Travels In The Blogosphere

My humble apologies for letting a week go by without a word from the Pragmatist. But while taking care of business, I've at least been charting my travels in the blogosphere on Twitter. And The Fine Print records a few sceptical and irreverent reactions to:

• the eagerly awaited judgment on MasterCard's multilateral interchange fees (MIF); and

• the latest draft of the Financial Services Bill.

You might also keep an eye out for a guest post on the Nutmeg blog.

Just when the sun is shining at long last...

One Simple Way To Stop Kicking The Can Down The Road

We all know with calm certainty that it each European economy functioned without the Euro. 

We can argue that Germany has done much better under the single currency, and that Greece has always been a basket case whatever the currency. But these economies functioned. 

Whereas the sovereign debt crisis is driven by complete uncertainty about whether the 'Eurozone' economic union will ever be sustainable, and the conviction that some economies are definitely doomed without their own national currency.

In this situation one might have thought the ultimate route to relative economic stability would be to set a date by which the Euro will be withdrawn. Everyone would then unite to deal with that fundamental economic fact. 

Some might argue that the decision to form the Eurozone also encouraged unity and stability, as should efforts to maintain it. Yet it's obvious that including weak economies in the drive towards monetary union created moral hazhard, driving national fiscal and banking sector irresponsibility to the point of fraud. And there's plenty of evidence on the streets and in the polls to demonstrate that the maintenance efforts are divisive rather than unifying. It's difficult to see how a decision to return to national currencies would drive the same behaviour - in fact it may eliminate it entirely, or at least reduce it to manageable, local levels where the national politicians and their banks would be stuck with the consequences of their fiscal profligacy rather than everyone else. That may explain why some resist, while it's in the job description of European officials to support the Euro in service of the single market fantasy policy.

At any rate, there's one simple way to stop the politicians 'kicking the can down the road'. 

Remove the can. 

Image from JMK Advisors.

The Politics of Cash

Over on Tomorrow's Transactions, Dave Birch quite rightly questions the assertion in the NY Times that cash is somehow important to "protect our civil liberties by preserving some untraceable payment method." Few people are obsessed with anonymity. But at the same time Dave applauds the notion that "Cash-based economies harm the poor by heightening the risks they face when carrying money and fueling government corruption and inefficiency."

I should declare at the outset that I'm a great fan of electronic money and online financial services, and I advise various clients in the payments and online peer-to-peer finance space.  But I also believe that innovation doesn't 'kill' anything - the new must coexist with the old. Calling for the abolition of old services brings the laggards out in force, sometimes to comic effect. That's one reason you won't hear me calling for the end of fractional reserve banking.

But the 'death of cash' is not a question of civil liberties or somehow liberating the poor from a cash economy. Many people - the so-called 'unbanked' in particular - still see cash as the best mechanism for maintaining control over their finances. What some people see as higher prices for not paying online or by direct debit etc, others see as a wise investment in a payment method that prevents them spending money they don't have.

 

Research commissioned by the Financial Inclusion Taskforce found that the 3 million British adults without a bank account (the 'unbanked') do not consider themselves as disadvantaged by not having bank accounts, cheque books and debit cards. They do not see much use in an ATM, cheque book, credit card or debit card because they don't tell you your balance until it's too late. A text message confirming a payment you just made is laughable.

And if you don't find your bank or its services trustworthy or useful in the first place, why would you give them all your personal details so they can text your bank balance to your phone?

Most importantly, the same research found that most of the so-called 'unbanked' are actually in control of their finances. They put cash in specific jars to cover certain expenses. They can readily see at any time how much is in the jar, so they 'always know where they are' in setting money aside for energy bills and so on. 

I agree that loan sharks and others may prey on this form of financial control. But it's not as if access to a bank branch, internet banking or direct debit has saved the rest of us from financial charlatans or the erosion of civil liberties...

Long live cash, I say.

How Cheetahs Can Leap The Digital Divide

ManyPossibilities; Hat-tip Confused

Confused of Calcutta explains that African entrepreneurs can cross the 'digital divide' by leap-frogging the legacy compliance issues that strangle blue sky discussions in western corporate headquarters and start-ups. 

There's certainly some serious infrastructure being put in place. Is it merely a coincidence that the two most popular posts on this blog by some distance are: 

Does Investment Beat Donations in Sub-Sahara Africa?

The Cheetah Generation: Will Facilitators Grow Faster in Africa?

The latest buzz seems to be about a natural resources boom in Mozambique, which the country stats suggest will need some serious investment in infrastructure, including everything from healthcare, water utilities, roads, housing and schools to remittance services. Time to brush up on your Portuguese...

