The Return Of Two Nations

One of the unforeseen consequences of the financial crash in 2007 has been an increase in the levels of inequality across the developed world. This has come about as a consequence of  the policy of quantitative easing. QE is the process by which a monetary expansion is used to stimulate aggregate demand in lieu of a more active fiscal policy. It acts by pumping liquidity into the banking system through the purchase by central banks of liquid assets - usually Treasury bonds. That, in turn, inflates the values of financial assets and quasi-financial assets, such as property. Those with assets have seen their wealth grow considerably, whilst those without assets have had to simply watch it happen.

This process has continued long enough to have more systemic implications. The current levels of inequality, of income and wealth, have affected both the supply side of the economy as well as the demand side. The impact on the demand side is easier to see. Wages and salaries have been stagnant for the best part of a decade in nominal terms. In real terms, their share of GDP has been falling consistently over a long period. This has increased the number of people who are just getting by, and we have seen the expansion of poverty relief initiatives. In 2010, when the Coalition came to office, Food Banks were relatively unheard of. They are currently a feature of contemporary life.

The impact of inequality on the supply side is a little more roundabout, but present nonetheless. Sluggish demand has helped to reduce the amount of productive investment in the economy. This, in turn, has capped productivity growth, which in turn limits the degree to which wages and salaries can rise. There has been a growth in part-time, zero-hours, minimum wage, employment in recent years, partly as a consequence of more restrictive benefit entitlements. This has made employment structures far more precarious than they were prior to 2007.

What investment there has been is directed towards unproductive assets (i.e. assets that are not employment creating), such as buy-to-let residential accommodation. Given the poor returns on cash as a consequence of QE, returns on property have provided some of the best risk-weighted returns on capital over the past ten years. However, this has tended to make property expensive to buy, causing a fall in owner-occupation, and adding demand to the rental sector. This demand closes the loop for buy-to-let property by bidding up rents, which underpins the returns to be had from property as an investment class.

One result of this process is a class of people who are doing very nicely and a class of people who are being left behind. There are different gradations within these two classes, but broadly speaking this is a useful distinction. These social divisions, derived from the underlying economic circumstances, have now found a political manifestation. In the UK, the manifestation was Brexit. By and large, those who supported Brexit are those who felt left behind in an economy where some were doing rather nicely, but they were struggling. The feeling was that there wouldn't be much to lose from leaving the EU. Of course, leaving the EU could well fail to solve the problem because it is much deeper than that.

A few weeks back, I drove past Blenheim Palace in Oxfordshire. It gave me an opportunity to reflect on an historical perspective to inequality. The current levels of inequality are not at all extreme when compared to the inequality of the Ancien Regime, or Imperial Rome, or even Feudal England. When taking a long perspective, we are in a relatively egalitarian age. What is different now is that we aspire to equality - both equality of opportunity and equality of outcome, an impossible task - in a way that is different to previous ages. We aspire to a more equal society, and it is this aspiration that is frustrated by the current state of affairs.

Looking ahead rather than backwards, how might this change? QE, the source of much of the current inequality, is an experiment that has done what it set out to do (i.e. to prevent a Great Depression style economic downturn after 2007). It is not clear how QE should be wound down. This is potentially the part of the experiment that contains the greatest dangers. Loosening too quickly risks an runaway expansion with an acute inflation risk. Loosening too slowly risks keeping on the economic brakes too long and causing damage to the economy in terms of unrealised production. There is evidence that the latter effect has made itself felt more readily than the former. Most Central Banks have stated that they intend to hold the underlying financial instruments until maturity, and then to fold the proceeds back into the money supply. That suggests we shall be in QE for decades to come.

If that's the case, then the underlying pressures that gave rise to growing inequality will also be in place for some time to come. Ultra low interest rates and unconventionally loose money are no longer unusual, they have become the new normal. This is where things become awkward. Rising inequality is a process and not a state. If QE is to continue for years to come then inequality will continue to grow for years to come, in the absence of any factor to prevent it. As this happens, the gulf between those doing nicely and those just managing will continue to grow. The ranks of the former will shrink, whilst the ranks of the latter will expand. Britain will again become the land of Two Nations again.

