Finance: Past, Present and Future

The public sector across the UK is on strike today over plans to change their pensions.  The mood amongst public-sector workers will have been soured even more by the Chancellor's announcement yesterday that the cap on public-sector pay increases will be 1% per annum until 2015.  If inflation stays close to its current level of 5%, that means a real pay cut of 4% per annum over the next three years! I am tired of hearing the argument that the private sector has endured pain  so now the public sector must follow suit.  I have three issues with this argument.  First, the private sector enjoyed most of the upside whenever things were rosy, whereas the public sector got the crumbs.  Second, there is a risk-return trade-off that people who make this argument are ignoring.  Private-sector workers earn a higher expected wage, but face a greater probability of pay cuts or redundancy. On the other hand, public-secto...

A number of weeks ago, I posted clips to the Hayek vs Keynes rap.  The artists behind the rap have received a letter from a nine-year-old girl in which she states her preference for Hayek over Keynes - great discernment in one so young!  The letter is reproduced below (hat tip to Dr Graeme Acheson).

There are two notable economic facts about weddings in the West.  First, brides spend an exorbitant amount on a dress which is worn only once.  Second, the costs of weddings have been rising faster than inflation for at least two decades.   Click here for an interesting article which provides economic / behavioural explanations for these two phenomena.  

Reports in Italy yesterday suggest that the IMF is preparing plans to grant IMF credit to both Italy and Spain -  click here .  It is somewhat ironic for me that a Bretton Woods institution is going to rescue two of the largest economies in the Eurozone.  According to UBS's head of foreign exchange strategy: “Fixed income investors are betting that either Germany moves towards a fiscal union with its eurozone partners or that, without the ECB willing to buy unlimited amounts of sovereign bonds in the secondary markets, the eurozone will break apart.” (quote from  Daily Telegraph - full text here ). As markets move faster than politicians (especially EU ones), a break up is much more likely than closer fiscal union.  

Following yesterday's rise of German bond yields above those of the basket-case economy which is the UK, Jeremy Warner, Associate Editor at the Daily Telegraph , has written a pessimistic piece on the future of the Euro - click here .

I love hearing from past students.  This time last year I met up with David Symington (BSc Finance '07 class) for breakfast at Harvard Business School.  David has recently completed an MA in International Economics, Emerging Markets & International Development at John Hopkins and is now on an ODI Fellowship in Zanzibar. After reading some of my posts, David sent me this article on the dismal state of the dismal science - click here .  Coincidentally, David sent me this article the very day I heard of Mark Blaug's passing - obit here .  Blaug was a great historian of economic thought - he was horrified that modern courses in economics were obsessed with mathemathical training rather than reading the works of great economists such as Adam Smith or David Ricardo.  His Economic Theory in Retrospect  should be read by all economists. 

As a student of corporate history, I gain an interesting perspective on the longevity of firms.  Very few firms in existence today were in existence 100 years ago.  One exception is IBM .  Warren Buffett has recently taken a large stake in IBM, which is testament to the fact that this firm is still very successful.  Why has IBM been so successful?   There are at least three reasons. 1. It has innovated and responded to the needs of its customers – small, medium and large business enterprises.  It started out with punch card readers and counting machines, moved on to mainframes and PCs, and today it provides firms with business solutions, consulting and software. IBM was once the market leader and main innovator in the PC and laptop market, setting industry standards along the way. But it quickly realised that this was not going to be a profitable business in the long-run and that its customers (businesses) were going to need integrated software and c...

Thomas Cook has been around for 170 years, but it is going through a very uncertain time as it attempts to renegotiate its debt with its bankers.  Its share price fell 75% in trading yesterday. My Corporate Finance class will soon learn that some of the major costs associated with debt are the costs of financial distress.  The publicity surrounding its debt difficulties will not be good for Thomas Cook.  Its managers will have their attention diverted from managing the business to dealing with creditors.  Its best employees may try and jump ship (excuse the pun!).  It will be unable to finance new profitable holiday packages.  But most of all, who will want to book their honeymoon or summer holiday with a company that may not be around in a few months?      

