS

And though NHS spending has been growing in real terms since 2010, this has not been enough to met the demand generated by an increasingly elderly population, resulting in stretched waiting times for operations and over-crowded accident and emergency wards.

…Economists are baffled about productivity’s weakness…

Since productivity growth is the key piece in the economic jigsaw, economists have been keen to work out why it is so abnormally weak. If they can diagnose the illness they might be able to recommend a policy cure that will rectify it.

But, alas, in seven years of investigations they are still searching for a coherent and broadly accepted explanation for the productivity disaster.

Some explanations are UK-specific such as historic under-investment in workers’ skills here, an excessively flexible British labour market, an unusually sclerotic domestic banking sector, or even damagingly loose monetary policy from the Bank of England that has kept low-productivity “zombie” firms alive. Some blame the ready availability of low-skilled migrant labour from the EU.

And it is true that something is particularly awry here in Britain, where the level of productivity has long been worse than peer economies such as France, Germany and the US.

Yet productivity growth has also been weak by historic standards across the developed world since the global financial crisis and official forecasters have been reducing their projections for many countries, not just the UK.

One view advanced by the US economist Robert Gordon is that the advanced world in recent years has essentially come to the end of a long era of technologically-driven productivity growth that began in the industrial revolution and that the lower rates we are experiencing today are the new normal. Others, however, regard that as hyperbolically pessimistic and cite exciting recent advances in biotechnology, robotics, quantum computing and materials science, among other areas, as fundamental reasons to be optimistic about the future of global productivity growth.

…but economists generally agree that Brexit will make productivity worse…

One thing economists do generally agree on is that leaving the European Union and putting new trade barriers between Britain and our largest and closest trading partners is extremely unlikely to boost UK productivity growth – and is far more likely to retard it.

The OBR’s latest productivity downgrades are not, in fact, due to its view of the impact of Brexit but rather a capitulation to the view that it has been unduly optimistic about a natural bounce-back previously.

The productivity issue should be separated out from the short-term negative impact of the Brexit vote. The slump in sterling since the vote in June 2016 has pushed up domestic UK inflation, which has eaten into household incomes and curbed spending.

UK businesses are also investing less due to uncertainty over the outcome of government negotiations with Europe over future trade arrangements after March 2019. Both these factors have hit domestic demand and slowed the economy down this year, just as Europe and the wider global economy seem to be perking up.

A disastrous no-deal Brexit could well plunge Britain back into recession. But this should really all be thought of as distinct from the longer-running and underlying problem of UK productivity stagnation.

…and, actually, they do think there are things that can be done to improve UK productivity

Aside from not leaving the European Union’s single market and customs union, most economists believe that the best way of encouraging productivity growth, at least in the long-term, in the UK is more investment.

A big part of this is state investment in transport infrastructure, which helps make private-sector firms more productive. Another important form of state investment is in education and skills to make individuals more productive. There is also investment by firms into research and development in new technologies, which well-designed government tax and subsidy policies can encourage.

Corporate governance reforms might also help here, by removing the incentives on chief executives and boards to underinvest from their profits.

A specific area that economists, such as Andy Haldane of the Bank of England, are increasingly looking at is improving management systems at the UK’s less productive firms (of which there are many) in the hope of bringing them up to the levels of their higher-performing peers.

Another group of economists, including Simon Wren-Lewis of Oxford University, argue that the Government has actually been holding back domestic productivity-growth since 2010 through excessive fiscal austerity – and that budget cuts have thus been a false economy and a major policy mistake.

Their prescription is for the Government to stop obsessing about bringing down deficits and focus instead on keeping overall spending demand in the economy sufficiently high.

This article originally appeared in The Independent on 23 November 2017

An NHS drugs rip-off and the myth of the ‘free market’ in pharmaceuticals

Extortionate hikes in drugs prices make for powerful headlines, as the Competition and Markets Authority’s provisional ruling against the Canadian pharmaceuticals company Concordia for overcharging the National Health Service millions of pounds for a thyroid drug shows. And memories are still fresh of the notorious American financier Martin Shkreli, who jacked up the price of a life-saving anti-parasitic drug called Daraprim by 5,000 per cent after acquiring its marketing rights.

But aren’t such prices the outcome of a sophisticated global market in pharmaceuticals? And don’t all economics textbooks teach us that if governments interfere in a free market, no matter how unfair some of the outcomes might appear, everyone is ultimately made worse off? Shouldn’t politicians and regulators shut up and get out of the way?

Such “free market” arguments are frequently faulty, but perhaps never more so than when it comes to the behaviour of pharmaceuticals firms. The profits of drugs companies flow from their patents, their exclusive rights to sell the drugs they have developed or acquired. But how long should those patents, those monopoly sale privileges, last? For how long should a firm be permitted to profit from a branded drug before the patent expires and other companies are allowed to manufacture cheap generic rival versions?