Perhaps it's time to brush up on our Disraeli?

Stephen Aguilar-Millan

© The European Futures Observatory 2018

Which World Are We Living In?

The July 2018 edition of Foreign Affairs contains a special feature on different perspectives of the world in which we are living. I was attracted to this approach because I often feel that the way in which we view the future depends upon, in large part, they way in which we view the present. If that's so, then it's important to gather different worldviews of the present in order to tap into how people expect the future to unfold. The feature gives us six views of the world - the realist world, the liberal world, the tribal world, the Marxist world, the tech world, and the warming world. Each of these has its merits and is worth considering.

The realist world provides us with a description of big power politics. The base argument is that the players might change, but the game remains the same. It is big power rivalry and conflict that drives forward events, and thus progress. Every now and then, the conflict turns violent, but this has a restorative effect as the game continues with different players. Much of this worldview is evident in contemporary geopolitics, and the author does not have to hunt too hard for examples of his case.

Opposed to the realist world is the liberal world. Whereas the realist world is marked by conflict, the liberal world is marked by co-operation. In this case, nations come together and agree to certain modes of behaviour for everyone's mutual advantage. This world order is dominated by international organisations and rule sets. The main justification for this is that it provides a sustainable basis from which to grow prosperity in many parts of the world. Some economists see this as a pre-condition to prosperity. Once again, there are many examples to support this worldview.

The disadvantage of the liberal world is that it assumes that all people are basically the same. This assumption is questioned in the tribal world. The core tenet of the tribal world is that people naturally divide into groups, and that it is the group identity that provides human cohesion. By defining 'us', we also, ipso facto, define 'not-us'. It is the tension between us and not-us that gives rise to rivalry and conflict. There are numerous examples where this view explains much of geo-politics.

The Marxist world considers what it is that defines tribal identities and comes up with the answer that it is a shared socio-economic experience that translates into a form of political tribalism that we call 'class'. In this case, conflict is driven by competition between the capitalist class and the proletariat, and between rival groups within the ruling class, as each strives to resist a naturally falling rate of profit. This worldview as its merits, but seems a bit dated in a world in which the rate of profit is rising rather than falling.

The tech world sees everything as a body of data that is waiting for an algorithm to compute. This is the world for which I have the least sympathy because I find it to be quite one dimensional. I think that part of my problem is that I don't share the base tenet of this worldview that history is nothing more that a sequence of technological advances. I will concede that there is a point to this, but, to me, this is only part of the story and a long way from the whole of it. To me, the lack of well developed examples in the piece is telling.

The final world - the warming world - is one that resonates with me. The basic tenet of the worldview is that all of the other worldviews are redundant because impending climate change, and our inability to deal with it collectively, has the capacity to fundamentally change the way in which we organise our affairs. To that extent, climate change matters more than anything else. When looking deeper into the future from today, this point has some resonance. However, I would argue that the evidence to date suggests that humanity won't be up to the job until it's too late.

The interesting thing I find about the six worldviews is that they are not mutually exclusive. It is entirely possible for, say, the realist view to reconcile with the liberal view in a world in which pragmatic co-operation is a rational strategy. Equally, the tribal worldview and the Marxist worldview are, in my opinion, different sides of the same coin. This makes things a bit more difficult when moving from the present into the future because a well nuanced view of the future would want to balance all of these perspectives. In many cases, there is a little of each world in the present and the problem is to assign weights to their relative importance. These weights are likely to vary over time. 

It is important to consider differing worldviews when conducting a futures exercise. We can consider how robust our views are by looking at the futures through a different lens. If it stands up to scrutiny, then perhaps we have something useful? If it doesn't, then perhaps we ought to keep thinking?

