Fiscal space

05. January 2021 · Write a comment · Categories: COVID-19, Demographics, Economics, Risk

NASA, ESA, and the Hubble Heritage Team (STScI/AURA), Public domain, via Wikimedia Commons

Fiscal space is defined as the difference between a nation’s sovereign debt-to-GDP ratio and the limit beyond which the nation will default unless policymakers take fiscal steps that are outside of anything they have done historically. That limit is sometimes referred to as the fiscal cliff, just to ram home the imagery of fixed physical limits beyond which disaster beckons.

How much fiscal space does the UK have? Moody’s have an answer, which depends most heavily on when you ask the question. In September 2019 it was as follows:

This shows the UK with a fiscal space (the “dynamic” means they assume interest rates increase as borrowing does, due to “crowding out” arguments – ie government borrowing pushing up the price of borrowing for everyone – so beloved of most economists) of around 175% of GDP, with this then projected to fall over the following 5 years as rates “normalized”. While the cost of borrowing seems to be dynamic, the actual borrowing itself is not allowed to be in these calculations – it is assumed that they just add to debt without increasing the revenue components of the primary balance.

Well of course then we had 2020, at which point (June 2020) Moody’s appear to have stopped talking about fiscal space and instead are now focusing on something called “debt affordability”. What happened to dynamism and crowding out? Not explained:

However despite this triumph of debt affordability, they then produce another graph to indicate that governments still need to be bearing down on debt to GDP ratios:

As they say in the document “rating implications will depend on governments’ ability to reverse debt trajectories ahead of potential future shocks”. Remember this was in June 2020. Let’s also remind ourselves of another graph:

Requiring governments to reverse debt trajectories in this environment is insane and likely to result in more deaths if not ignored. However as recently as last month in their issuer comment for the UK they said:

However, compared to the government’s March budget (that was quickly overtaken by events), there are some initial signs that fiscal policy outside of investment is likely to be less expansive than previously announced. What remains unclear is whether this ambition will be able to withstand the political pressures that seem to be inevitable given the government’s previous commitments. Even before the Spending Review, longer-term spending commitments for health, education, and defence had already been announced. Together, these three areas account for around 60% of total expenditure.

I have been hard on Moody’s in this piece, they are most certainly not alone. But this attempt to divorce sovereign debt levels from what is actually going on in countries needs to stop as does the constant discounting of the value of any government spending at all. Political pressures to spend more on health and education are not always things that governments need to “withstand” in order to look good in a Moody’s graph. There are far more important things at stake.

 

Change and Innovation-Speak

03. January 2021 · Write a comment · Categories: COVID-19, Economics

Blaise Pascal, mathematician and philosopher, once said:

All of humanity’s problems stem from man’s inability to sit quietly in a room alone.

This seems to have a particular relevance at the moment, when many of us are being asked to do precisely that. I also agree that this is definitely a problem we have. However I prefer to think of it as just one consequence of our inability to think about change in any rational way. We fear change, which is why we yearn so much to go back to “normal” at the moment, even if normal life was pretty unsatisfactory for many of us before the pandemic struck. We fight against change if we think what we have is threatened from outside the room we might otherwise sit quietly in, whether that is the loss of our income or that of our influence in the world or our “sovereignty”.

The only way in which we can contemplate change is in the context of some utopian ideal of improved productivity making one aspect of our lives much better while not requiring us to change any other part of them. Hence so much resistance to any idea of redistributing what we already have in favour of “Pareto improvements” to the economy, ie those which benefit some people without making anyone else worse off, and the obsession amongst economists with the “productivity puzzle” in the UK in particular:

So we look for ways to achieve this miraculous productivity improvement while leaving everything else essentially unchanged and the magic word which promises this more than anything else is innovation. Innovation will enable us to do more with less (or, more usually, make us do a lot more much cheaper, therefore encouraging us to use even more in the process). Innovation will have spin offs in lots of other areas we have not even imagined yet, but they will all be good ones! Innovation will solve the productivity puzzle.

In The Innovation Delusion, Lee Vinsel and Andrew Russell challenge this. As we have become more and more desperate for all change to look like innovation, we have made actual innovation harder to achieve, while saddling ourselves with higher and higher maintenance costs of new “innovative” infrastructure which is increasingly unsustainable to finance, rather than maintaining what we already have better.

I therefore prefer the quote that they use, from Kurt Vonnegut:

Another flaw in the human character is that everybody wants to build and nobody wants to do maintenance.

Innovation-speak, as they call it, is not innovation at all, but presenting ideas as innovative when they are not. As they say:

It plays on our worry that we will be left behind: our nation will not be able to compete in the global economy; our businesses will be disrupted; our children will fail to find good jobs because they don’t know how to code…Innovation-speak is a dialect of perpetual worry.

No wonder we are unable to sit quietly in a room alone.

And in the coming years when we will need to make substantial changes that work well enough for all of us to be able to continue living on this planet together, this approach will not work. We need for our thinking not to be magical, but grounded in realism. We need to make new things that we can afford to maintain sustainably. Innovation-speak will not get us there.