For ever? Even the most ideologically blinkered free market enthusiasts might see the problem in that. Ten years? Fifteen years? How about two years? And at what price should the company be permitted to sell those drugs while it enjoys the exclusive sales licence? Bear in mind that the marginal costs of production for a drug will generally be negligible and that the research and development costs will vary wildly from product to product.

The truth is that there is no right or wrong answer to these questions. There is no economic theory that tells us what the optimum patent duration or permitted sales price of drugs should be to incentivise private investment.

The length of patents set by states is often between 10 and 20 years. But there’s nothing scientifically determinate about such choices. And countries are within their rights not to grant patents if they feel the social costs outweigh the benefits, as India did when it dismissed the request of the Swiss multinational Novartis to patent the cancer drug Glivec in the country in 2013.

As for drug prices, they are often informally regulated. As the Cambridge University economist Ha Joon-Chang puts it, the profits of pharmaceutical companies are, in a sense, “social creations”.

In the UK there is a voluntary agreement between the NHS and the pharmaceutical industry to govern the prices of certain key drugs. We saw this in action last week when the UK health authorities successfully negotiated a lower fee on two breast cancer drugs with their manufacturers, Pfizer and Novartis.

Yet given the critical commercial importance of state regulatory approval for all drugs and the inevitable fact that this process can impede competitive forces there’s also a strong social expectation about how companies should price drugs outside of such agreements, even when the drugs are out of patent. Concordia ignored these expectations when it jacked up the price of out-of-patent liothyronine tablets from 16p a pill in 2007 to £9.22 a pill today. Shkreli ignored the US equivalent when he nakedly gouged US patients on Daraprim by raising the price from $13.50 to $750 a pill.

Pharmaceuticals are a big global business. The estimated value of the international prescription drugs market was $800bn (£200bn) in 2016. Pfizer and Novartis, each have a market capitalisation north of $200bn. The wider sector invested almost $90bn in the research and development of new products last year.

Yet the reality is that pharmaceuticals firms – large and small – are in an informal and delicate economic partnership with the state sector in all the countries in which they operate and sell their medicines. The partnership is based on mutual understandings of acceptable behaviour. When pharma companies (and their financier owners) fail to observe the rules of that partnership, or attempt to deny its existence, they fully deserve the backlash they get.

This article originally appeared in The Independent on 21/11/2017

Here’s what to look out for in Philip Hammond’s Budget this week – and how to tell if the Government is serious or not

At 12.30pm on Wednesday Philip Hammond will step up to the House of Commons despatch box and deliver the UK’s first Autumn Budget. The long tradition of the Spring Budget will thus come to an end. But some of Hammond’s colleagues in the Conservative Party are warning that it could be the end of the road for him as Chancellor too.

Hardline Tory Brexiteers, affronted by Hammond’s cautious approach to leaving the European Union, are pushing for him to be replaced with an enthusiast for the project. And then there is the competence factor. A national insurance increase for the self-employed in the March Budget was withdrawn on Downing Street’s orders within weeks, in an epic humiliation for Hammond. If this Budget similarly unravels it is hard to see how he could carry on.

The overall economy is slowing as higher inflation bites into household wages, which are still growing only feebly, and as businesses sit on their hands rather than invest due to the uncertainty created as Brexit approaches in 2019. That context inevitably limits Hammond’s room for manoeuvre against his self-imposed fiscal rules.

Yet the political bomb that went off at the June general election, robbing the Conservatives of their expected majority, has scrambled politics and created huge pressure for more spending. Even many Conservatives are calling for the Chancellor to ease austerity in order to take the wind out of the sails of the Labour Party under Jeremy Corbyn.

So the personal stakes are high, the economic outlook is uncertain and the political scene is unusually fluid. So what are the big issues to look out for on Wednesday? How is Hammond likely to approach them? And what numbers should we pay particular attention to?

Housing

Ministers have been talking up their plans for a large expansion of house building to address what they now accept is a UK “housing crisis”. The Communities Secretary Sajid Javid has been lobbying for a substantial increase in public borrowing to deliver more homes and promised last week that the Budget will show “just how seriously we take this challenge”.

The Treasury has flown a kite of a stamp duty cut for first-time homebuyers. But what really matters is how much state money will be put into supporting housing construction, after the relatively modest sums announced during the Tory party conference in October were widely dismissed as inadequate. Housing associations will be looking for significantly more grant money to enable them to build more social housing for rent.

Local authorities seem likely to win permission to borrow to start the construction of council housing again after it effectively ground to a halt in the 1980s. But keep an eye on how much additional council borrowing will be projected by the Office for Budget Responsibility to gauge how significant this loosening – and therefore housing delivery by local authorities – is expected to be.