The report of the High Pay Commission (HPC) was released yesterday - click here .  In previous posts, I have lamented about high pay – see here and here . The HPC’s report finds evidence that “Excessive high pay damages companies, is bad for our economy and has negative impacts on society as a whole. At its worst, excessive high pay bears little relation to company success and is rewarding failure.....Our findings also show that the argument used by many senior figures in British business, that pay must escalate in order to attract the best talent from abroad to UK companies, is a myth. Our own evidence shows that global mobility is limited, with only one successful FTSE 100 chief executive officer poached in five years – and even this person was poached by a British company.” The scale of the relative rise in high pay uncovered by the HPC is staggering. “Previously unpublished figures show that pay at the top has spiralled alarmingly to stratospheric levels...

It looks like Simon Johnson (former chief economist at IMF) has it in for big banks - click here and here . He is right, of course, to be worried about big banks.  I have always had a problem with big banks because they are perceived to be 'too big to fail' or 'too important to fail'.  The great irony for me is that the 2008 crisis actually resulted in some banks becoming even larger behemoths than before.   In 1900, there were nearly 100 banks in the UK, and the top five banks only had circa 25% of the market.  Today, retail banking in the UK is dominated by the 'Big Four'.  As these institutions are believed to be 'too big to fail', taxpayers have to bail them out whenever they get into trouble.  The implicit policy of 'too big to fail' prior to 2008 resulted in many of these banks taking too much risk in the first instance as they knew taxpayers would bear some of the do...

The ongoing campus protests in the US are being clamped down by heavy-handed police tactics - see article in HuffPost here (thanks to Barry Quinn for the hat tip).  This is a worrying sign as freedom of speech and the right to protest are fundamental rights in any democracy.

Niall Ferguson, the master of counterfactual history, has an interesting article in the WSJ on what Europe will look like in 2021 - click here .  He foresees a United States of Europe, with its capital in Vienna and the Germans very much in the driving seat. His crystal ball gazing takes an interesting twist as follows: "And in 2013, in a historical twist only a few die-hard Ulster Unionists had dreamt possible, the Republic of Ireland's voters opted to exchange the austerity of the U.S.E. for the prosperity of the U.K. Postsectarian Irishmen celebrated their citizenship in a Reunited Kingdom of Great Britain and Ireland with the slogan: 'Better Brits Than Brussels'." Ferguson is always provocative, but he has a better handle than most on the rise and fall of Empires and how finance is right at the centre of these movements.

Northern Rock (or at least part of it) was sold yesterday to Virgin Money.  At the time of its nationalisation, we were told that this could be a "good" investment for the British taxpayer.  It hasn't been, and it never was going to be.  Ed Balls believes that the Tory government got a poor price for it - click here .  The irony, of course, is that Balls was at the heart of the New Labour government which allowed and encouraged  banks to take imprudent risks in the first place.  What a nerve! The taxpayer loss on the Northern Rock (estimated at circa £400m) is small change compared to the eventual loss to taxpayers associated with the bailouts of RBS and Lloyds-TSB.  In 2009, RBS posted a loss of £24.1 billion (£24,100,000,000) and Lloyd's TSB a loss of £10.8 billion.  The RBS loss in 2009 holds the world record for the single largest corporate loss posted by a failed bank. Hyun So...

My blog has been going for just over a month, and it has had close to 2,000 hits, several of which have been from exotic locations such as Sierra Leone and Iraq - thanks to all my readers.   What an amazing thing the Internet is!  I am old enough to remember the pre-Internet era.  I remember my first introduction to the Internet in 1995, when I was a PhD student at Queen's University.  Sunny Teoh, a good friend from Malaysia, showed me how to browse in the Elmwood Computer Centre.  The first thing I searched for was <economist jokes> ( click here  for a taster).  I remember it like it was yesterday.  Today I use the Internet on a daily basis, and I can't imagine my working life without it.  But has it made me a more productive academic?   On the plus side, I can now easily obtain papers and working papers at the click of a mouse.   I can also communicate with scholars around the world via email or Skype...