Not now Cato

24. May 2020 · Write a comment · Categories: Economics, Risk

Burt Kwouk and Peter Sellers in 1975’s The Return of the Pink Panther. Photograph: Allstar/ITC

Stephen Fry at the Hay Festival a few nights ago regaled us with many tales from his new book Troy. They were full of people making The Tough Decisions based on The Science or, as they tended to call it then, Prophecy. The seer Aesacus interpreted a dream about a flaming torch meaning Priam and Hecuba needed to kill the son Hecuba was carrying to stop him from bringing the destruction of Troy. Noone could bring themselves to kill the baby, who grew up to be Paris, and Troy was indeed destroyed. However rather than ignore The Science, they outsourced the deed, ultimately to the random wildlife roaming Mount Ida and so it never got done. Now my question would not be why they ignored The Science, but why they felt that The Science was something to be consulted with in secret with no second opinion and then enacted in a half-hearted way because they didn’t really believe it anyway. It’s almost as if there was no actual science in existence to give them an alternative.

One of the other interesting things Stephen said was in response to the question of whether there was value in students studying the classics at school. His very strongly argued case rested on two main points:

  • The value of learning stories made up not by a single writer but by a people; and
  • The greater level of understanding of much other art if you know “the second language” of the classics.

It is of course a highly elitist argument, but as a way of understanding an Elite which are currently following The Science in a direction they don’t really believe in, perhaps more relevant than it has ever been. Because if we are ruled by a group speaking in a second language and resistant to evidence-based policy perhaps we need to start acting accordingly.

Currently we are reading a lot in the media about how terrifyingly quickly Government debt is growing and how urgently we will need to cut Government spending once the pandemic is over, even on those key workers we have realised our (by any historical standards) fantastically rich economy cannot do without. I am thinking of the Institute of Fiscal Studies of course, the Adam Smith Institute and ultimately all arguments of this sort end up including the Cato Institute too. Now I could start to rebut these claims, pointing out that Government debt is not particularly big, that it is currently very cheap and that the last thing we will need for an economic recovery from it is austerity or whatever the Johnson Government decide to rebrand such a policy to make it politically acceptable.

But I am not going to waste my ink, particularly not now. One reason would be that there is an element of Jonathan Swift’s dictum at play here, ie:

Reasoning will never make a Man correct an ill Opinion, which by Reasoning he never acquired.

But another, in my view much more powerful, reason is that we are pretty universally experiencing a trauma which has triggered fight, flight or freeze responses that have impaired our thought processes quite significantly. As Joanne Stubley from the Tavistock and Portman NHS Foundation Trust puts it so well:

Whilst the wish to be involved and to contribute clearly may have altruistic, reparative aims inherent in it, there is also a growing sense of competition that is emerging – competition for who is the expert, who will lead the research, the clinical pathways mapping or write the best paper on Covid 19. This jostling for position may be fuelled by survival anxieties both in relation to the threat of the virus (life and death anxieties that propel us to action) but perhaps also anxiety for what will occur when the threat has passed. We have lived with the reality of austerity in the NHS for many years, and services have become accustomed to the competition inherent in the marketplace economy. With the threat of serious economic downturn and recession looming, this causes further anxiety in relation to the long-term viability of services. Holding in mind a compassionate, thoughtful position that allows for cooperation becomes so much more difficult when this part of the brain is turned down when under threat – survival in the immediate threat does not make use of this more sophisticated mode of thought and behaviour.

Put simply, we don’t know what we are experiencing yet. It is too soon to say on almost any level. If someone is giving you a prognosis on what will happen economically under different exit strategies from Lockdown then they do not yet have the data to know what they are talking about. Noone does. The best thing that science (as opposed to The Science) can tell us currently is that we don’t know.

So we don’t know and we can’t think. We therefore need to be very cautious about what we do next.

 

Let’s stop worrying about “damaging” GDP and transfer risks back to where they belong

30. March 2020 · Write a comment · Categories: Actuarial, Climate Change, Economics, Prediction, Risk

“We won’t go back to normal, because ‘the normal’ was the problem.”

For me the turning point came on 12 March, when the FTSE 100 fell by 639 points or around 11% of its value in one day. What were the newspaper headlines that day?

Only the Times and the Financial Times had the stock market fall on their front page at all. Everyone else led with some variant on the Prime Minister saying that many families would lose loved ones. The attention switch was so complete that when KPMG published their UK Economic Outlook for March 2020 the following week – forecasting a main scenario for Gross Domestic Product (GDP) in the UK to fall by 2.6% in 2020 then grow by 1.7% in 2021, and a downside scenario for GDP to contract by 5.4% in 2020 and by another 1.4% in 2021, representing a slightly more severe recession than the downturn experienced in 2008-09 – nobody noticed that either (19 March and 20 March headlines here and here respectively), sandwiched as it was between the announcement that schools were to close and the Prime Minister saying that we had 12 weeks to turn the tide.

KPMG’s report was an example of damage function modelling of course: trying to model changes in economic activity due to some phenomenon and summarising that change in terms of a change in GDP. I have recently been quite exercised by similar considerations with regard to climate change damage functions and the inconsistencies of the ones in most current use with climate science. However it has become increasingly clear to me that I may have been missing the point. I realise I was focusing on damage functions because I felt they were leading to extreme optimism in the modelling of the impact of climate change on our economies and that it was this link which was most likely to get the attention of policymakers (and other actuaries!).