Public sector pay

The Conservatives’ 1 per cent cap on public sector pay has already been lifted for prison officers and police. But the pressure to ease it for teachers, nurses and other public servants is now intense, especially with multiple warnings over recruitment.

Yet lifting the cap will not be cheap. The Institute for Fiscal Studies calculates that allowing wages to grow in line with inflation would cost around £6bn extra by 2019-20. The unions are demanding even more – a 4 per cent rise. If the Conservatives do relax the cap substantially this will have an immediately obvious impact on the public borrowing projections.

Young people

Labour enjoys a huge polling lead among the under-40s, largely thanks to Jeremy Corbyn’s striking promise to abolish tuition fees and ambition to “deal with” their debt burden. In response, the Government has already made the tuition fees system more generous. And there have been some suggestions that the Chancellor in the Budget might cut national insurance contributions for younger workers, financing it by restricting pension tax relief for older workers. But the big question is whether such incremental reforms will draw attention away from Labour’s simple, eye-catching, offer to the young?

Welfare cuts

Cuts to working-age welfare and universal credit put in place by the previous Chancellor George Osborne were set to bite over the coming years, and are projected to push up inequality and poverty. There have been signals the Chancellor will cut the contentious six weeks that recipients of universal credit must wait. This will cost some money, but the bigger question is whether Hammond will defray the overall package of cuts.

A key number to look out for is whether the £12bn of savings projected to come from the welfare budget over the next five years actually comes down or not on Wednesday.

Infrastructure investment

As well as talking up house building, ministers have been stressing their commitment to more infrastructure investment to help solve the UK’s productivity crisis. There will almost certainly be plenty of talk about this in the Budget – there always is.

But how should we judge the substance? In the March Budget public sector net investment was pencilled in to creep up from around 2 per cent today to 2.3 per cent in 2021-2022. Labour’s manifesto, by contrast, pledged to take it up to 3 per cent of GDP. Will the Conservatives match Labour?

Fiscal policy

The Chancellor’s fiscal rule requires him to run a structural deficit of no more than 2 per cent of GDP in 2020-21. In March he had around £26bn of headroom against this target. Public borrowing has been rather lower than expected so far this fiscal year, but the OBR has said it plans to slash its productivity forecasts on Wednesday, which will probably have the effect of wiping out some of this fiscal improvement over the medium term. The big-picture macroeconomic question for the Chancellor is whether he scraps or modifies his 2 per cent target in order to spend and borrow more on all the areas discussed above – and also on the NHS and education.

There is a strong economic argument that doing this would actually help support overall GDP growth at a time of weak private-sector demand and growing Brexit headwinds. When Labour has argued for such a relaxation of spending cuts in the past the Government has always batted it away with the claim that the bond markets would panic if they deviated from the fiscal plan. Yet it’s notable that even some professional investors in UK Government debt are now urging the Chancellor to increase borrowing to spend on infrastructure.

This article was originally published in The Independent on 20/11/17

Think you're too savvy to put your savings in a rip-off hedge fund? Think again

"Um, hello - can I tell you about the real world?" Those were the words of a remarkably self-confident Scottish hedge fund manager, Hugh Hendry, on BBC's Newsnight in 2010. He was addressing the Nobel laureate economist Joseph Stiglitz in a memorable debate about Greece.

The spicy and combative Hendry made for great television. He was invited back onto the show. Indeed, Hendry went on to appear on Question Time, where he airily cut off the then-deputy Scottish first minister, Nicola Sturgeon, with the words: "I know what I'm talking about, Nicola."

The loquacious Hendry became something of a media personality for a period; the face of the UK hedge fund industry. But now, seven years on, the real world has told Hugh Hendry something. Last week he announced the closure of his hedge fund Eclectica, after haemorrhaging investors' money. It may have something to do with the fact that last year Hendry was apparently betting on a break-up of the entire European Union.

Hedge funds are investment pots, which claim to deliver superior returns to ordinary managed funds due to the intellectual brilliance of their managers. Often - and certainly in the case of Hendry's fund - the strategy is to take large, counterintuitive bets on the direction of markets: bets that ordinary fund managers don't have the courage or the freedom to make.

Sometimes these bets pay off and the rewards are spectacular. Often they don't. And as a group, hedge funds have delivered miserable results in recent years, registering lower returns, on average, than funds that simply passively track the major stock markets. Not much evidence of brilliant minds there. And those average returns for the sector have probably been upwardly biased by "survivorship bias". This means closed-down funds like Hendry's simply fall out of the various indexes of the hedge fund sector, flattering its overall recorded performance.

This matters. In 2016, more hedge funds closed than in any year since the financial crisis. Some 260 hedge funds were shut in the first quarter of 2017 alone - almost 3 per cent of the 10,000 total.

