Modelling Stability after Revolutions

Dom Aits is presenting a seminar tomorrow on political stability after revolutions, applying mathematical methods. Here, he blogs about his work.

The crisis unfolding in the Arab world, and in particular in Egypt, shines light on how suddenly imposing a democratic political system on what was previously a dictatorship can have dire consequences. The key to working out why there is such violence after a revolution is set within the beliefs and the expectations that people and organisations hold for the future of their new government.

There is always a cost with a political revolution. The act of revolution itself – to overturn what has come before – can bring personal loss and economic ruin to name a few. But the sacrifice that comes with this is the very characteristic that makes the aftermath of a revolution so unstable.

This seminar aims to explore how important beliefs and expectations are, and how the sacrifice that comes with a revolution warps them. The political system will be analysed from a different angle applying economic ideas to a new context. This new angle uses logic in a very similar vein to that used in economics, and applies mathematical abstraction to uncover different ways at looking at elections, democracy and the behaviour of pressure groups.

What the seminar will ultimately focus on is a policy tool that can be applied to stabilise post-revolutionary states that fundamentally tackles the issue of future expectations and beliefs.

The executive summary is below:

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The most noteworthy aspect of the recent political revolutions in the Arab world is that there is nearly always a failure to suddenly superimpose a democratic style of government based on Western political constitutional foundations onto a set of domestic government institutions. In my paper, I argue that there is a need to consider the notion of a ‘learning equilibrium’ – to recognise that it takes time for institutions and socio-economic agents to adapt their expectations about the new state of governing such that a stable democratic political environment is generated.

The model I develop defines all groups that aim to implement a manifesto (or a set of beliefs) as pressure groups, which I assume are strictly competitive entities by nature. These groups, at a point in time, can either decide to work within the rules and confines in the current ‘state of government’, or aim to change this ‘state’. If a pressure group wants to change the state, it can still work within the confines of the current state of government, and hence does not have to reject it. This is the case when there are elections that allow the peaceful transition between states of government. A pressure group can work to change a state of government without having to reject the current state.

How a pressure group makes the decision to reject a state of government consists of four factors – a minimum-bound utility, a realised utility, an optimal utility, and a Feasible Time Frame.

Pressure groups are considered to be no different to any other economic homogenous agent, and thus utility is the key concept used in this paper. As a starting point, each pressure group has a minimum-bound utility – this is the minimum utility a pressure group will accept in order to conform to a state of government.

I argue that pressure groups gain utility from their expectations of how they will succeed in the future. Critically, there are two types of utility that a pressure group considers. The first, optimal utility, is what the pressure group would gain in an ideal world (in their opinion) when they are faced with realising their own limitations. This is expressed as an optimisation problem in the paper. The second type of utility is realised utility. This is what the pressure group actually gains from the current resources and successes that it has when it considers its future prospects.

Utility is realised over a set of time intervals called Feasible Time Frames. The intuition is similar to how any organisation operates. An organisation tends to have a strategy that is reviewed from time to time to make adjustments (i.e. consider timely reports and project reviews). Between these reviews, there needs to be time for the strategy to be implemented, and hence during this process (unless critical adjustments have to be made) that strategy will remain on the whole intact. I argue that pressure groups follow a similar mechanism and realise utility at the end of these time intervals.

So at the end of a time interval, if realised or optimal utility is lower than the minimum-bound, a pressure group will reject the current state of government.

The purpose of the paper is not to analyse a revolution itself, but to look at the aftermath.

I argue that after a revolution, the minimum-bound utilities of pressure groups increase. This takes into account the sacrifice that comes with the revolution, due to: the physical human loss, the interruption of ‘normal life’, the economic cost etc. In other words, pressure groups want the revolution to be worth something to make up for the cost of participating in it, and so expect more from the new state of government. At the same time, in the aftermath of a revolution, political processes and the functioning of the state (and economy) tend to be stunted (i.e. slow recovery) for a while – so realised and optimal utility are likely to fall. Combine this with pressure groups’ impatience leading to a shortened feasible time frame, and the conditions for a quick rejection of the newly established state of government increase quickly.