But of course GDP is only ever a proxy for some of the things we regard as important, rather than something that is important in itself, and a flawed one too. As Diane Coyle’s excellent book, GDP: A Brief But Affectionate History, makes clear. Its problems include:

  • It under-records growth by failing to capture fully the increase in the range of products in the economy;
  • It becomes a worse measure as the world economy consists less and less of material items, eg online activities; and
  • It can show positive growth caused by clearly unsustainable practices and those which deplete natural resources.

When KMPG released their economic outlook, it was as if they were trying to drag a weary world population away from the windows and balconies from which they are still trying to connect with each other and what is still real in the world back to the Monopoly game that they have set up in the front room.

It took a lot to get our behaviour to follow this change in attention. When Wuhan went into lockdown on 23 January, I was talking to Stuart McDonald, now a member of the COVID-19 Actuaries Response Group, about the talk he was planning to do at the University of Leicester on 18 March and deciding he would probably need to add a few slides about coronavirus. Italy went into lockdown on 9 March and yet on 12 March we had a second call where we still felt on balance that it might go ahead as long as we took sensible precautions, but by this time it was almost entirely about getting accurate messaging out about COVID-19. We called it off the following day. The UK finally went into lockdown on 23 March.

So perhaps it is no wonder that we have so far been unable to change human behaviour to anything like the same extent in response to climate change, which is a bit like COVID-19 in slow motion, progressing unseen with each stage of its development effectively locking us into the next steps in its relentless escalation. In the same way that movement restrictions may not slow down the increase in new cases for perhaps around a week, stopping carbon emissions now would still see us locked into further warming for 40 years. And even with the greater immediacy of coronavirus, it has only been when we have decided we care more about saving each other than maintaining our GDP that real progress has become possible.

My view is that some things that must be different post COVID are already clear. I think as a society we are going to demand more resilience, for example:

  • Resilience of our health service – this means much higher levels of spending, building deliberate over-capacity into the system in normal times;
  • Resilience of our food supplies, for example strengthening domestic supply chains;
  • Resilience of our population, so that we do not have 1.6 million food parcels needing to be given out in a year by the Trussell Trust, in the absence of a pandemic, for instance; and
  • Resilience of our infrastructure – to everything from floods to banking crises to pandemics to storms and heatwaves.

The Institute and Faculty of Actuaries (IFoA) has therefore shown great timing in its launch of its 2020 thought leadership campaign The Great Risk Transfer. The campaign aims to examine the trend of the transfer of risk from institutions to individuals, and how people can be better equipped to manage the financial risks they now face. I think the campaign rightly highlights the fact that risk transfer is all one way, but it clearly also goes way beyond the finance sector. Rail franchises never took on any real risk, it appears, even before the pandemic. Nor have PFI contracts, despite the price tag. By contrast the incremental removal of risk pooling by corporations for their employees and/or government for their citizens over the last 40 years has been relentless and in one direction only.

As Andrew Simms, one of the Green New Deal Group, said on Twitter yesterday about taking lessons for the climate emergency from the pandemic crisis:

Those roads with a fraction of the traffic, the drop in aviation, the economic shift to put public health & well-being first, the speed with which the brain adapts to the new normal: as someone said, these things are a postcard from the future we need to get to. Let’s take notes.

Actuaries and the Event Horizon

18. January 2020 · Write a comment · Categories: Actuarial, Climate Change, Economics

Credit:ESO, ESA/Hubble, M. Kornmesser Information extracted from IPTC Photo Metadata: This artist’s impression depicts a Sun-like star close to a rapidly spinning supermassive black hole, with a mass of about 100 million times the mass of the Sun, in the centre of a distant galaxy. Its large mass bends the light from stars and gas behind it. Despite being much more massive than the star, the supermassive black hole has an event horizon which is only 200 times larger than the size of the star. Its fast rotation has changed its shape into an oblate sphere. The gravitational pull of the supermassive black hole rips the the star apart in a tidal disruption event. In the process, the star was “spaghettified” and shocks in the colliding debris as well as heat generated in accretion led to a burst of light.

We all know the concept of an event horizon. It is the point where you move past a point of no return without realising it, as David Finkelstein theorised in 1958 would happen as you approached a black hole. Steve Keen has set out why we may have done precisely the same thing with the climate here. The language is a little fruity in places (but justifiably so, in my view, to differentiate between serious economic research and the rubbish which Nordhaus and others have polluted the field of the economics of climate change with, the first 25 minutes gives you the general idea).

What should actuaries do in an event horizon situation? Well in some ways it depends on the political climate you are working in. Can anyone imagine an equivalent of Donald Trump saying that he didn’t believe in black holes and that spaghettification was invented by Italy to support their pasta industry? This probably doesn’t seem as ridiculous as it would have done only a few years ago, which demonstrates how the political environment has changed.

What actuaries have to do in an event horizon situation, in my view, is not to give up. That means:

  • pushing clients hard towards decarbonisation as quickly as possible; and
  • offering people investment opportunities which are part of the solution rather than the problem (the FT has pointed out that there is a proliferation of green funds, however Richard Murphy (one of the Green New Deal group) and others have pointed out that there is no way currently of knowing which if these funds are truly green – actuaries could play a leading role in accrediting funds to help with this.