But running a failing hedge fund can still be very profitable for the fund managers themselves. Their traditional "two and 20" fee-charging formula (where they cream off 2 per cent of all assets under management every year, plus 20 per cent of any capital growth) means any investment success they achieve over an extended period ends up profiting the manager far more than the investor.

Of course, as we've seen, a great many funds never survive for an extended period. They simply shut up shop when they lose money after making a big bet that goes wrong. But 2 per cent of, say, a £50m seed investment is still £1m. Get a lucky run for only a few years, and a manager can accumulate an impressive fortune. No wonder hundreds of new funds open every year.

The media focus in relation to hedge funds tends to be on the potential risks they pose to financial stability.

Could they blow up the system like banks did in 2008? That's not entirely misplaced, given the size to which they could grow and the influence some of the larger ones can have on specific markets. Yet the greater risk from hedge funds is to the money of those who are naïve enough to invest in them.

So given the obviously poor returns of hedge funds, are investors yanking their money out of the sector en masse? Not exactly. Today there is around $3 trillion (£2.1) trillion of money worldwide invested in hedge funds - almost double the amount of seven years ago. Even when returns have been awful, the cash has continued to flow in. Some of that money will belong to naïve rich people. But a large and increasing share, according to UK regulators, now comes from ordinary pension schemes, as their stewards seek to juice-up their overall results through an allocation of part of their money to "alternative" asset classes.

A report last year from SCM Direct estimated that 4.8 million people in the UK are invested in hedge funds through their pension schemes. The Tesco pension scheme has around £738m in hedge funds, while Lloyds Bank's has a £1.9bn allocation. The West Midlands local authority pension scheme had £226m in such funds; West Yorkshire £259m. And so on. The vast majority of the ultimate beneficiaries of these schemes are likely to have no idea that they are exposed to hedge funds and their awful returns and rip-off fees.

A tiny number of hedge funds do deliver market-beating returns over a long period. But the vast majority don't. Investing in them is, generally, a terrible idea. It's an approach overwhelmingly likely to enrich people like Hendry and leave you personally worse off. But the people who look after your retirement savings are doing it anyway.

That's the "real world" of investment with other people's money. And it's certainly not the one Hugh Hendry was introducing us to seven years ago.

INTERVIEW: Jean Tirole

Jean Tirole throws his head back and laughs. “You’re kidding!” he exclaims. I’m not kidding, I insist. It’s true. I explain to him, once again, that when proposals for regulatory price caps on energy bills are floated, politicians and respectable commentators in Britain tend to start discussing Marxism.

Tirole’s incredulity is significant. The 64-year-old Frenchman won the Nobel memorial prize in economics in 2014 for his pioneering theoretical work on how utilities ought to be regulated. Tirole is a global authority on the subject, his research influencing regulators the world over. And he knows there is nothing Marxist or communist about restricting the prices a privatised natural monopoly such as energy can charge customers.

“Price caps were introduced initially to deregulate,” he explains, citing the caps imposed by the Thatcher government on what British Telecom could charge after privatisation in 1984. Allowing the newly private BT to jack up prices when there was no competition would have ripped off captive customers and destroyed the social legitimacy of the whole project.

“I can’t believe that price caps would be seen as a communist plot or something like that,” he says, shaking his head at the primitive nature of our national debate.

The key challenge for regulators, as Tirole explains it, is in designing caps so that they are fair to consumers and yet do not discourage private sector investment in the field. It’s not an area in which lectures about the failure of the Soviet Union are particularly relevant.

Yet, as I interview Tirole, who is in London to promote his new book Economics for the Common Good, it gradually becomes clear that I’m not going to get any specific answers to the pressing economic questions of contemporary UK politics. Is Theresa May justified in pushing through a cap on energy prices? What about Jeremy Corbyn’s proposals to nationalise the electricity system, the water companies and the trains? Tirole refuses to be drawn.

Why? Tirole cites something he calls “Nobel prize syndrome”, or the tendency for winners of the biggest prize in the discipline to dispense their economic prescriptions without doing their homework. Since he hasn’t researched the specific details of the UK sectors in question – analysing the degree of monopoly power of firms, the historical context, the likely behaviour of consumers, etc – he won’t commit.

“I really think we should be more humble and not talk about things about which we have an opinion but we have nothing special to say,” he explains. “[The pressure is] stronger when you have the Nobel prize because people believe you know everything!”

Nevertheless, he does caution Labour against regarding national ownership as a magic bullet solution to frustrations with the performance of a privatised utility.

“I’m not a big fan of privatisation but nationalisation can also be even worse,” he explains. “The issue is that [nationalised] firms tend to be overstaffed very quickly because politicians find it easy to create jobs at the expense of the consumer or the taxpayer. I don’t think the role of the state is to be a producer or a job provider. I think the role of the state nowadays needs to be a strong regulator, defining the rules of the game.”