More Risk, More Trials, More Error, More Success

I was at a Coadec event for encouraging tech start-ups in London on Wednesday. Much of the focus was on demonstrating why London and the UK are better locations for starting businesses than elsewhere. Certainly the Polish and Turkish entrepreneurs seemed to think so, although the Turkish guys did point out they'd tried the US and couldn't get a visa ;-).

That's nice to hear, but a bit underwhelming.

Research from the IEA has already shown it's easy enough to start a business in the UK, though the insistence on the 'employment' model still makes it a bit awkward for small businesses to take on staff. 

The real point is that we can't pick which businesses are going to be successful. The best that we - and government - can do is to ensure "a climate in which enterpreneurship can thrive". In other words, we have to encourage more trial and error. We have to welcome failure in order to see success.

Actually, I think we're okay with failure in the context of genuine innovation. It's a long time since anyone went to prison just being unable to pay their debts as a result of an honest small business failure. A lot has been done to make it easier to clean the slade and start afresh. And UK figures referred to at the Coadec event suggest that entrepreneurs fail an average of 3.5 times before succeeding (although the IEA also suggests that an entreprenuer is more likely to be successful if he or she has been successful before). 

Where we do have a problem, quite rightly, is with failure in the management of our major institutions. In this context, trial and error is acceptable. But running an established business process in a way that results in significant errors or outright disaster is not. Unfortunately, concerns here tend to drive higher levels of (fairly ineffective) regulation, which in turn stifles innovation and competition where it's needed most. Indeed, the European Commission Consumer Scoreboard suggests that the more highly regulated a consumer market is, the worse reputation its suppliers have with consumers - lowest of the low being financial services. In March, the FSA listed the key risks to consumers from FSA-regulated providers as being pressure selling; failing to provide ongoing service to existing customers; poor complaints handling; inefficient day-to-day business processes; cancellation blockages; lack of proper infrastructure; complexity and volume of communications; excessive and/or unfair charges; and changes in terms and conditions without notice or appropriate reasons. The FSA concluded:

"... on the whole, financial service providers were seen to generally fall short on their promises, to the extent that the majority of consumers in the study considered that there had been an erosion of trust between them and their financial providers. In particular, they cited an inability on the part of financial service providers to offer the most appropriate solutions for them."

How do we get these businesses "to offer the most appropriate solutions" to their customers' problems?

It seems to me that our heavily regulated institutions are too risk averse. As a result, genuine innovation among those institutions is virtually non-existent.

The sub-prime crisis, for example, was not caused by banks intending to take on more risk. A shortage of 'safe' assets - a deposit crisis - meant they were actually trying to transform high risk mortgages into low risk bonds, by bundling the mortgages together and cutting them up in different ways, repackaging them and so on. The bank that invented the process way back in the mid-1990's actually did sensibly trial it first, before deciding that it ultimately wasn't sustainable. So the huge errors and bank failures over a decade later resulted from imitators who had adopted the faulty process without adequate monitoring, controls and due diligence procedures that would have told them when to stop. Evidence of this has emerged in the resulting 'fraudclosure' scandal, where no one was sure who owned many of the underlying mortgages when they were called in.

There is no room for complacency on this front, but there's still plenty going around. Even the bank that realised the potential for the sub-prime crisis was recently caught out by its own process failures, allegedly while trying to hedge its existing financial exposures (i.e. reduce risk). These institutions are so smug that they pay half their 'profits' in bonuses even while failing to maintain adequate risk monitoring systems.  

Maybe if they committed themselves to taking more risk to solve their customers' problems instead of their own, these institutions would organise themselves to be better at monitoring and managing that risk than just selling the same old stuff. In doing that, however, they would need to engage in lots of little trials and ensure they had a good understanding of why each trial did or didn't work. We don't need big rolls of the dice. 

But where's the pressure to do this? Governments and regulators the world over are 'clamping down on risk-taking', after all. 

Perhaps the same effect will be achieved by the many start-ups focused on financial services. But again we run into the headwind of regulation and tax incentives, ironically designed to benefit consumers, which only serve to perpetuate the status quo. As recently discussed at the Finance Innovation Lab, regulators and policy-makers will need to improve their understanding of how the innovation process needs to work before customers will be better off.

Image from TVTropes.

Innovation Is Vital For Growth, Not Just Cost-Cutting

There's a lot of concern about how to grow the UK economy. Some have pointed to banks and the public sector as 'the enemies of growth' because they are 'extractive', rather than inclusive 'facilitators'. Government spending is too high, as are taxes, and there's a concern that national public sector pay awards have 'crowded-out' private employers. Banks are not lending. 

But there's much more to this, of course. 