Steve Keen is very pessimistic about the possibilities of a Green New Deal to meet the need to keep warming below 2 degrees above pre-industrial levels. And there are many that believe that you cannot decouple economic growth from carbon emissions. But they may be wrong, and in my view it is worth pursuing the restructuring of our economy which would be required to deliver it, if only to reduce the level of carbon rationing that will be required otherwise within our lifetimes. We do not have a Government which is remotely interested in this in power at the moment, so following this path comes with considerable professional risks, particularly when short term knee jerk policies to deal with currently failing companies (eg FlyBe) are going to be dominating the headlines, with even more to follow once the long-term realities of Brexit become apparent after 31 January. Another event horizon it would seem.

A possible manifesto for the next generation

06. December 2019 · Write a comment · Categories: Climate Change, Demographics, Economics

I am an actuary. I have worked for over 22 years either in, or serving in some capacity (apart from the two years I spent learning to be a teacher), the finance industry. I spent the 12 years before that mostly either bringing up children or writing unpublishable novels, with some early career experiences in the security printing industry thrown in which I thank principally for teaching me early that no way of doing things is for ever. Seven of my former employers no longer exist, mostly swallowed up in subsequent corporate transactions. I am increasingly convinced that a “career” like mine is no longer possible for the next generation, and my most recent evidence for this is based predominantly on two excellent books.

The first is The Finance Curse by Nicholas Shaxson. This demonstrates, convincingly, that a huge part of our current malaise as a nation, whether it is the loss of control over our own affairs, or the current, Victorian, levels of inequality or the fact that we don’t appear to invest in any of things we need to prosper as a society any more, can be traced back ultimately (sometimes via very cunning circuitous routes) to the Faustian pacts the City of London have lobbied the rest of us into with the rest of the world.

The second is The Pinch by David Willetts (and link to his slides – one of which is shown above – on it from 2015 here), whose central argument is that we are not attaching sufficient value to the claims of future generations, and that this is an intellectual failure of my generation: the one that spawned both me and Boris Johnson. I will declare an interest here: David is Chancellor at the University of Leicester, where I work as an actuarial science lecturer, in addition to all of his many other achievements and will be speaking at the Leicester Actuarial Science Society on 11 March on intergenerational fairness linked to a new edition of his book.

So for any highly talented twenty-somethings looking to make his or her mark in the world (and I have been privileged to meet and teach many of you over the last few years), I would, very hesitantly (because you probably don’t need me of all people to be giving you an agenda), suggest that the following things might be a priority for your generation:

  1. Don’t be distracted by the short term. Most people now want action on climate change, for instance, which has been delayed to a ridiculous extent by our inability to place sufficient value on the needs of future generations. Most of the things worth working towards and campaigning on are long-term problems with solutions which require long-term patient consensus-building. Our generation have been unable to do this seriously, yours cannot afford to be so distracted.
  2. Stay focused on the big issues: What is the proper allocation of wealth between the generations? Most of the problems we fixate on, like obesity or anti-social behaviour or credit card debt are just symptoms of the breakdown of the inter-generational contract which the baby boomers (because we felt that we could do so because of our greater numbers) have visited upon our societies. We have then presumed to pass moral judgement on the generation we have so comprehensively wronged, which is of course an easier message for many in our generation to hear but is one of the main reasons we have become too distracted to deal with the big long-term issues that we face as a society.
  3. Don’t make it all about good guys and bad guys. It is easy to vilify individuals in this great inter-generational psychodrama that we have all been living through, and it might make you feel momentarily more empowered or encouraged as a result, but in the long term the power is with you anyway and you will be more effective if you make it about good and bad systems. Good systems pursue the interests of our own people, whereas bad systems pursue the interests of people who need to be persuaded to invest in our society but have no real long term interest in doing so: ie other societies who clearly need to prioritise their own people’s needs and tax avoiding multinational companies and individuals.

I would like to finish with the concluding sentences of The Pinch:

The modern condition is supposed to be the search for meaning in a world where unreflective obligations to institutions or ways of doing things are eroded. The link between generations past, present and future is a source of meaning which is as natural as could be. It is both cultural and economic, personal and ethical. We must understand and honour those ties which bind the generations.

In the nine years since The Pinch was published we have done the very opposite of honouring the ties which bind the generations. We must hope that the generation following us have more wisdom.

Actuaries and the Green New Deal

20. September 2019 · Write a comment · Categories: Actuarial, Birmingham, Climate Change, Economics, Legal, Pensions, Regulation, Risk

Images from the Birmingham Climate Strike on 20 September 2019

On the day millions have taken to the streets across the globe to demand a more urgent response to the climate emergency, it seems a good time to write about the crossbench Decarbonisation and Economic Strategy Bill, originally tabled by Caroline Lucas and Clive Lewis in March this year, which has now been formally launched. This “Green New Deal Bill”, as it has been dubbed, sets out a legislative framework for the changes that are needed to make the Green New Deal (a programme of action neatly summarised in the Green New Deal Group’s fifth report here) a reality. The impacts of these proposals would be far-reaching and radical, changing the way our economy operates and what we value. As well as revolutionising the way we live, this would also significantly affect the current work of actuaries and provide many opportunities for people with the actuarial skill set to be centrally involved.

