But the NAO review of the HS2 project is in many ways much more a criticism of the Department of Transport than it is of the high speed rail link itself. According to the NAO, ‘the Department’s methodology for appraising the project puts a high emphasis on journey-time savings, from faster and more reliable journeys’. Surely this is a sensible thing to do? Faster mean less journey time. It seems obvious.

The problem is that this is a mere fraction of the whole story. It is a purely static way of trying to measure the benefits of major transport infrastructure projects. Immensely complicated models of rail networks exist, in which every single journey can be mapped. Infrastructure investments reduce journey times. So the total time saved can be calculated from the models. Economists over the years have hammered out a consensus on how to put a value on these savings.

The problem is not in how time is valued. The problem goes to the very heart of the approach to which transport planners are wedded. The journeys which are made after the investment are assumed to be the same as the ones which were made before. This approach completely misses the point. Major infrastructure projects have the capacity to transform areas, to make new economic activities possible. Their benefits are dynamic, not static. Successful projects alter dramatically previously existing journey patterns.

Exactly the same problem was encountered in the long struggle to get approval for Crossrail. The purely static benefits of time savings generated by the massive, conventional transport models were never enough to justify the cost of Crossrail.  But the dynamic benefits of building it are huge. London could not survive for long as the world city with a transport system creaking at the seams and bursting to capacity. Eventually, after a lengthy intellectual battle, the Treasury prevailed on the Department of Transport to take into account these dynamic benefits, which justify the costs of Crossrail many times over.

But it looks as if, with HS2, that the Department has slipped back into its old comfort zone. The NAO’s criticism is precisely that it has ‘poorly articulated the strategic need for a transformation in rail capacity and how High Speed 2 will help generate regional economic growth’. In other words, the dynamic effects created by transforming the network.

The North faces many economic challenges. One of these is that it just does not have enough connections, it is not networked strongly enough with the prosperous and dynamic South. The North needs to generate more exports to London and the South. HS2 makes it more connected, and gives it the dynamic potential to meet this task.

Paul Ormerod

As published in City AM Wednesday 22nd May 2013

None of the massive debts incurred by the Bank of Scotland (the BOS bit of HBOS) and the Royal Bank of Scotland will be allocated to the Scots. And the Bank of England will continue to support sterling as the Scottish currency, whilst at the same time the Scottish government will have complete freedom on economic policy.

Even by the standards of politicians, these are fairy stories pedalled on an epic scale. The Scottish electorate are being treated like children by the SNP.

In the unlikely event of this massive confidence trick working, there will be a great opportunity to conduct a real life experiment with monetary policy. If Scotland chose to remain within what would then become the Sterling Zone, the Bank of England would of course set interest rates and English regulatory bodies would control Scottish banks.  The Scottish government would be no more able to set its own fiscal policy than the Greeks or the Portuguese are at the moment. If they tried to be too profligate, the Bank could step in and appoint an unelected Prime Minister, just as the European Central Bank did with Italy, a far larger and more important country than Scotland.

So the obvious answer would be to allow everyone in Scotland to choose their own currency. The idea is not ludicrous. In 19^th century America, many different currencies were in circulation, especially in the West, and it was not until the creation of the Federal Reserve as late as 1907 that the dollar became the sole legal tender.

Scottish banks could continue to issue their own colourful notes, but without the back up of a lender of last resort. Economists of the Austrian School in particular argue that this would lead to banks being much more prudent, and that what the world needs is much less, not more, banking regulation. Scotland would be a test bed for the theory.

Why stop there? Bitcoin could be used for transactions, as could air miles or vouchers at supermarkets. Gresham’s Law says that bad currencies drive out the good, but does this law still apply in the modern era? Masses of data would be generated about how trust, in the competing currencies, spreads across networks of individuals.

Regrettably, the majority of the Scottish electorate seem too level headed to vote for independence. But from a purely scientific perspective, this will be a loss to the world.

Paul Ormerod

As published in City AM on Wednesday 15th May 2013

But what does the data tell us? In the 1930s, output in America fell by nearly 30 per cent from its 1929 peak. This time, the fall was only 3 per cent, and the level of output is now higher than it was below the crash. The latest US labour market figures show continued growth in employment. Over 5m net new jobs have been created over the past three years, all of which have been in the private sector. Unemployment has just fallen to a four year low.