Tirole has been based at France’s respected Toulouse School of Economics for a quarter of a century. But like many of France’s top economists, such as Thomas Piketty, he studied in America. Tirole received his doctorate from the mighty Massachusetts Institute of Technology in 1981 and spent seven years researching there.

Ambivalent as he might be about the merits of public ownership, one thing Tirole is insistent on is the imperative for the state to give people good information to make certain markets work. He is scathing about the idea, promoted by libertarians, that the best thing governments can generally do is simply get out of the way.

“I found it totally outrageous when some American politicians during and prior to the financial crisis said we should not give financial information to people,” he says.

“My goodness! You have to tell them about the risk of teaser rates, about what happens if interest rates go up. They don’t have PhDs in economics. Even if you have a PhD in economics you may not even know if you should switch supplier!”

He says that competition authorities everywhere need to pay much more attention to the insights of behavioural economics and the limits of our cognitive capabilities, citing the work of this year’s Nobel economics laureate Richard Thaler. “When you offer 500 pension plans to consumers we are unable to choose. I think there are too many options. You need to standardise things so you can compare offers,” he says.

The vast majority of winners of the Nobel Memorial Prize in Economics since it was established in 1969 have been American. Britain comes second. But France’s performance is respectable. Tirole is the third Frenchman to have been recognised by the Swedish committee, following Gerard Debreu and Maurice Allais in the 1980s.

What, I inquire, does he make of the striking recent critique from President Emmanuel Macron of “postmodernism”, the theory developed by French philosophers Jean Baudrillard and Jacques Derrida in the mid-20th century that everything is relative and there is no such thing as objective truth. “The worst thing that could have happened to [French] democracy” is how Macron described it in an interview with a German magazine.

Tirole shuffles a little uncomfortably on his sofa and says he doesn’t want to get into “academic conflicts”. But it’s clear where his views lie in this debate. “Economics is an inexact science. We have to be humble. But the idea that everything is cultural I think is completely wrong” he says.

While he stresses that competent economists always take culture and social norms into consideration, that doesn’t mean everything is relative and one cannot say anything definitive about the world.

“Otherwise I would not want my salary to be paid by the French taxpayer,” he says. “I think that would be a shame. We [economists] need to be useful to society.”

‘Economics for the Common Good’ is published by Princeton University Press

This article was originally published in The Independent on 16/11/17



FULL TRANSCRIPT:

UK polls show high public support for bringing things like water, rail and electricity back into public ownership. Labour’s manifesto pledges to renationalise them. Regardless of whether that’s a good idea or not, does this level of public dissatisfaction enable us to say privatisation in these industries has been a failure?

Let me just say, I’m not an expert on British matters. Is it a failure of privatisation or is it a failure of regulation? That’s really the issue. We need to design good regulations. It’s not easy because by definition those are by and large monopolies. You can introduce a bit of competition here and there, but you really need to design good incentives and because they are monopolies you cannot easily benchmark. You can do that across regions, but even that is difficult. You have to be aware of pitfalls of regulation. So for example, if you try to give what we call “high-powered incentive schemes”….so you try to encourage a firm to reduce cost, then you know there’s a danger that quality won’t be very good because to reduce costs you can reduce quality. That’s the easy way to reduce costs. But of course that’s not the right way. If you try to incentivise firms to be more efficient you also have to more carefully monitor quality. And we have seen that a little bit on the railroad industry. You have to make sure there is enough maintenance of the track etc. We had that in the UK actually with British Telecom [after privatisation in 1984]. Things like that we have to be aware of. Just [to] deregulate for the sake of deregulation is bad. It’s not an easy exercise and sometimes you’re going to leave some rents on the table. That has to be accepted….I’m not a big fan of privatisation but nationalisation can also be even worse. The issue is that [nationalised] firms tend to be overstaffed very quickly because politicians find it easy to create jobs at the expense of the consumer or the taxpayer. That’s my main worry. I’m not saying privatisation is wonderful. It’s still a monopoly. It’s very hard to regulate. You may not get quality of service or right prices. But the same is true for nationalisation. You still have a monopoly and on top of that you have this soft budget constraint in that you can overstaff the firm. We have seen that all over the world – it’s not a British problem. You use a firm to create jobs and try to get some more votes. In the end it’s going to create a very expensive firm. I’m not against nationalisation by ideology. If a bank fails you may say we’ll nationalise the bank as long as we’ll privatise it again in two to three years, which is what the Scandinavians did in their [banking] crisis. That’s fine. I’m not an ideologue. But I don’t think the role of the state is to be a producer or a job provider. I think the role of the state nowadays needs to be a strong regulator, defining the rules of the game. It’s not very good at producing stuff.