The paper ends with a policy contribution to tackle this. I argue that that to create stability, a learning equilibrium needs to be established whereby pressure groups gradually adapt to the new state of government. This can be achieved by removing the pressure groups’ high expectations of the post-revolutionary state of government. Both political demands from the pressure groups and the supply of such concessions from the government need to be mediated. The idea is to create a model with slowly increasing terms of office for subsequent states of government to avoid a new revolution and to suppress violence.

I propose beginning with a one-year term before new elections, and increasing the terms by one year until a four or five year limit is reached. With short terms in office, pressure groups cannot realistically demand huge improvements in the country because they will be forced to realise that this would be impossible given the imposed term of office. Similarly, those running the state cannot offer similar promises either, because the electorate will be less likely to believe that those promises can come to fruition. As terms of office increase in length, pressure groups will eventually mediate their expectations to work within a democratic, election-led political process, and hence the impetus for further revolution is more likely to be suppressed.

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Our Favourite Infographics

Felix Nugee

The world we live in is becoming ever more data-based. This affects everything from the sports we play, to the cars we drive, to how we evaluate policy questions. But few amongst us want to spend our time trawling through spread-sheets or running programs on matlab in order to understand them fully. If a picture can speak a thousand words then an infographic can speak 1 million data points. Here we’ve collected a few of our favourite infographics from the past couple of months.

Changing British social attitudes:Screen Shot 2013-10-25 at 2.39.10PM

Social mobility by geography in the US:Screen Shot 2013-10-25 at 2.35.40PM

Putting false rape accusations into perspective:

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Interactive on the arms trade (click through, Chrome only):Screen Shot 2013-10-25 at 3.11.30PM

The real value of the national debt:

Freedom and equality for LGBT+ community in Europe:

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Most common second language in parts of London:Screen Shot 2013-10-24 at 8.58.54PM

Not technically infographics, but our favourite flowcharts:

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The Energy Price Freeze – What Will it Actually Do?

Rob Natzler & Tommy Peto

So what will a price freeze actually do? Not very much, it seems. Neo-classical economic theory suggests that a sudden supply-side shock[1] could lead to blackouts if prices are frozen. A crisis in the Middle East or a decision by Russia to turn off the gas taps could lead to a sudden spike in the international price of fuel. If British energy companies aren’t able to raise their prices to cover their increased costs, they’ll start making losses, and may well decide to throw in the towel. Even if they are able to get authorisation from the government to raise prices despite the freeze, in a neo-classical world of efficient markets and instant price changes the delay may be long enough to cause a temporary period of blackouts nonetheless.

Only prices in the energy market aren’t instantly flexible. Energy companies are required by law to warn all customers of a future energy price rise 30 days in advance of it being carried through. Neo-classical economists may argue that this statutory requirement leads to inefficiencies, but it means that the imposition of a price freeze has little impact on the ability of energy companies to adapt to a huge and unexpected supply-side shock.

It’s hard to imagine that any price freeze system wouldn’t have a ‘knock-out clause’ in case of emergency. By the far the most likely is a requirement for companies to acquire government permission before raising their prices. Under the current system, companies would either need to wait 30 days to raise their prices, or would have to persuade the government to repeal the statute which insists upon the minimum. A price freeze system where the government of the day need not raise Parliamentary support before permitting sudden rises is going to be no slower than one in which Parliamentary support is additionally needed. It may even permit a faster response to sudden supply-side shocks, so that the price freeze system reduces the chance of blackouts.

It is true that a government running a price freeze system might be more suspicious of pleas by energy companies for emergency price increases than one under the current system. This is both unlikely and avoidable, however. Unlikely, because a massive and unexpected supply side shock of the sort we’re talking about is unlikely to go unnoticed by the government. Avoidable, since an incentive structure scheme where energy companies who make profits having misled the government into breaking the price freeze suffer confiscation of profits plus a fine will ensure all energy company pleas are made in the sincere belief of a crisis.

But what about investment? Well, it’s unlikely to fall as a result of the price freeze. Energy companies standardly offer a fixed-rate deal for periods of time longer than the 20 month period Milliband is insisting on[2]. Whilst they will get hit by needing to offer this package to all of their customers, it is fair to presume that they will choose to raise their prices either immediately following the election or immediately after any Labour victory.