The main proposals which I think would impact actuaries are as follows:

  • Bring offshore capital back onshore to make sure that government, not markets, can make the big economic decisions. This would obviously impact all businesses operating in financial markets. There would also be large movements in the value of some businesses as a result of economic decisions which have previously been left to the market now being made by government. Modelling the impacts of such changes and helping businesses manage the transition are examples of where actuaries can add value here. We are already seeing increasing disinvestments from coal, but this would seem to be just the start of a much wider realignment (one possible view of the potential is discussed here).
  • Greater coordination between the Bank of England, the Treasury and the Debt Management Office. This means the end of the independence of the Bank of England by the look of it, with monetary policy and fiscal policy run in much closer cooperation with each other. It also means more regulation for banks and the supported emergence of local banks and a new national investment bank.
  • New bonds, nationally and locally, and new pension arrangements targeted at the green renewal of our infrastructure. For instance, tax rules on pension schemes could be changed to require a minimum percentage of assets invested in such bonds in order to continue to qualify for tax relief.
  • New objectives for business, and new kinds of businesses. For instance, the UK-based Corporate Accountability Network argues that the whole focus of corporate reporting will have to change, and so too then would corporate behaviour because there is very strong evidence that what is reported by any organisation is what becomes important to it. The Green New Deal Bill provides for changes to both company law and accounting to embrace the need for legally required and enforceable reporting on progress towards any company becoming carbon neutral. This will certainly lead to new business structures as a result and, I would imagine, many new business opportunities for those with actuarial skills as a result.
  • Replacing our measures of progress. This is something I have long supported. The main problem is that there are many possible candidates for this, but that also means that there is a great opportunity for actuaries to be involved in constructing appropriate indices which are globally respected, thereby helping to change what we value away from our current GDP and FTSE fixations.

Of course there are also opportunities for those with actuarial skills to block the transition to an economy that isn’t constructed in such a way as to make environmental destruction inevitable. Employers like these would probably make those with the actuarial skillset very lucrative offers to use their skills. I hope that most of us, and particularly those just at the start of their careers, will resist such offers. We now know that tobacco firms hid the evidence of the damage done by their products for decades and firms such as Exxon have done the same in denying the science on climate change for over 40 years. Please don’t be part of the problem when you could be such a valuable part of the solution.

At Leicester, we intend to launch a new module on our MSc Actuarial Science with Data Analytics programme next year, specifically on the ideas behind the Green New Deal and focusing on the areas where ideas still need to be developed (one of the most exciting things about the Green New Deal is that it is still an area of live discussion, with many of the policy details still being developed). I would welcome any input from members of the Green New Deal Group or those with research interests in this area who would be interested in helping us develop the detailed curriculum of this module before launch.

This is an exciting time for those who are comfortable working with data and communicating what they have found in it. Let’s make sure that those skills are applied to the needs of 99% of the global community.

Catch 22 and Actuarial Practice

03. August 2019 · Write a comment · Categories: Actuarial, Climate Change, Economics, Pensions, Regulation

Source: https://unsplash.com/photos/g0b_tx3i0_8. This image is from Unsplash and was published prior to 5 June 2017 under the Creative Commons CC0 1.0 Universal Public Domain Dedication

Catch 22 can in no way be compared to actuarial practice. One puts its characters in impossible positions, with constantly shifting targets, rewards often inversely proportional to the social usefulness of the characters’ actions and against a backdrop inordinately preoccupied with death. The other has recently been on our TV screens directed by George Clooney.

The most recent link between the two was provided by John Taylor’s excellent Institute and Faculty of Actuaries (IFoA) presidential address last month. He encouraged us all to look at Jimmy Reid’s 1972 speech at Glasgow University (an extract showing the passion with which it was delivered can be seen here). So I did. John picked out the following passage:

I am convinced that the great mass of our people go through life without even a glimmer of what they could have contributed to their fellow human beings. This is a personal tragedy. It’s a social crime. The flowering of each individual’s personality and talents is the precondition for everyone’s development.

Inspiring as that is, my eye was drawn to a different passage of Jimmy Reid’s speech:

Society and its prevailing sense of values leads to another form of alienation. It alienates some from humanity. It partially dehumanises some people, makes them insensitive, ruthless in their handling of fellow human beings, self-centred and grasping. The irony is, they are often considered normal and well adjusted. It is my sincere contention that anyone who can be totally adjusted to our society is in greater need of psychiatric analysis and treatment than anyone else.

They remind me of the character in the novel, Catch 22, the father of Major Major. He was a farmer in the American Mid West. He hated suggestions for things like Medicare, social services, unemployment benefits or civil rights. He was, however, an enthusiast for the agricultural policies that paid farmers for not bringing their fields under cultivation. From the money he got for not growing alfalfa he bought more land in order not to grow alfalfa. He became rich. Pilgrims came from all over the state to sit at his feet and learn how to be a successful non-grower of alfalfa. His philosophy was simple. The poor didn’t work hard enough and so they were poor. He believed that the good Lord gave him two strong hands to grab as much as he could for himself. He is a comic figure. But think, have you not met his like here in Britain? Here in Scotland? I have.