One of the sources of the public discontent with privatisation is a legitimacy problem of private profits from what were traditionally non-profit sectors. What about the idea of non-profit companies running these services?

You still need the governance – you don’t want this firm to be without control. You need someone who is going to hold the managers accountable. I’m the chairman of a foundation, a not-for-profit, the Jean-Jacques Laffont Foundation. We could spend the money and waste the money. So it’s very important that we have a board of directors. Out of the 15 directors 13 are outsiders. They check what we’re doing and they’re also monitored by the French accounting office. We need to be checked.

But what about something like the Bank of England, which has operational independence? What about a not-for-profit water company that has a mandate for investment and good quality service and a fair deal for customers but how you achieve that we leave in your hands…

You could have that. But you could also have that at the level of the regulator, if you have an independent regulatory agency who is going to basically resist political pressure and industry pressure.

But that still has the profit motive for the company…

That’s right. But the profit motive when regulated well. I don’t see anything wrong with that. If you have a regulator that is checking on you, making sure that you are delivering quality and not overcharging, not cheating on the consumer, then the profit motive is not that bad. In the US public utilities in the seventies were private – and by the way they were not functioning that well. In Europe we had nationalised public enterprises – which were not functioning that well [either], except in France we had EDF, which for various reasons, did a decent job. But once we had the introduction of competition that became a little bit harder to think about because you had this tension between a state being a regulator and the state being an owner. That was difficult. We don’t have that much experience, expect in development or education, with foundations and schools…You could have non-profit, but you still need the governance structure. Who is going to oversee that entity? If you have a strong sense of mission that may occur in healthcare, in NGOs for example, that can be fine. But you cannot just rely on people being nice and doing the right thing. What I’m sure of is that you need a strong independent regulator. Independent central banks are not completely independent. People think Janet Yellen can do anything she wants, or Mario Draghi can do anything he wants. But there are constraints. And if they repeatedly did wrong things they would be kicked out. Even if they do the right thing they might be kicked out! That’s another issue.

One of the debates we have in the UK is that nationalisation would be expropriation and would create such a legal morass that it would be impossible…

Banks are different because banks when they are nationalised are valueless. Of course there are still court proceedings and the like and the shareholders will argue it’s not completely valueless. But it’s easier. It’s more difficult [for other companies]. Which value do you take? Do you take the share value? But of course that depends on expectation of nationalisation. The book value? But is that a good measure of the investments that have been made? And so on. It’s just very difficult to find the right price to nationalise.

Is that an insurmountable barrier?

No. Think about “eminent domain”. It’s a case where you want to build a highway or a railroad and you confiscate somehow…and then there is some court proceedings saying is that fair or not? You could [do that]…it’s a bit harder. For real estate you have the value of land, you look at comparable houses, comparable pieces of land. It’s harder here because you have monopolies! There’s no traded prices. You can expect a more conflictual processes. Again I’m not a big fan of nationalisations. Not on principle – there’s nothing wrong with the public being involved. I’m very concerned with the firm being used for purposes which are not very good purposes – creating jobs which are not needed. Overstaffing is a big concern. We cannot afford that anymore. A period of high growth and high wealth is fine – you can have some slack. We are in a period of low growth and high debt [so] spending a lot of money and taxing consumers and taxpayers [is dangerous]…

So would you say to Labour that the answer to public discontent about privatised industries is to focus on the regulatory architecture?

Yes, definitely. And make sure you have the right people, that you don’t have political appointees. Sometimes you do. You get top people. We know that central banks are able to attract top people. If you screen enough and you focus on expertise rather than political friendship – there is always this tendency because Congress and Parliament always tries to get their friends appointed. That’s bad.

In the UK context the concern is less that the regulators are bad people, but that the regulators and competition authorities are toothless and they don’t take enough consideration enough of ordinary people’s behavioural biases…

The same exists in France. It’s part of the duty of governments to actually inform consumers. It’s true with electricity, it’s true with elections, it’s true of everything. Our world is very complex, there’s a lot of information we don’t have, we don’t process. We have behavioural biases. People need a choice, but they also need help with the choice. We have to pay attention not to give too much power to the Government in those choices. But having a little bit of advice from experts…explaining the trade-offs – not saying you should go for the incumbent or the entrant…but at least giving them some elements to think about those issues is very important. We have to explain what the risk is [such as] “watch out, there are teaser rates”. I found it totally outrageous when some American politicians during and prior to the financial crisis said we should not give financial information to people. But my goodness! You have to tell them about subprime, about the risk of teaser rates, about what happens if interest rates go up…if you don’t inform them…they don’t have Phds in economics…even if they have Phds in economics you may not even know if you should switch supplier! You need help. Same thing when you offer 500 pension plans to consumers. We are unable to choose. I think there are too many options. You need to standardise things so you can compare offers. It’s not about comparing the options. It’s trying to make things comparable. I don’t have time to compare different offers – there’s just no way.