This makes the price freeze essentially a gamble between Milliband and the energy companies as to whether their guess of the market price for 2015-17 is going to be accurate. If wholesale energy prices rise, consumers win; if wholesale energy prices fall, the companies make more money than they would have otherwise, and consumers lose out. In either case, when you consider the 30-year lifetimes of energy projects, the 20 month blip price freeze period is highly unlikely to deter investors.

Of course, all this is assuming that there are investors still choosing whether or not to invest in projects due to come online in the 2015-17 period, by no means a certain assumption given the average historical time to complete a new energy project since 1995 has been just over four years[3]. In fact, this category seems to represent only a small sub-set of investors, with most investment decisions being made currently being those whose returns will be won post price freeze. So the price freeze policy effects only a small sub-set of the returns on a small sub-set of investment decisions – a far cry from the claims of mass blackout resulting from investment flight some of the more alarmist political commentators have been claiming[4].

That’s not to say that Milliband’s policy isn’t going to hit investment, however. Following the 20-month price freeze period, he’s planning on introducing a new energy regulator designed to increase levels of competition in the energy market by holding the small number of large, vertically-integrated firms that currently make up Britain’s energy suppliers more accountable. Depending on the model you use, a less oligopolistic energy market may lead to either higher or lower returns to investment, so we can’t say for certain what the pro-competitive reforms will do[5]. The Select Committee for Energy and Climate Change called for them back in July[6], however, so energy companies should probably assume some kind of change is inevitable regardless as to who wins the election.

What we can say, however, is that current uncertainty as to exactly what form the new ‘consumer-friendly’ pro-competitive regulator will take is likely to deter investment. A new regulator means new rules, and new builds may stall until those rules are known, as investors shy away from betting that their project is going to meet all the new regulatory standards. That’s not to say that their investment will go elsewhere – investors lacking contacts and know-how in foreign energy markets or alternate sectors have no incentive to trade out in the short-run – but that some aspects of new projects may have their construction time increased as investors hit a pause button and ‘wait-and-see’.

The flip side of this is that investors may see some parts of the energy sector as a better source of investment in the interim. A new regulator may be harsher on standards for coal or CCGT power stations, but is unlikely to come down hard on new green energy builds. Technology in the renewable sector is developing at a rapid pace, and Milliband’s history as Energy Secretary under the last government saw a large number of pro-green taxes on polluting fuel sources being introduced. Investment on polluting builds may or may not stall due to uncertainty as to how the new regulator will view them, but investment in green energy may actually increase as its short-run prospects relative to other methods of energy generation actually improve due to higher levels of investment certainty[7].

That said – and this is worth saying – overall investment is still likely to fall. A new regulator may also mean a deterioration in the returns to investment following 2017. Whilst this isn’t a definite, some investors may want to reconsider their options until the market situation becomes clearer. This relatively minor hiatus in investment is extremely unlikely to lead to either blackouts or a failure to meet green targets, but may well lead to price rises in the short run as the supply of energy temporarily fails to rise in tune with increasing demand.

The irony of the situation is the Ed is being branded a socialist for proposing a pro-market reform by instituting a tougher regulator. Meanwhile, the option of returning to pre-2002 price controls on a permanent basis remains as yet unmooted.


[1] A sudden demand-side shock is obviously also a possibility; however, over the 20 month period proposed by Ed Milliband it stretches the imagination to think of a situation where domestic energy needs increase so much faster than expectations as to drive fixed-price energy suppliers out of business.

[2] Indeed, Npower were briefly advertising a deal to freeze their prices from 2013-2017 under the slogan “Why wait for Ed?”

[3] We hasten to add that this is an estimate cobbled together through looking at the histories of all post-1995 power station conversions and new builds – if there’s an industry expert who can give us a more precise figure for future builds in the 2015-17 period, that would be much appreciated!

[4] One further argument is that investment flight may occur as Milliband’s policy indicates a government who are ‘market-meddlers’ and so may interfere in the energy markets in the future. This just doesn’t cut mustard in this instance, however – price controls in the UK existed as recently as 2002, and Milliband’s scheme is laid out for a finite period of time and with the clear justification of solely being to tide us over to a new regulator. Insofar as we don’t already have a reputation for being prepared to meddle in energy (and very few countries do not), it’s unlikely this policy is going to give us one, or make our existing one worse.