Elsewhere in the West, the recovery continues, although it is nowhere as strong as people would like. The crisis of 2007 to 2009 was very severe. But in the clear majority of OECD countries, the level of output is now at its highest ever. There are three geographic areas where the recovery seems to be consolidated: North America, Australasia, and what we might loosely term “Middle Europe”.  The temptation to translate the phrase into German is difficult to resist, for this group comprises Switzerland, Austria, Germany, and their immediate neighbours Poland, Slovakia and the Czech Republic.

In the UK, GDP growth admittedly remains fragile, but the Office for National Statistics is in the process of revising up its recent estimates, leading to the distinct possibility that the double-dip recession was avoided. Further upward revisions to the GDP figures seem likely.

Yet another example of the exotic species of recovery deniers is David Blanchflower, briefly a member of the Monetary Policy Committee under Gordon Brown. In the autumn of 2009, Blanchflower attacked George Osborne’s proposals, if he were elected, to reduce the then £175bn public sector deficit. The plans would mean that “unemployment could easily reach 4m,” he said, and indeed that “5m unemployed or more is not inconceivable”. Our current level of unemployment is 2.5m.

Of course, economic forecasting is an inherently difficult exercise. So when Will Hutton argued in June 2008 that “a British version of Fannie Mae and Freddie Mac must be created now,” he could not have imagined that, in September of the same year, these mortgage institutions would collapse and have to be nationalised by the US authorities.

Western economies are not recovering as quickly as they normally would following a recession. The readjustment of balance sheets in the personal and public sectors is taking longer than expected, although the corporate sector is in rude good health. But it is inappropriate to deny that a recovery really does exist.

Paul Ormerod

As published in City AM on Wednesday 8th May 2013

Some of the evidence usually quoted is statistical. Thus from 2011-12 crime fell 8%, while the number of police was reduced. Real spending on cancer services in England fell 3% in 2012 even though waiting times and access to diagnostics improved. International evidence is that the high spenders on health services get very little extra for their money. Within Europe some of the best results are in Finland and Sweden which spend 9% of GDP on health services compared to 11-12% in the Netherlands and France. It is however possible to resist such statistics where changes could be attributed to longer term trends. Crime  has been falling since 2002/3 and Finland is securing the benefit of its long-term investment in prevention programmes.

It is easy to brush aside any one set of figures but less easy to dispute two key pieces of reasoning. One is the value paradox in the public sector. Increases in spending pull management attention towards the new spend. There is glory in white shiny expanses of new buildings and a sense of achievement from increased staff and extended service. There is no glory in a half-empty parade ground. Any manager who brings about such change can look forward to the esteem of his local community. Naturally scarce management time has to concentrate on making a success of the new programme. Any failure to deliver or to use the funds available will be highly visible.

With growth there is little pressure to drive more value from the existing spending. Nor is their management time for bringing about change in the way that services are organised. In fact in this time of plenty any move to reduce costs would be seen as an insult to hard working professionals nor would it arouse any support from the wider public. For a manager it may be positively dangerous to raise such matters as they are taken as treachery to the organisation.

Once the new money dries up there is then a strong incentive to lever value from the total spend. There will be pressure to meet rising demand with limited capacity. One effect within the health service is already to generate more interest in the use of digital communication. There will be pressure to use limited staff time more effectively. Trusts can get the message that they can use the cast resources which they have more effectively. The new pressure also raises the role of local managers: they have to improve communication rather than the quiet routines of the expanding times – and they also have the greater insight into how to improve the service.

There is a second key area where less may mean better – that is in staffing. Here the new pressure can work to change the model from a high turnover force of new entrants to a stable, well trained – but smaller – team. There are well known gains to experience – in most occupations it takes ten years to become a problem solver with some capability for devising solutions and taking initiative. Even the bible of army field service regulations stresses the need for the officer on the spot to decide what to do in the light of changing circumstances. The ten year group are worth much more to the organisation than new starters who can conscientiously follow instructions for twenty minutes. For the less to do more there has to be a different kind of staff team. A highly trained elite force with experience is worth much more than a conscript army of new joiners. Even if there were more money, the supply of time is falling to the NHS with more part time working and shorter hours. The new pressure could bring about the change in approach to staff which could put greater value on their time and contribution. Fewer staff could mean more investment in training and IT support and more job satisfaction from a pride in achievement.

Nick Bosanquet

Volterra Associate for Health and Emeritus Professor of Health Policy, Imperial College

As published in the British Journal of Healthcare Management.