But given people aren’t behaving in the way the designers of the market would like them to act, is it then legitimate to protect those people who are being financially penalised through price caps? The UK government is doing this through an electricity cap for people on standard variable tariffs.

In France you have the right to come back to the incumbent [electricity supplier] if you are not satisfied. Which is a strange option because it says you can always try and come back. If the price goes up you can always come back to a regulated tariff…

Labour also wants to have a French-style rent increase cap…

It would be better actually to index on market conditions. You move into an apartment which is very costly, you have children in school…and you don’t want your landlord to tell you after six months that by the way it’s twice as expensive. Capping the rent between different leases doesn’t make sense, because you don’t want rent control. Rent control is bad. But within a lease, you have to protect the person who rents. Because otherwise you have hold ups. And the question of course is: how do you do it? The best thing of course is to index it to something, but something which is objective somehow. In France you are protected. And I think it’s fine. But of course there are cases where it’s hard to find the right cap. So for example in electricity, we know the wholesale price is supposed to reflect scarcity if there is not too much market power (sometimes there is). And if you put a price cap you are going introduce more scarcity mainly for the peak supply. That’s a big issue – sometimes there is not enough peak capacity. If you cap at a very low level the rate, you won’t have such [investment] plans. In France people have kept the cap because they think there is a lot of market power. [It] has been proved that there’s market power in those peak periods. But then you create shortage. So what is done is that you introduce capacity markets. You require suppliers of electricity to sell you the electricity to show they have capacity so that they can cover peaks. Price caps are useful to constrain market power so the first question is: is there market power? In the [residential] rent stuff there might be a hold-up once you have moved into a flat. And also in electricity market during very scarce supply periods. Then the question is: what level do you want to put the price cap, knowing that it will have bad consequences? It will curb market power but could cause a shortage of capacity.

So a well-designed cap is not a bad thing?

That’s right. But we face that everywhere. Let me give you the example of the credit card market. In [previous] times if you use your credit card to shop you’ll be using it at the same price as if you use cash – there was no surcharge, simply because American Express of Visa or Mastercard would tell you you’re not allowed to surcharge if you’re a merchant. Then the regulator said no, the merchant should be allowed to surcharge because they pay a fee, maybe 3 per cent for Amex or Paypal, and they should be allowed to pass through that to the consumer. But of course you have an interesting pattern in the UK, Australia and some other places in the US too is that most merchants didn’t actually surcharge but some surcharged a huge amount. You know the cases where you pay £10 or £15 once you have booked Ryanair or something…What regulators are trying to do now is cap the surcharges. And the question is what level you pick. The proposals right now are mainly a cap – 3 per cent less something – actually we have a paper in Toulouse saying it’s too lenient in that case. But that shows the difficulty…

Do you about Booking.com stuff? It shows why finding a cap is difficult. If you are a hotel, Booking says you have to accept the condition of “price parity” or “most favoured nation”. If you buy from Booking as a consumer you have to pay the same price as on the website of the hotel or Expedia. But look at a situation where all hotels are on Booking and you are sure as a consumer to get the lowest price on Booking. You as a consumer are never going to look anywhere else because all hotels are on Booking and you’re never going to get a cheaper price anyway. Then Booking can go to the hotel and say “look, my customers are unique customers. You are not going to reach them unless you accept 20-25 per cent [commission]”. Huge market power. And the by the way the market power doesn’t come from dominance in the reservation system because Booking.com has only 20 per cent of reservations. It could have 2 per cent – it doesn’t matter! As long as it has unique customers it can ask any price. The decision in relation to Booking.com in France and Germany was not to go for a price cap because what would it be? 8 per cent? 14 per cent? Nobody had a clue actually. With a credit card we basically designed the rule to tell you what the price cap should be. At least you have principles for thinking through the price cap. Whereas in the case of Booking the economists haven’t done their homework. We don’t even know where to start. We certainly think 25 per cent is too big. But is that 8 per cent? 14 per cent? What was decided was something else saying you could get a lower price. In France you can get a lower price on the website of the hotel. Which creates also some problems - the danger then is that the consumer goes on the website of Booking, finds the hotel he or she wants, and then goes to the hotel directly and then Booking gets no reward, which is not fair either. In the case of Booking the decision was not to go for a price cap because we didn’t know how to calibrate the price cap. We had different remedies. They [price caps] can be a good thing. But if they’re poorly calibrated they can have bad effects.

We have a very primitive debate in the UK. Whenever anyone says “price cap” we hear “Marxism” or “slippery slope to communism”….