[5] Schumpeter and Arrow have differing opinions on the way competition through investment might play out in a more competitive oligopolistic market.

[7] However, this aspect of our conclusion is largely speculative.

Why a little PAT on the back can solve our Population Problem…

Ravi Prasad

You know when you finish reading a novel that has expeditiously elevated to its climax, you’re sometimes forced on completion to spend an additional amount of time piecing together what you’ve just read? Well, I found myself doing exactly that having recently turned over the final pages of Dan Brown’s latest epic, Inferno.  Written in Brown’s typically eloquent prose, Inferno is the riveting tale of the Harvard symbologist, Robert Langdon, who is recruited by the World Health Organisation to track down the location and prevent the release of an alleged plague, invented by the scientific genius Bertrand Zobrist, whose chilling ideology is to protect the world from uncontrolled overpopulation through controlled extermination of the human race. Amidst twists and turns and cunningly clever deception, Brown poses the reader a deeply disturbing but hypothetical question; “Would you kill half the population today in order to save our species from extinction?”  Inferno’s conclusion is surprising, both by Brown’s standards and fictional norms. The main antagonist of the novel, Bertrand  Zobrist, achieves his objectives and unleashes a highly contagious airborne vector virus which renders one third of the global population sterile. In essence,the bad guy wins. A gloomy and dramatic conclusion of this sort reflects Brown’s own concerns about the potentially damaging consequences of population growth left unchecked, a concern that is now mainstream.

Fears of overpopulation are growing

Fears of overpopulation are growing

Overpopulation fears are not new, Robert Malthus in his 1798 work: “An Essay on the Principle of Population”, speculated that the power of population is so superior to the power of the earth to produce subsistence for man”. Whilst Malthus’ own fears of imminent collapse were short-lived; there has been a continuous and growing movement of scholars who share similar Malthusian beliefs. An increase in the global population from 2.5bn in 1950 to 7bn in 2011 is seen as the harbinger of economic, social and political problems. Economic theory, too, attests that an increase in the population growth rate reduces income per capita using a simple neoclassical growth model. One needn’t open economics textbooks though; turn over the first few pages in any major newspaper and expect to be bombarded with statistics that posit crises in food, water, energy and more. The solution, they say? Massive behavioural change, sustainable growth and education and contraception to curb population growth. Stewart Wallis of the New Economic Foundation has gone as far as calling for a ‘Great Transition’ to a new economic order… One would be forgiven for thinking that an impending doomsday is on the cards.

As far back as the Malthusian movement goes, a counter-movement has co-existed. They argue that the earth is more than equipped to deal with upward population pressures. They cite the fact that the world improved its living standards and lifted millions from poverty at the same time as the population explosion took hold, and this was down to technological improvements, in agriculture, resource management and energy efficiency to name a few. Improvements in technology, they say, will allow continued economic expansion even with further population growth. Besides, the latest United Nations projections state that the earth’s population will stabilize by 2062 at around 10 billion, after which point global population will fall anyway…One would be forgiven for thinking that the fuss being made today about overpopulation is irrelevant and that in reality, there is little to fear.

Amidst countless stats, predictions and supposed real life evidence, it is easy to get lost within these two opposing views. What this article seeks to achieve, is to disentangle the two, showing that both views rely on critical assumptions.

To do this, I introduce a concept I call “Population Accommodating Technology” (PAT). PAT enables populations to survive, and encompasses technologies of all sophistication which range from something as simple as a water well to the latest, most efficient, agricultural and energy obtaining techniques. Because population growth and the demand for scarce resources are strongly correlated, we can use the interaction between PAT growth and population growth as a proxy to predict the likely outcome of a larger population. In the first view outlined, that of the “overpopulation is a reality” movement, the assumption made is that population growth will be greater than PAT growth. Whereas the second view, that of the “overpopulation is a myth” movement, assumes the opposite.

To decide which assumption, and therefore which movement, is more realistic, it is important to consider the time frames in which we view both assumptions. We know that it is highly likely that the population growth rate will continue to fall – UN estimates suggest that global population is currently growing at 1.14% annually, down from a peak of 2.19% in 1963. This downwards trend is set to continue, it will become less than 1% by 2020 and less than 0.5% by 2050.