This type of dominance is not unusual in team sports. One of the most extreme examples is Scotland, where no team apart from Celtic or Rangers has won the league since 1985. Even at the elite level of the European Champions League, there is a concentration of success. There are several thousand professional soccer clubs across Europe. Yet in fifty-six seasons, only twenty-one teams have ever held that title. And there is a heavy concentration even within that small group of victors, with just six clubs winning a total of thirty-three times between them, the other twenty-three championships being distributed amongst fifteen other teams.

After the event, after a team has been stupendously successful, it is always possible to tell a story about why it happened. The legacy of Matt Busby, the genius of Alex Ferguson, massive income from worldwide merchandise sales, and so on. But it is not really possible to predict success in advance. There are in fact very deep-seated reasons why we observe both periods of dominance by a team, or small group of teams, and why these cannot be forecast before it happens. Team sports take place in an evolutionary context. Managers try new tactics, buy new players, discard others, and clubs innovate in how they raise income. The environment does not stand still, it evolves.

The UCLA ecologist Stephen Hubbell has an evolutionary theory which tells us a lot, not just about biology, but about our social and economic worlds. In ecosystems just as in team sports, at any point in time we observe a small number of species – teams – which are very successful, and a large number which are not.

Our natural instinct is to think that success is due to superior qualities. But Hubbell’s theory assumes, as a deliberate simplification, that the differences between species are irrelevant to their success. Almost incredibly, but backed up by some high powered maths, evolutionary situations have an inherent propensity to deliver the sorts of outcomes we observe in the real world. Massive success for a few at any point in time, and unpredictable changes over time in who is the Top Boy of the moment.

Of course, the theory is not completely true. Some teams are better than others. But self-reinforcing success followed by an unpredictable fall is entirely characteristic of all evolutionary systems. United, after all, were once just the works team of the old Lancashire and Yorkshire railway and were called Newton Heath. They had to be rescued from bankruptcy not once but twice. So supporters of Barnet and Brentford can live in hope.

Paul Ormerod

As published in City Am on Wednesday 1st May 2013

The finding has been queried by a trio of fellow Americans. Reinhardt and Rogoff do seem to have conceded that their own calculations contain a glitch. The new analysis has been seized on by opponents of austerity policies. But how much does it matter that an error was made? At the moment, the debt to GDP ratio in the UK is just below the crucial level of 90 per cent. Does this miscalculation mean that George Osborne should change tack and spend to try and stimulate the economy?

In defence of Reinhardt and Rogoff, they never elevated their suggestion into a ‘theorem’ or a ‘law’. They simply suggested that high levels of public debt tend to be a Bad Thing. Even the most devoted Brownite would surely accept that there is some limit to how much public debt can be incurred relative to the size of the economy. The real question is: what is this limit?

A great deal depends upon the extent to which an increase in debt leads to higher interest rates. More public expenditure financed by issuing long-dated gilts at around the current yield of 2 per cent is one thing. But if it causes gilt yields to rise to, say, 4 per cent, it is pretty disastrous.

Higher interest rates would have an adverse effect on business confidence. If rates doubled, the capital value of the outstanding stock of gilts held by the private sector would fall by 50 per cent – a severe negative shock to the wealth of the sector. And higher taxes will at some point be needed to meet the higher interest payments.

There is a lot of evidence to suggest that high public debt levels relative to GDP are indeed associated with higher interest rates. The Mediterranean economies are just the latest example of this. But there is no automatic connection between debt and rates. The relationships which are coaxed out of the data are not like the laws of physics.

So much depends upon psychology. Osborne pushing up debt by cutting taxes might be one thing. Balls doing the same by hiring more bureaucrats might be perceived quite differently. But at some point, regardless of who the Chancellor might be, an increase in public debt would have an adverse impact on the economy. The theoretical channels by which this happens are well understood.  And an ounce of good theory is worth a ton of applied econometrics.

Paul Ormerod

As published in City AM on Wednesday 24th April

Watch Paul present this argument on Newsnight in debate with Nobel prize winner Joseph Stiglitz (feature from 23:30)

I participate in many economic reviews and have been engaged in regional economic policy for a decade (or two). What has been refreshing in the North East is the willingness to embrace opportunity and distinctiveness. Too often, I see ‘sector strategies’ which mean that everyone is chasing the same mobile investment in a zero sum game, and where the investment (if any) can disappear again as fast as it arrived.

And the region has some real distinction. It is the only part of the UK with a positive balance of trade in goods, for example. It has created a set of supply chain investments around the Nissan plant, where component suppliers have invested not only to supply the Sunderland plant, but also to export to elsewhere in Europe. And these are not the only success stories – there are high tech spin-offs from the universities, and specialist exporters in subsea marine, alternative energy, and biomedical areas.