Clearly even the generous private credit available during the noughties merely went on houses and consumer spending, rather than building sustainable and globally competitive businesses, especially in the regions. As Steve Randy Waldman of Interfluidity recently explained in the context of southern Europe's troubles, it's the poor allocation of capital, not lack of finance or high labour costs, that causes "an incapacity to produce tradable goods and services in sufficient quantity." Governments aren't alone in their ability to waste money and other resources.

How do these things fit together?

Experience shows that countries whose governments try to spend more than 30 - 35% of their overall output (GDP) gradually produce less and less. That's because governments impose taxes to pay for spending (and borrowing), and tax is a 'deadweight cost' or economic inefficiency. As output declines, the government receives less and less tax so ultimately must spend less on public services. Those services then start to break down. Eventually, everyone speaks Greek. UK government spending is about 50% of GDP. Yet tax receipts have averaged around 38 per cent of GDP over the last twenty years and have never exceeded 40%. The UK government can a funding gap (deficit) of up to 2.5% of GDP before it becomes a 'structural deficit' - an albatross around the country's neck that takes a special effort to remove - George Osborne's current challenge. By contrast, the Australian and Swiss governments spend around 35% of GDP (source: OECD, IEA, p. 47).

On a regional basis, the UK picture gets worse. Public spending in London and the South East has remained under 40% of regional GDP. But public spending equates to 45% of regional production in the East, and a whacking 70% of what the North East produces. Public spending in England is cruising at 50% of national output, while in Scotland it's at 60% and in Wales and Northern Ireland the good citizens are dragging around a millstone of government expenditure equal to 80% of their GDP  (source: HM Treasury, hat tip IEA, p. 57).

So, if you live somewhere outside London and the South East your community has a choice. Either you ask the government to start spending a hell of a lot less on you. Or you make sure the region produces enough so that government spending only represents about one third of your output. Pick neither and you'll αρχίσουν να μιλούν ελληνικά.

It's possible that high public sector pay rates make both of these tasks harder - it means the government is spending more (on its staff), and it's more expensive for businesses to hire the staff they need, so they charge higher prices and their products are are less competitive.  Public sector pay is mainly agreed centrally, in national pay awards. Those who work in more expensive places than the average, like London, get paid a bit more. But employees who work in places where it's cheaper to live than average don't get paid less. So their communities will find it harder to keep government spending in the right proportion to what their community produces.

But this does not necessarily mean labour costs are the main reason for some regions being more competitive than others. Steve Randy Waldman, of Interfluidity, argues that competitiveness is about capital much more than labour:

"... to the degree that unit labor cost statistics capture what they claim to capture ... European workers, North and South, have come to earn roughly equal pay for equal product. Southern European workers do earn less overall, simply because they produce fewer or lower-value goods and services than their Northern neighbors. [But] unit labor costs are not the problem at all: it is the scale of aggregate output. And what determines the scale of aggregate output? Is it the laziness of workers? No, of course not. We all know that when residents of poor countries emigrate to rich ones, the same weak bodies and flawed characters that produce very little at home suddenly explode into economic vigor. The difference is “capital depth”, broadly construed to include all the physical equipment, business organization, public infrastructure, and governance that collude to enable two small hands and a broken mind to accomplish outsize things. Workers’ pay level is not the problem in Southern Europe [or, say, UK regions]. It is deficiencies in the arrangement of capital, again broadly construed, that have left Greece and Spain unable to produce value in sufficient quantity to compete with their neighbors."

 As a result, Steve suggests: 

1. "If Southern Europe lacks competitiveness, the part of the cost structure that needs to be reformed has to do with rents paid to capital rather than the sticky wages of workers; and

2. "The European periphery was rendered uncompetitive by toxic patterns of capital allocation." For this he cites Arnold Kling's recent paper for the Adam Smith Institute, which concluded:

"...economic progress involves creating new patterns of [sustainable] specialization and trade [PSST]. When new opportunities suddenly emerge, there can be periods in which high productivity growth in industries with relatively inelastic demand creates a surplus of workers. It takes time for entrepreneurs to discover new ways to exploit specialization and comparative advantage, and it takes time for the labour force to adapt to new skill requirements. These real adjustments are needed in order to restore full employment."

In short, the UK and each of its regions needs to foster self-employment and entrepreneurship, by creating an environment in which it's easy to start and grow new businesses. Removing the difference between public and private sector pay may help incentivise public sector workers to move to the private sector - as could laying off more public sector workers. The necessity to find new work may be the mother of invention, after all. But that doesn't remove the ultimate need to focus on fostering the process of creating new businesses for those workers to join.

Image from NE Generation.