You’re kidding! I thought price caps were introduced initially to deregulate to some extent. So for British Telecom, to get a pricing structure which was closer to what was more economically oriented. I can’t believe that price caps would be “communist” plot or something like that…

So how do you regulate giant internet companies – Amazon, Google - with huge market power? You don’t seem to reach any conclusion in your book…

Economists haven’t quite done their homework. You have to think much more about those things because they are the new economy. We are going to get those network effects which are very powerful. You will have superstar firms making big profits. The question is: what do you do with these firms? Somehow you want to make these firms contestable, which is a jargon for saying if someone is more efficient in some market niche then you want his firm to be able to enter, which may be difficult if Google bundles the various services. It’s going to be hard to compete against a zero price service. So you have to be very careful that entrants can enter in a particular market segment. And by the way they all do that. If you think about Google itself it started small. Amazon started selling online books. Think about Uber. I cannot predict, but my guess is that Uber is not entering the taxi market, I mean the current taxi market. But in five years from now, or ten years from now, there won’t be any taxis any more, at least not with drivers. Uber is trying to enter a niche and then expand. They all do that. You cannot enter every market at the same time. It’s too risky, too complicated, too costly. You start with one and build out.

What about them buying competitors. Should this be allowed by regulators?

This is a complicated area. What’s happening is those firms are buying future competitors. At the same time it’s pretty hard for the anti-trust authorities. Given those a young firms and you don’t know where they are going and you don’t have any data. Are they future competitors? We don’t even know. The principle is easy. If you want to merge with someone who’s going to compete with you in the future? No. But the practice is harder. And that’s one of the things we need to think through. But the anti-trust authorities don’t have an easy job. The idea you need some total concentration [measurement] makes no sense. A start-up has zero sales, or very small sales! Then there are lots of specific issues. We talk about Booking.com…I give some insight about the anti-trust, but we need much more work. In Toulouse we have developed this theory of two-sided markets, the economics of platforms. We have been saying for a long time, when you do anti-trust don’t look at one side of the market. You have to look at the two sides, otherwise it makes no sense. Many of those platforms they charge zero to one side of the market – you get a great deal for your credit card or your search engine – it’s wonderful. You’re selling your data. And then they charge huge prices to advertisers and to merchants and so on. On one side of the market you’re a pure monopolist and the other side you’re preying on your competitors because you’re charging zero prices. It’s just a completely wrong picture. The anti-trust authorities also have to adapt to the new economy. We are a bit ahead of the anti-trust authorities but we are behind what’s going on. We have to work harder.

Do you have much contact with regulatory authorities? Do they consult you, because you are obviously an authority on it…

To be honest I’m pretty involved in the policy debate, but on other issues. The labour market and climate change issues. A bit in competition policy issues…Also I’m pretty involved in banking policy. But there’s only so much time. Fortunately there’s a number of very highly qualified economists in competition authorities who actually who have read that stuff [of mine]. So for example what we said on “patent pools” has been adopted in the European Union. And the same thing for credit cards. But I haven’t played any role…The ideas are maybe used, but just because you have some bright people in those authorities! I’m not in Brussels.

Would you like to see regulators taking more account of behavioural economics?

No question. I’m a big fan of behavioural economics. Also I recognise the threat it may pose, you know. We have to be careful. It’s in its infancy. Economists have been working on it for 20 years. But it’s not a mainstream thing.

President Emmanuel Macron recently criticised “post-modernism” and its influence on France. Would you agree with that?

I don’t want to get into academic conflicts. I’m a strong believer that there should be a back and forth between theory and empirical work, connection with the facts. And theory’s important as well. You have to be explicit what your assumptions are, what your logical reasoning is, and so on and so forth. This is the scientific method. Economics is an inexact science. We have to be humble. But we also have a methodology that we have to claim. And that’s very important. And the idea that everything is cultural I think is completely wrong! Because then everything is qualitative and you cannot say anything. That doesn’t mean that culture plays no role, which is a different thing. Social norms, culture – we are studying that in economics, of course, they’re important. The people who stress those things, of course they’re not completely wrong. But we should not go all the way and say that everything is relative and therefore you cannot say anything. Otherwise I would not want my salary to be paid by the French taxpayer! I think that would be a shame. If there was not a minimum of consensus and knowledge at any point of time, which evolves of course, how could I justify my salary? We need to be useful to society.

Do you feel that you’re successfully resisting what you describe as ‘Nobel prize syndrome’?

I try not to get into politics and areas in which I’m not competent – there are many areas in which I’m not competent. There’s always a grey zone – where do you stop? You have some common sense, you have stuff from your colleagues, you have some knowledge. It’s always tempting to go beyond. I cannot say I never go beyond where I should stop. I’m mindful of the temptation – I try to resist. I really think we should be humbler and not talk about things about which we have an opinion but we have nothing special to say. It’s stronger when you have the Nobel prize because people believe you know everything!