This got me thinking about the investment requirements of the Green New Deal, as this would need to be a huge programme of work to transform our infrastructure and economy away from the carbon-burning planet-trashing Doomsday machine it currently is, which in turn would need huge levels of investment.

I have previously written about some of the views about how we might reduce our current reliance on carbon: the one with the most coherence in my view being the Green New Deal.

However there is a problem. Since our current system, the one which needs to be transformed, is currently predominantly doing the financial sector’s equivalent of rewarding people for not growing alfalfa (for example the misallocation costs estimated by SPERI at £2.7 trillion between 1995 and 2015 from having too large a financial sector here), any Green New Deal spending, at least to start with, is going to have to come from the Government.

The authors of the latest report from the New Economics Foundation anticipate that the massive increase in public spending required to make it happen would be between £20 billion and £40 billion a year. This level of public spending is inconsistent with our current ways of measuring fiscal space, or the room for additional Government spending. Government borrowing is normally expressed in terms of a percentage of GDP and has historically been around 1.3% pa in normal times (ie other than wartime or bailing out the banks). They therefore suggest:

  • The development of a new framework, defined in terms of the threshold beyond which there is a significant risk of adverse economic effects. This would have prevented the damaging austerity policies since 2010, for instance.
  • The parallel development of a tool which would allow policymakers to accurately assess the implications of holding back fiscal space compared with the implications of borrowing for investment, and therefore allow politicians to come to an informed view on the best combination of fiscal intervention or fiscal prudence at a given point in time, including with respect to climate related risks.
  • More explicit cooperation between the Bank of England and the Treasury, including the use of a new public investment bank (or network of banks) such as a green national investment bank (GNIB) – to increase commercial lending to green industries.

A particular interesting aspect of the GNIB is the proposal to make it independent of political interference. In the same way as those economists who argue for independent central banks so that governments don’t pursue damaging monetary policy in particular for electoral gain, some advocates of the GNIB believe it could be used as a backstop against governments underusing fiscal space for ideological reasons.

Richard Murphy points out that https://www.gov.uk/government/statistics/individual-savings-account-statistics shows £40 billion was saved in cash ISAs in 2017 / 18, and suggests that Green ISAs, backed by a Green Investment Bank and paying, say, 3% a year would be more attractive than current cash ISAs, therefore potentially meeting the GND funding requirements on their own.

Simon Wren Lewis, in his discussion of the many of the arguments around the Green New Deal and how it should be funded, makes the following excellent point (amongst many others):

No one in a 100 years time who suffers the catastrophic and (for them) irreversible impact of climate change is going to console themselves that at least they did not increase the national debt. Humanity will not come to an end if we double debt to GDP ratios, but it could come to an end if we fail to combat climate change.

The Catch 22 of the title originally described the catch which kept pilots flying highly dangerous missions in World War 2 – they could only get out of them by being certified insane, but the very fact of trying to get out of them showed that they were in fact sane and therefore they had to keep flying. If we want far fewer actuaries to be employed in not growing alfalfa in the future and far more working on making the finance structures of our economy work better, whether to support a Green New Deal or more generally, we first need to embrace the idea that our current economic priorities are indeed insane.

 

Business macroeconomics for actuarial students – the first year

24. June 2019 · Write a comment · Categories: Actuarial, Economics

I have just finished teaching the Business Macroeconomics module on the BSc Mathematics and Actuarial Science programme at the University of Leicester for the first time, as part of our response to the Institute and Faculty of Actuaries’ (IFoA) Curriculum 2019 exercise, which has refreshed and in many cases entirely revamped what is expected to be learnt by actuarial students.

Actuarial students are not expected to be experts in economics, but they do need to know enough to be able to ask sensible questions and also to be aware of what is available to them from economics when tackling business problems. One stimulus for the revamp of the Business Economics subject by the IFoA was the general feeling that actuaries had, in some cases, been drawing on a narrower range of economic thought than needed to fully address all dimensions of the increasingly complex and multidisciplinary problems we face as a profession.

One of my key references when structuring the course (while not wanting to depart too far from Sloman, the source of most of the syllabus, in my first year of teaching it) was The Econocracy: The Perils of Leaving Economics to the Experts, by Joe Earle, Cahal Moran and Zach Ward-Perkins. As graduates from economics degrees themselves, they make a very convincing case for how economics as it is taught at university has little to do with the real world, often uncritically setting out a model based on rational individuals and an economic system that tends towards equilibrium. They advocate amongst other things the teaching of different schools of economics and also a greater focus on economic history. As the new IFoA syllabus had specifically added these last two points as part of the review, I felt encouraged that this was also criticism shared by the actuarial profession. Indeed, the Actuarial Research Centre of the IFoA have recently engaged Dr Iain Clacher on a project to understand how economics interacts with the actuarial profession, with the following initial conclusions:

  • The current regulatory environment may be counter-productive in some cases, particularly if it is based on too narrow an economics focus.
  • The much more quantitative approach to economics which has been dominant for the last 60 years or so may be pushing us towards a world where we think less.
  • There is scope for the actuarial profession to take much more from economics in trying to understand what is really going on.