Today the Queen attended a service at Westminster Abbey to mark the 400th anniversary of the Authorised Version (or King James Version) of the Bible.    Although scholars have highlighted the impact of this version of the Bible on society ( click here ), the development of literature and the English language ( click here ), what has been its impact on economic development? We can maybe get an answer to this question, if we look at the work of Sascha Becker and Ludger Woessmann, who have recently published a paper in the Quarterly Journal of Economics , which suggests that Bible reading had a powerful impact on economic development in Germany.  Below is the abstract of their paper:  Max Weber attributed the higher economic prosperity of Protestant regions to a Protestant work ethic. We provide an alternative theory: Protestant economies prospered because instruction in reading the Bible generated the human capital crucial to economic pros...

Will being born or living through the present financial and economic crisis affect your future decision making?  Recent work by Ulrike Malmendier and her co-authors suggests that experiences of macroeconomic instability and depression make individuals less willing to take financial risks in the future - click here .  In addition, they find that corporations managed by executives who grew up during the Great Depression were less likely to rely on debt finance and more likely to use internal finance – click here for the paper.  The big question for me is why the experience of macroeconomic instability and depression is forgotten by subsequent generations.   As the recent crisis has demonstrated, we are all too quick to forget the lessons of the past.   One possible reason is that economic history has been removed from the curriculum in economics departments and been replaced by classes in analysis, stochastic calculus, econometrics etc..   We need ...

Although we are all currently focused on the short-term upheavals associated with the European debt crisis, there is a more interesting long-run issue which we would do well to understand.  This issue is the decline of American hegemony.  Over the past 20 years, China has emerged as an economic superpower.  In 1991, its share of world GDP was under 5%, whilst the US share was circa 25%.  By 2013 China's share will be 15% and the US share will be 19%!  It is reckoned that China's share of world GDP will equal that of the US by the end of this decade! Globalisation has been cheered on by successive US administrations, and the costs to date have mainly been for US workers, whose jobs have been off-shored or who face downward pressures on their wages due to competition from overseas.  But maybe the largest cost to the US, however, will be the decline of its hegemony and the concurrent rise of China. Mich...

On Friday of last week I had the privilege of examining Chris Colvin's PhD at the London School of Economics.  His dissertation is a study of the Dutch cooperative banking system in the 1920s, a period when the Dutch banking system experienced a severe crisis.  The main findings of his PhD are as follows: 1. Religion played an important role in the stability of cooperative banks during the crisis. 2. Cooperative banks which faced greater competitive pressures took more risk. 3. The ability of banks to limit their liability resulted in them taking greater risks. Although one needs to be circumspect about drawing policy lessons from an historical episode like this, there are two things from this episode which should, at the very least, get us thinking.  First, competition in banking may not always be a good thing.  Second, to use modern parlance, owners need to have 'more skin in the game' in the form of some form of extended liability.  See my previous post on ...

Click here to read an open letter from students in Greg Mankiw's Econ class.  It appears that they are dissatisfied with the focus and underlying worldview of the module.  Economics has long been regarded as the dismal science, but given the inability of economists to forecast the Great Crash of 2008, it is in danger of being viewed as an irrelevant science.  There is, however, a more sinister view regarding economists.   Charles Hickson, my mentor and former colleague, lambasts the economics profession in the introduction to his 2001 book with the late Earl Thompson.  He suggests that economists simply serve the elite of society by devising theories and models that justify the elite's laws and policies.  In other words, economists have sold out, and have, in the process, lost their integrity. Which is it?  Dismal, irrelevant or corrupted science?  Unfortunately, it is probably all three.  In my humble opinion any resuscitation will ...

Professor Charles Goodhart , the Norman Sosnow Professor of Banking and Finance at the London School of Economics, has suggested some deep structural reforms, which are designed to prevent future crises emerging in the EuroZone.  His two main proposals are as follows. 1. Political reform Goodhart argues that “the single most important political reform for the EU is to have the President of the European Commission elected by the voters… The purpose of the exercise is to construct a European polity, and power centre, that answers directly to the people of Europe, and is not simply an apparatus managed by national political leaders.” 2. Fiscal reform in the form of tax-raising powers According to Goodhart, “as has been exemplified in the recent crisis, it is problematical to try to issue money without the power to support that via taxation.  Equally without access to money (notably via taxes), the power to undertake counter-cyclical, or cross-country, stabilisation is limite...