Previous and predicted population growth rates

Previous and predicted population growth rates

Of course the total size of the population will still increase to its forecast 10bn despite falling (but non-negative) population growth rates, and scarce resources will therefore be in higher demand, which in turn means PAT growth will need to be sufficiently strong to oppose these headwinds. Fortunately, there is no conclusive evidence to believe that PAT growth is exhaustive, after all PAT growth stems from innovation which Joseph Schumpeter classified as a function of entrepreneurial behaviour. Providing human capital continues to follow historical incremental trends (it’s not unrealistic to assume that as time progresses we will build our species’ knowledge base yet further), and the profit motive is still omnipresent, then, in theory, entrepreneurship should never be lacking. The knowledge of today becomes the PAT of tomorrow. There are already signs of tomorrow’s technologies that have the potential to negate resource shortages. Take the freshwater crisis for example, researchers at MIT have found a new single-atom thick graphene sheet which can significantly reduce the cost of desalinisation, meaning that 70% of the earth’s surface is now potentially accessible for drinking purposes. This is not the only desalination technique that is becoming viable mind you, America recently began construction of itslargest desalination plant in San Diego, powered by highly pressurized water. Similar ground-breaking technologies can be found in agricultural techniques and (renewable) energy extraction. Yet simply because these technologies are not in mainstream use at the moment is not indicative of their failure as PATs. This is to be expected, when the initial breakthrough is made there is always a time lag before the technology becomes both feasible in terms of energy efficiency and costing for mainstream use. Yet once in use, these technologies bring with them Schumpeter’s “creative destruction”; unforced, automatic and clean change of our economic systems – and mankind’s best hope to confront the population growth challenge.

An answer to the freshwater crisis? Desalination

An answer to the freshwater crisis? Desalination

Where PAT’s shortcoming lies is in the fact that it is dispersed unequally throughout the world; those areas which have the lowest population growth rates have the most PAT (e.g. the developed world). Those areas with the highest population growth rates have the lowest PAT (e.g. parts of the developing world particularly Sub-Saharan Africa and Southern Asia). It’s clear that PAT is therefore at its weakest on the most important battlefields against population growth, and with PAT diffusion being a gradual process at best, there is the possibility of short term damage.  And this is where I think Dambisa Moyo has got it bang on in her latest book “Winner Take All”. Moyo argues that the world’s, especially China’s, unprecedented drive for resources has and will continue to push up commodity prices, at the same time increasing political tensions to extents that make resource conflict increasingly likely in the immediate term.

What can the world do? First, the mentality that we adopt towards population growth should not be one of despair. Population growth is to slow down and ultimately will become negative according to UN predictions (if you want to hear more about this come back in a few days time), at the same time our population accommodating technologies will become greener, faster, more reliable and cheaper. Secondly, the debate should shift from how to alter individuals behaviour (something which has proved notoriously difficult) to how to promote the invention of PAT and its distribution around the world. Only PAT has the power to tackle the challenges we face head on; asking developing nations that solely want economic growth to recycle more and cut back on energy consumption is a non-starter. Finally, in the coming years while PAT diffuses and improves, international organisations must stand strong against those who choose to satisfy their resource demands through conflict. Population expansion doesn’t have to be a problem. The combination of PAT growth and good global governance is the necessary counterbalance.

Originally on the ForwardForum blog

Debunking austerity – how big were the costs to growth?

Jonathon Hazell

One of the best things about conference season is that it gives you a good insight into which of last year’s policies each party thought were popular, and which need to be quietly binned. The result? Both main parties seem to agree that austerity is a vote winner. Consider: Labour pivoted to the ‘cost of living crisis’, whereas the Conservatives think voters austerity so much that they have decided to propose semi-permanent austerity, spending and tax cuts be damned. George Osborne sees vindication in recent output growth. However as Simon Wren-Lewis notes, a single quarter’s good performance is weak success at best, pointing out that:

‘We could close down half the economy for a year. The next year economic growth would be fantastic. Only a fool would argue that this showed that closing down half the economy for a year was a great idea.’