One quote from The Econocracy which particularly struck me was:

It is hardly an exaggeration to say that it is now possible to go through an economics degree without once having to venture an opinion.

One of my objectives in teaching this module was therefore to change that, and to try and focus as much as possible on giving students the opportunity to develop opinions as they grapple with trying to understand what is really going on.

Have I succeeded? Well while it would not be true to say that I have been entirely successful, neither would it be accurate to say that I have not succeeded at all. I changed the examination from one where 80% of the marks were for multiple choice questions to one where only 16% were, with 60% devoted to four long questions requiring, at least in part, higher order skills of analysis and the ability to make an argument. The examination was 70% of the overall module mark, with 30% for a 3,000 word mini project which investigated whether the Office for National Statistics were correct in their proposal to re-designate student loans within the national accounts and asking students to comment with reasons on whether they agreed with the approach taken for valuing student loans for sale. And I broadened out the references within the course significantly, for example:

Amongst many many others.

Students found it tough at times, as some of the feedback I received made clear. Much of macroeconomics can be counter-intuitive, particularly for first year undergraduates. But those who engaged with the module definitely ventured opinions along the way! There was a lot of reading required, for much of which I provided more concise lecture notes, but there is plenty of scope for being more targeted next year in what we dig into in more detail. There will be less on the schools of thought at the beginning next time, as in my view it makes much more sense drawing this out as particular aspects of economic theory are being discussed – much better I think to work on the students’ comfort in group working initially, so as to get them discussing the subject more openly earlier. I also did not use the material built around the Core Project’s The Economy as much as I would have liked this time, although it was available to the students. I will be discussing how I can remedy this at the RES Nuffield Foundation Workshop: Teaching and Learning with CORE at the University of Warwick this week!

It has been a very stimulating experience and greatly increased my understanding of how actuaries have traditionally approached economics questions, while also allowing me to explore ways in which I would want those approaches to change. I look forward to Year Two!

Dr Strangelove’s Pension

01. May 2019 · Write a comment · Categories: Actuarial, Climate Change, Economics, Pensions, Prediction, Regulation, Risk

The War Room with the Big Board from Stanley Kubrick’s 1964 film, ”Dr. Strangelove”. Source: ”Dr. Strangelove” trailer from 40th Anniversary Special Edition DVD, 2004 Directed by Stanley Kubrick

In 1960, Herman Kahn, a military strategist at the RAND Corporation, an influential think tank which continues to this day, wrote a book called On Thermonuclear War. It focused on the strategy of nuclear war and its effect on the international balance of power. Kahn introduced the Doomsday Machine (which Kubrick used in his film “Dr Strangelove” alongside many other references from the book) as a rhetorical device to show the limits of John von Neumann’s strategy of mutual assured destruction or MAD. It was particularly noteworthy for its views on how a country could “win” a nuclear war.

For some reason Kahn came to mind as I was looking through Resource and Environment Issues: A Practical Guide for Pensions Actuaries, from the Institute and Faculty of Actuaries’ Relevance of Resource and Environment Issues to Pension Actuaries working party, which summarises the latest thinking on the climate change-related issues scheme actuaries should be taking into consideration in their work. I will come back to why.

The section which particularly caught my attention was called How might pensions actuaries reflect R&E issues in financial assumptions? This section introduces two studies in particular. First, we have the University of Cambridge Sustainability Leadership (CISL) report on Unhedgeable risk: How climate change sentiment impacts investment. This posits three “sentiment” scenarios (paraphrased slightly for brevity – see the report for details of the models used):

  • Two degrees. This is defined as being similar to RCP2.6 and SSP1 from the Intergovernmental Panel on Climate Change (IPCC) AR5. Resource intensity and dependence on fossil fuels are markedly reduced. There is rapid technological development, reduction of inequality both globally and within countries, and a high level of awareness regarding environmental degradation. It is believed that under this scenario global warming will not raise the average temperature by more than 2°C above pre-industrial temperatures.
  • Baseline. This is a world where past trends continue (i.e. the business-as-usual scenario), and there is no significant change in the willingness of governments to step up actions on climate change. However, the worst fears of climate change are also not expected to materialise and temperatures in 2100 are only expected to reach between 2°C and 2.5°C. This scenario is most similar to the IPCC’s RCP6.0 and SSP2. The economy slowly decreases its dependence on fossil fuel.
  • No Mitigation. In this scenario, the world is oriented towards economic growth without any special consideration for environmental challenges. This is most similar to the IPCC’s RCP8.0 and SSP5. In the absence of climate policy, the preference for rapid conventional development leads to higher energy demand dominated by fossil fuels, resulting in high greenhouse gas emissions. Investments in alternative renewable energy technologies are low but economic development is relatively rapid.

The modelled long-term performance for a range of typical investment portfolios is worrying:

CISL suggest quite different investor behaviour depending upon which climate change path they think the world is taking: moving into High Fixed Income if No Mitigation seems to be the direction we are heading, but adopting an Aggressive (ie 60% equities, 5% commodities) asset allocation if the Two Degrees scenario looks most likely.