In a letter to this week's Economist , one of the leaders of the Occupy Movement stated that they are not anti-capitalist - they are just opposed to an unjust society where the 99% bail out the financiers and banks who have created a huge economic mess.  We were all told the lie that the bailout was necessary to prevent economic meltdown.  Despite all the bailouts, we still have economic mess and ordinary people are feeling the economic pain of having bailed out the financial system through falling real pay (if they are still in a job!) and reduced provision of public services.  This is why we have the Occupy movement. You can read an interesting and short op-ed by Joseph Stiglitz on the Occupy movement here .

     Roger Backhouse has an interesting piece in the NY Times on how the economics profession has ignored "capitalism" for too long - it no longer even discusses economic systems.  According to Keynes "economists should become more like dentists: modest people who look at a small part of the body but remove a lot of pain".  However, Backhouse argues that we need more general practitioners!  Click here to read more.

One of the lead articles in last week’s Economist argued that “lying is at the heart of civilisation” and “lying is one of the things that makes the world go round”.   Think about it for one minute.   If lying was socially acceptable and prevalent, would contracting and economic exchange be even possible?   Would the very fabric of society not crumble?   We could trust no one – the government, doctors, business, our parents, our professors, our friends, and even our nearest and dearest.   Sadly, the prevailing postmodern and relativistic culture in which we live believes that there is no such thing as truth.   You can watch Os Guinness argue for why we need “truth” by clicking here . In the City of London, there was once a phrase “my word is my bond”.   People in the City could be trusted – social opprobrium (and even jail) would be the result of someone caught lying and cheating.   Maybe the tolerance of lying and dishonesty has been ...

Ulster Bank, founded in 1836, has been one of Ireland's most successful banks over the past 175 years.  However, yesterday it announced that it had written off more than £1 billion of bad loans (mainly in the property sector) in the first nine months of 2011.  Click here for further details.  Along with Charles Hickson, I have examined the corporate governance of Irish banks (including the Ulster Bank) in the nineteenth century ( click here ).  Bank directors back then had incentives to ensure that their banks did not take excessive risk, which could potentially result in large loan losses.  First, directors were usually shareholders, holding about circa 1% of shares each, which meant that they stood to lose wealth if their bank performed poorly.  Second, they did not receive stock options or remuneration tied to performance.  Third, as with all bank shareholders at the time, the...

You might be interested to know that the Occupy Wall Street campaign is receiving support from Econ students at Harvard.  A number of students have walked out of Greg Mankiw's lectures to show solidarity with the Occupy campaign.  You can read about it at Greg Mankiw's blog and at the Harvard Crimson .  The irony is that they missed a lecture on the distribution of wealth! Could a similar group emerge at Queen's?  Will students walk out of my money and banking lectures?  I hope not!

Are students born in the summer more likely to get 2.2s?  Click here for an interesting study from the UK on the effect of being born in the summer on future educational attainment.  For the record, I'm a December baby!

The EuroZone deal, which was put together last week and was prematurely lauded as a success, is beginning to unravel thanks to the decision of the Greek government to hold a referendum on the deal.  The Greeks (Athenians really) gave the world democracy, which comes from two Greek words meaning "mob/people" and "power/rule".  The irony for me is that the whole euro project, which is an entirely undemocratic one, may be dealt a death blow by the power of the people. The big puzzle for many people seems to be why the EU keeps lurching from deal to another, yet there is no solution in sight.  Are the French and German governments incompetent?  Is the political dynamic within Europe too complex, resulting in gridlock?  My view is the EU elite have known for a long time that Greece (and maybe some others) will have to leave the euro, and they are happy enough to lurch from one unsuccessful deal to another as ...

It seems that my blog was not the only place which did a piece on religion and economics on Reformation Day - click here for the Guardian's interview with Sasha Becker, where he suggests that religion may explain why some EU countries have higher budget deficits than others.