Moreover, there is real engagement from these businesses into bottom-up organisations such as BioNow, which can support the development of new research and development initiatives to drive still further investment, innovation and new opportunities. This is not ‘we need help’ but ‘give us the freedom to get on’. And of course this is the attitude which built the North East’s economy in the first place.

So the outcome of the Economic Review has been to identify the ways in which that energy and optimism can be supported, harnessed and liberated. After all, investors, employers and the buyers and sellers of goods and services all exist within a context of rules, regulations and expectations of ‘how we do things round here’. The review has welcomed the willingness of seven Local Authorities in the region to come together to support the agenda around skills, transport, economic development and inward investment.  The Combined Authority, together the Local Economic Partnership will set up North East International to support exporters and bring together efforts to attract Foreign Direct Investment. They will also work together on skills investment.  This partnership working is a key way in which local and regional institutional capacity can be developed to give the region that base of activity which creates a positive feedback to optimism and ‘can do’.

That is turn will help create what I have called ‘stickiness’ – how new firms and investors are encouraged to stay, graduates to take local jobs, and entrepreneurs to develop.  Stickiness is what has already been created around the Nissan plant, with the development of an effective supply chain.  Innovation occurs in problem solving, and this is much more about supply-demand relationships than about peer-group ones, though the peer-group may create a solution.  A healthy mix of collaboration and competition is what drives innovation which in turn drives productivity and growth.  Getting the new off the ground may require some policy support – but we must be careful not to create a stifling bureaucracy.  Small firms need to become bigger, but the starting point for this is just one more contract.  Supporting the networks which make this possible is a key task and I look forward to helping make this possible over the months to come.

Bridget Rosewell

The reality is different. There is indeed a small number of local authority areas where employment has never really recovered from the closures in the 1980s. But, equally, there are former mining areas which have prospered.

Thirty years ago, in 1983, there were 29 local authority areas in the UK, out of a total of over 450, in which mining accounted for more than 10 per cent of total employment. A mere handful of areas still remain scarred by the closures. Wansbeck, on the bleak Northumbrian coast, had 21 per cent of its jobs filled by mining in 1983.  Now, employment remains 25 per cent lower than it was then. Elsewhere, reality is not as bad as the image.

The old mining areas at the heads of the South Wales valleys are meant to symbolise industrial decay. But in Merthyr Tydfil, there are 8 per cent more jobs than there were in 1983.  Admittedly, in Blaenau Gwent, based on Ebbw Vale, employment is 12 per cent lower. This is hardly permanent devastation. In Easington on the Durham coast, miners made up no less than 41 per cent of all local employment. But even after this devastating blow, losing almost half the area’s jobs, employment now is only 9 per cent lower than it was in 1983.

In contrast, there are real success stories. North West Leicestershire and South Staffordshire used to have lots of miners. But employment in both areas is now some 40 per cent – forty! – higher than it was in 1983.

The experience of the individual mining areas differs dramatically in terms of their resilience, their ability to recover economically. Three years ago, I published a short article in Applied Economics Letters on the changes in employment in all the mining areas between 1983 and 2002. Total UK employment grew by 23 per cent, and in the ex-mining areas as a whole by just 9 per cent. But it was growth and not decline.

A key influence on this has been the attitude of the workers. Statistical analysis shows that the more militant an area was in the bitter and controversial miners’ strike in the winter of 1984/85, the less well it has done subsequently. In Leicestershire, one of the success stories, only 10 per cent ever supported the strike in the first place. In Wansbeck, support was 95 per cent, and even when the strike was ending rapidly in March 1985, 60 per cent were still out.

Economies have the capacity to recover from even the most dramatic adverse shocks, both at national and local levels. But to do this successfully, the workers must be willing to embrace the future rather than cling to the past.

Paul Ormerod

As published in City Am on Wednesday 17th April 2013

Thatcher had no illusions about the failure of the old model, but not all of us were so prescient. Along with Sir Mervyn King and Sir Alec Cairncross (surprisingly in both cases), I was one of 364 economists to write to The Times in 1981, complaining about her policies. I am now very willing to my admit error.

It was not just about macro failure. The micro British economy was dominated by oligopolies, producing either unwanted (coal) or low quality products (cars) at ever-increasing levels of subsidy. The supposed success of full employment was the result of massive over-manning and low productivity, which produced low living standards. In 1979, Thatcher inherited the Maxi economy, so-called after the notorious final product of the Austin-Morris car empire.