Elsewhere the report suggests hedging via cross-industry diversification and investment in sectors with low climate risk. For example under No Mitigation, it is possible to cut the maximal loss potential by up to 47% by shifting from Real Estate (in developed markets) and Energy/ Oil & Gas (in emerging markets) towards Transport (in developed markets) and Health Care/ Pharma (in emerging markets). However over 50% of losses in all scenarios remain unhedgeable (ie unavoidable through clever asset allocation alone).

The second report (Investing in a time of climate change) from Mercer in 2015, focuses on the following investor questions:
• How big a risk/return impact could climate change have on a portfolio, and when might that happen?
• What are the key downside risks and upside opportunities, and how do we manage these considerations to fit within the current investment process?
• What plan of action can ensure an investor is best positioned for resilience to climate change?

The section I was drawn to here (it’s a long report) was Appendix 1 on climate models used, and particularly those estimating the physical damages and mitigation costs associated with climate change. The three most prominent models used for this are the FUND, DICE and PAGE models, apparently, and Mercer have opted for FUND. They have then produced some charts showing the difference between the damages exepcted for different levels of warming predicted by the FUND model compared to DICE:

The result of this comparison, showing lower damage estimates by the FUND model, led the modellers to “scale up” certain aspects of the output of their model to achieve greater consistency.

Both of these reports have been produced using complex models and a huge amount of data, carefully calibrated against the IPCC reports where appropriate and with full disclosure about the limitations of their work, and I am sure they will be of great help to pension scheme actuaries (although there does some to be some debate about this). However I do wonder whether as a profession we should be spending less time trying to find technical solutions in response to worse and worse options, and more time trying to head off the realisation of those sub-optimal scenarios in the first place. I also wonder whether the implicit underlying assumption about functioning financial markets and pension scheme funding is a meaningful problem to be grappled with at 3-4° above pre-industrial averages as some of this analysis suggests.

In the summary of Mark Lynas’ excellent book Six Degrees: Our Future on A Hotter Planet, the three degree increase for which damages are being estimated is expected to lead to Africa […] split between the north which will see a recovery of rainfall and the south which becomes drier […] beyond human adaptation. Indian monsoon rains will fail. The Himalayan glaciers providing the waters of the Indus, Ganges and Brahmaputra, the Mekong, Yangtze and Yellow rivers [will decrease] by up to 90%. The Amazonian rain forest basin will dry out completely. In Brazil, Venezuela, Columbia, East Peru and Bolivia life will become increasingly difficult due to wild fires which will cause intense air pollution and searing heat. The smoke will blot out the sun. Drought will be permanent in the sub-tropics and Central America. Australia will become the world’s driest nation. In the US Gulf of Mexico high sea temperatures will drive 180+ mph winds. Houston will be vulnerable to flooding by 2045. Galveston will be inundated. Many plant species will become extinct as they will be unable to adapt to such a sudden change in climate.

The [IPCC] in its 2007 report concluded that all major planetary granaries will require adaptive measures at 2.5° temperature rise regardless of precipitation rates.[and] food prices [will] soar. Population transfers will be bigger than anything ever seen in the history of mankind. [The feedback effects from the] Amazon rain forests dry[ing] out and wild fires develop[ing] [will lead] to those fires [releasing] more CO2, global warming [intensifying] as a result, vegetation and soil begin[ning] to release CO2 rather than absorb[ing] it, all of which could push the 3° scenario to a 4°-5.5° [one].

The last time the world experienced a three degree temperature rise was during the geological Pliocene Age (3 million years ago). The historical period of the earth’s history was undoubtedly due to high CO2 levels (about 360 – 440ppm – almost exactly current levels). I would suggest that our biggest problem under these conditions is not that over 50% of losses on pension scheme investments remain unhedgeable.

In his recent article for Social Europe, the unbearable unrealism of the present, Paul Mason presents two graphs. The first is the projection by the United States’ Congressional Budget Office of the ratio of debt to gross domestic product until 2048 in the United States.

The second is a chart from the IPCC showing how dramatically we need to cut CO2 emissions to avoid catastrophic and uncontrollable breakdown.

Mason feels that capitalism is too indebted to go on as normal and too structurally addicted to carbon. In his view Those who are owed the debt, and those who own rights to burn the carbon, are going to go bankrupt or the world’s climate will collapse. This feeling is echoed by George Monbiot here, where he cites a paper by Hickel and Kallis casting doubt on the assumption that absolute decoupling of GDP growth from resource use and carbon emissions is feasible and summarises some alternative approaches to the capitalism he feels no longer has the solutions.

Others dispute this, claiming that the Green New Deal is the only chance we have (here, here and here) to prevent irreversible climate change.

Whether you agree with any of these predictions or none of them, agree that we face a climate emergency or feel that is too extreme a description, it all brings me back to Kahn and Dr Strangelove. We seem to have replaced the MAD of the cold war with the MAD of climate change, except that this time we do not even have two sides who can prevent it happening by threatening to unleash it on each other. It is just us.

What we really cannot afford to be doing, via ever more complex modelling and longer and longer reports, is giving the impression that the finance industry can somehow “win” against climate change rather than joining the efforts to avert it as far as possible.

« Older articles