This is a more general problem. In politics austerity seems like a debate between partial truths, with recent events seeming to have austerians carrying the day.  But empirical economics has spent the last five years testing the claims of austerity, and fairly emphatically found the reverse.

Looking back on the 2010 general election campaign and after, the argument rested on two points:

1) Multipliers on government spending were small, so fiscal contraction would barely harm  overall demand

2) Austerity could be expansionary for growth due to business confidence effects,

This was taken to mean that the overall costs to growth were small.

Government spending multipliers

These are the fall in total demand associated with a given pound of tax rises or spending cuts.  Put simply, small government spending multipliers mean austerity will be relatively painless. When the OBR and the IMF forecast the economic effects of coalition spending plans, they used a multiplier of 0.4-0.5. However the balance of evidence suggests under current circumstances, multipliers are about three times as high, around 1.5. We know this because of a very public mea culpa from the IMF – their chief economist, Olivier Blanchard, released a study earlier this year working out multiplier values based on how overoptimistic IMF forecasts had been. These estimates are also consistent with the best historical evidence we have. So when we see that UK growth performing very badly relative to its OBR forecast in 2009, this is completely consistent with much more severe than anticipated effects from austerity (on which more below):

AusterityGraph1

So why were forecasters so over-optimistic in 2009? Normally monetary policy can offset the effects of a fiscal shock by cutting interest rates. Given that they have been at their zero lower bound since 2008, monetary policy has essentially been exhausted as a tool. The jury is still out on quantitative easing, but most studies over the last few years give it a much smaller and less certain impact than conventional rate cuts.

Expansionary austerity

The complementary argument put out (mostly by George Osborne)  in 2010 was about austerity boosting growth, through so-called ‘confidence effects’. The basic idea was that households and businesses were cutting back spending because of uncertainty over high public debt, potentially higher tax rates, or a sovereign debt crisis. Regardless of whether or not this is a sound analytical argument (and it is difficult to more than assert a theory of the mass psychology of households and businesses) it had some empirical backing from a paper by Alberto Alesina and Silvia Ardagna, which the Treasury explicitly relied on to make their case. Alesina-Ardagna claimed that fiscal consolidation led to higher growth. However they did so on the basis of some quite flimsy statistical work. In a nutshell, if their result holds at all it is when output growth is strong (i.e. the opposite of the UK recently), and interest rates can be cut by central banks. The IMF debunked it in 2011 on that very basis, after controlling for whether fiscal contraction takes place at the peak or trough of the business cycle. This explains the massive underperformance of the Euro Area and the UK versus less contractionary countries:

AusterityGraph2

Costs to growth

Given the above, then, it’s no surprise that the best estimates of the costs of austerity have been huge.  Alan Taylor, one of the world’s pre-eminent macroeconomic historians, attempted to estimate the total cost to output of budget contraction since 2009 along with his co-author Oscar Jorda. The result? Austerity probably cost the UK 3% in terms of lost output. By the very nature of counterfactuals, we can never know if this figure is correct. But serious criticisms of the paper, including by the authors themselves, have tended to focus on the fact that they fail to control for interest rates being at the lower bound, when monetary policy is exhausted. In this light, 3% is probably a conservative estimate of the total cost of austerity. Given that there has been no comparably rigorous piece of contradictory analysis, this should be, at the very least, our base case.  Jorda and Taylor underline this in a graph:

AusterityGraph3

As important as the work above is the total absence of the reverse – serious and unrefuted empirical economic research coming out in favour of the pro-austerity arguments has been slim to none. Given the debates that sometimes mark out macroeconomics as a discipline, this speaks volumes.

So does writing against austerity equal staking out a political position? I would argue exactly the opposite. At least in terms of the cost to growth, the line that austerity is disastrous is apolitical. Rather, from a macroeconomic perspective it is a firmly refuted position, like the gold standard, or money supply targeting. And yet it doesn’t seem as if key political actors have updated their beliefs to fit this – it is for this reason that Simon Wren-Lewis  likens the debate to ‘climate change denial’.

Economics and politics seem to have reached opposite conclusions to the same debate. What does this say about the impact of economics on policymaking? And if the evidence isn’t enough to sway this particular political discussion, are we going to be permanently worse off?

Update: Turns out the OBR broadly agrees with Jorda and Taylor