Stephen Aguilar-Millan

© The European Futures Observatory 2018

A Murmuration Of Markets

I was raised in a clockwork universe. Most of my education was based upon the presumption of Newtonian physics. This presumption extended into how I was taught economics. It was believed that human affairs could be distilled into mathematical models that worked like clockwork, a dance of algorithms.  It could explain our behaviour and, more importantly, could be used to predict how we would behave in the future. Models of markets were described in very mechanical terms.

If demand exceeded supply, consumers would bid up the price of goods paid to producers until the market cleared. If supply exceeded demand, producers would lower the prices paid by consumers until the market cleared. Intuitively, this reasoning has a great appeal. We can see it happening in any fruit and veg market in virtually any country. If there is fruit and veg left at the end of the day, the market traders reduce the price to get rid of it. Equally, if there is a rush on certain products, the traders can re-price the stock to account for the additional demand.

It's hard to say when I stopped believing this view of the world. The model of how markets behave didn't quite fit the facts of the real world. I think that it was the issue of food waste that first confirmed my suspicions. According to the Newtonian model of supply and demand, there should be no food waste. The price of food should fall and the market should clear (i.e. there should be no waste). For there to be waste meant that the markets weren't functioning as they should.

This has been the usual policy response when reality doesn't quite accord to what the theory would lead us to expect. If there is a mismatch between what the models lead us to expect and what we actually experience, then there has to be a flaw in reality. We have been able to rub along with this for most of the time because most of the remedial action has been to tinker around at the edge of markets. For most of the time, markets worked perfectly adequately. Until suddenly they didn't.

The financial crisis is dated differently in different parts of the world. In the US, it is dated from the demise of Lehman Brothers in 2008. In the UK, we tend to date the crisis from the run on Northern Rock in 2007. Irrespective of which date we select, the point is that we are describing different aspects of the same thing - the failure of global markets. If markets fail on such a systemic scale, then perhaps it's not the fault of reality? Might it be that there are fundamental flaws in the models of markets? Could it be that we ought not to be slaves to Newtonian mechanics?

There was a deep soul searching in the economics profession following the financial crisis. It was patently obvious that economics, as a profession, was not fit for purpose. And so, a quest for a new economics started, this time based on the presumption that reality is always right, and that models either describe reality, or they don't. If they do, they are useful. If they don't, they are redundant. Taken from this perspective, human affairs might not have a Newtonian certainty after all.

If we reject the clockwork universe, what do we have to replace it? Markets are obviously a fact. They generally work adequately for most of the time. So how can we conceptualise this behaviour? There are some, and I count myself in this number, who are attracted to a more organic view of human affairs. Might the economy work less like a giant clock, and more like a giant organism? Admittedly, a very complex organism, but an organism nonetheless. 

If we accept that view, then economics can be extended to include aspects of the economy that have been downplayed. The models can be extended to include the dynamics of time and space, two pretty important features of the economy that classical economics ignores. We can include the social and political dimensions that traditional economics dismisses as normative. More importantly, we can introduce such features as the impact of the environment - natural resources and the climate - which current models abstract away from. We can start to arrive at a more rounded view of human activity by incorporating more of reality into the rather bland Newtonian economic models.

Supposing we adopt this approach, how would we represent markets? There is one feature of the natural world that could be very instructive here. Starlings have a collective behaviour - a murmuration - that could help us to understand how markets work. The Starlings fly as a group, much in the way that we shop at supermarkets as a group. No one starling is in charge, and each starling acts on their own volition, very much in the way that we can all exercise choice in our shopping habits according to our individual needs and desires. External factors can change the behaviour of the murmuration. If a bird of prey comes into view, the murmuration will fly away from it, very much as the imposition of VAT on a product will discourage us from purchasing it. 

Despite this, there is still much we do not know about collective and aggregative behaviour in the economy. The insights of the macroeconomists suggest that the economy in the aggregate is not the same as the sum of all microeconomic activity. Perhaps we are having trouble in explaining this disconnect because we are looking in the wrong place. Perhaps we should study the mechanics of general equilibrium less, and study the murmurations of starlings more?

Stephen Aguilar-Millan

© The European Futures Observatory 2018