Her key economic contribution at the micro level was in opening up markets and promoting competition. Until 2008, this delivered remarkable improvements in living standards and growth. Real wages doubled and supply side changes brought better living standards to working class people. This delivered phones, air travel and central heating. Working people became home owners, with a new range of opportunities for themselves and their children. People no longer had to wait six months for a phone from the nationalised monopoly. Even the protests against Thatcherism became easier because networks could carry mobiles.

It is also wrong to blame Thatcher for the decline of British manufacturing, not least because manufacturing production rose 7.5 per cent during her term of office. In any case, old industry was doomed by its failure to innovate. Powerful unionisation must take some share of the blame, given the extraordinary strike record in British factories after 1960. The average number of working days lost each year to strikes in the 1970s was 12.9m, compared to 660,000 in the 1990s. It was impossible to invest in manufacturing, unless you were a government agency, for 30 years.

Yet there was one area where Thatcher did not change Britain — the middle class’s addiction to public spending. In fact, change increased the interest of the middle class in this area. Privatisation and outsourcing reduced the number of manual workers working in the public sector. The unions were a shadow of their former selves. The working class was in the market.

But the middle class was divided between a minority in enterprise, and many who were still in the public sector as teachers, university staff and doctors. She changed the workers, but not the middle class and the intellectuals. Most still regard government action as the only guarantee of civilisation and condemn Thatcher with the ultimate damning term of “neo-liberalism”.

The recession has only confirmed these attitudes. Health is a particularly striking example. There is now less support for pluralism, competition and new entrants for health services than 20 years ago. The most taboo word in Whitehall is no longer sex or communism, but competition. The new NCB (National Commissioning Board or NHS England) recently produced a 326 page manual on specialist services without mentioning the possibility of new entry through tendering.

The new class divide has already produced political change. In the last election, the biggest swing to the Conservatives (14 per cent) was in working class Cannock, and the biggest swing to Labour (3 per cent) in prosperous South Islington. Working class voters have a much clearer view of the pernicious effects of the welfare system in causing longer-term drop out from the workforce, with dire consequences for health. Many of the most severe long-term medical conditions afflict those who are out of the workforce.

The Islington middle class wants a new age of resurgent public spending and government activity. Much of the media supports this. Collectivism by direct ownership is being replaced by collectivism through regulation and indirect control of resources. This new corporatism is the biggest long-term threat to economic recovery.

Nick Bosanquet

Nick is an associate of Volterra alongside being an emeritus professor at Imperial College, and a member of the advisory board at Reform.

This article was featured in City Am on Monday 15th April 2013

Economic theory helps us understand a bit more about why this is the case. One thing which the last few years in Europe have shown very starkly is the massive difference between debt which is denominated in nominal terms and that which is in real terms. Nobel Laureate Chris Sims makes the point clearly in his recently published Presidential Address to the American Economic Association.

As Sims puts it, real sovereign debt promises future payments of something the government may not have available—gold, under the gold standard, Euros for individual country members of the EMU, and dollars for developing countries that borrow mainly in foreign currency. Nominal sovereign debt promises only future payments of government paper, which is always available. In other words, money can always be printed. Sims notes almost in passing that ‘obviously, outright default on nominal debt is much less likely than on real debt’.

In order to be able to repay any given level of debt, a country must be capable of generating in the future what are called in the jargon ‘primary surpluses’. These are simply a surplus of government revenue over expenditures, taking interest payments out of the picture. For a country with its own currency, as long as it is capable of generating any primary surpluses at all, it need not default. In accounting terms, the present value of its debt is simply the discounted value of future surpluses. It might not be worth much, but its debt has some value. In contrast, if the debt is in real terms – in Euros for the Italians and Spanish – the country needs to be able to generate primary surpluses which cover its debt commitments in real terms, an altogether more challenging task.

There is a definite risk of the Southern European countries becoming trapped in a real debt spiral, from which the only escape is either – or possibly both – default on debt or exit from the Euro in order to be able to denominate their debt in nominal rather than real terms. France is now looking uncomfortably close to this group.

The experience of the 1930s suggests that exiting the Euro may be far from being a disaster. Once the taboo on leaving the gold standard was lifted, those countries which exited early revived earlier than those which chose to prolong the agony.  One reason was that the financial position of the state was once again judged to be viable. The UK quit in 1931, and the very next year our GDP had exceeded the pre-crash peak in 1929. France waited until 1936, and even by 1938 its output was lower than in 1929.

Paul Ormerod

As published in City Am on Wednesday 10th April 2013