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This is the personal website of Mark Cliffe, Chief Economist of the ING Group.

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GDP – a Digital Remix

GDP Digital Remix

 

In a recent article for Project Syndicate, I argue that more than a decade after the global financial crisis, macroeconomists have failed to absorb three crucial sets of lessons. The models that most are using are still struggling to cope with disruptive change, and with the fact that both balance sheets and inequality matter.

Moreover, the key target of economic policy, Gross Domestic Product (GDP), doesn’t provide much help. So with a view to ‘remastering’ macroeconomics, in a new ING report, produced with the help of John Calverley, Carlo Cocuzzo and I investigate how GDP could be remixed. We pay particular attention to the impact of the rapid digitalisation of the economy that has been gathering momentum over the past 25 years. Pursuing the music analogy, our focus is on a digital remix of GDP.

The key conclusions, on conservative assumptions, are that:

  1. Official data understates US real GDP growth by 0.75% per annum, and overstates inflation by 0.4% due to inadequate measurement of the digital economy and the exclusion of investment in certain intangibles.

GDP Digital Remix Table

2. The under-measurement of the digital sector may be about 0.5% of GDP annually, which arises because of rapid price declines, the plethora of new goods and services and the extent of free goods. The improvement in quality is significantly under-measured so that output is understated and inflation overstated. Mis-measurement of the digital sector may go back 30 years or more but is likely an increasing problem as it becomes more pervasive in the economy.

Digital good price
*Note: hypothetical illustration

3. Correctly accounting for all intangibles by including them as investment could add 0.25% to GDP annually. Intangibles still left out by US statisticians include investment in brands, some types of intellectual capital, training, and the value of firms’ organisation and structure.

Intangibles

4. The under-measurement of GDP is probably even greater than the 0.75% p.a. we claim, perhaps 1% annually or even as much as 2% because of the growing importance of services in general, where the calculation of quality improvements is much harder than for manufacturing.

Services vs Manufacturing

5. US trend growth has slowed by about 1.1% p.a. since 2004, according to official figures. Not all of the slowdown can be explained by mis-measurement in the digital sector and intangibles, because some of the mis-measurement we find occurred prior to 2004. Nevertheless, we suggest that perhaps as much as half of this slowdown may be explained in this way.

US Trend GDP per capita

Why it matters

Official statistics suggest that productivity and trend GDP growth have slowed in the last decade and we are told that median living standards are little higher than 10 years ago in many advanced countries or even 20 or 30 years ago in the US. Our Digital Remix casts doubt on these assumptions, arguing that the data is overly pessimistic.

That said, the report cautions that there are other shortcomings in GDP as a measure of prosperity, such as failing to reflect non-market activities or environmental degradation, that may be less benign. But it is clear that the digital era has exposed, more than ever, the limits of GDP as a measure of welfare. And if ‘you manage what you measure’, as the old adage suggests, these GDP flaws raise troubling questions about government policy and economic decisions, which are liable to be distorted as a result.

Read the report in full here.

 

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Time for Macroeconomics to be Remastered

What Economists Need to Learn

In a new article for Project Syndicate, entitled  What Economists Still Need To Learn  , I argue that conventional macroeconomic models failed to predict, explain, or offer remedies for the global financial crisis. Yet a decade later, much of the profession remains in denial and treats the crisis as just a rude interruption.

I group the crucial lessons that macroeconomists need to learn into three main categories:

  1. economies are not self-correcting.
  2. balance sheets matter.
  3. distribution matters.

While some academic economists are making progress with more heterodox approaches, their insights have had little impact on the forecasting models still being used by practitioners in the policy-making and corporate world. Meanwhile, the global backlash against the economic and political status quo is changing the game while it is still being played. As talk of a global recession begins to grow, it’s worrying that macro-economists still have no clear idea what to do about it…

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The Circular Economy’s Six ‘C’ Challenge

Why market forces alone won’t drive it

In a recent presentation to the Financial Services Forum I addressed the financing of the Circular Economy. A growing number of companies are beginning to acknowledge its potential to deliver sustainable development. But adopting its zero waste philosophy of reduce, reuse and recycle – what I called the ‘veganism of sustainability’ – is easier said than done. Why aren’t circular business models taking off faster? Market forces alone plainly aren’t enough. Here are the six ‘C’ challenges:

circular economy market forces

 

  1. Consumer demand. A vocal minority of consumers are advocates of sustainable living, but few are willing to pay up for it. Surveys show that few consumers are prepared to pay more for green products, let alone ones that embrace fully circular principles. And what they tell pollsters may overstate their real appetite to do so. Lack of accepted definitions and labelling of circular products doesn’t help, but in any case businesses face the challenge of making them price competitive.
  2. Counter trends. Although sustainability is now a cultural trend, there are still cultural trends running in the opposite direction. Some business models are not merely waste-intensively linear, but actively accelerating resource use. Fast fashion has spurred rapid increases in clothing purchases and disposal, with so far limited push back. E-commerce is fuelling a want-it-now culture of over-ordering, fast delivery and return. Moreover, the burgeoning middle class in the emerging markets are embracing the consumerist habits of the developed world.
  3. CSR investor pressure. Businesses are also facing pressure to ‘go circular’ from investors adopting more ethical corporate and social responsibility (CSR) principles. But while this trend is growing, it is hampered by controversies over whether these principles lead to higher investment returns. Some studies show that they do, but the question of whether the profitability of sustainable principles are the cause or the effect of business success is unresolved.
  4. Costs. For many businesses it is cheaper to use virgin raw materials or brand new parts rather than to embrace recycling, reuse or reassembly. Prices of non-renewable resources, while volatile, have been cycling around a flat trend for decades, providing little incentive to limit their consumption.
  5. Culture. Apart from cost, it is simply easier for businesses to continue with traditional resource-using production and distribution methods. Although enlightened large corporations and idealistic start-ups are embracing circular principles, there is still a long way to go in shifting corporate cultures towards circular economy principles. In part this is because, unlike the traditional linear business model, the circular business model involves new forms of collaboration and transaction with companies along, and even outside, existing supply chains.
  6. Creativity. Having accepted the culture of circularity, companies need to innovate and invest in it. Creativity is required not just around eco-design, reuse, repair, and recycling, but also business processes, supply chains and market places for recycling and second-hand products, parts and materials.

Of these challenges, the final challenge of creativity is perhaps the most important. Innovative breakthroughs would go a long way in helping to address the other challenges. The precedent of the rapid progress in reducing the cost of renewable energy, and the development of new platform businesses, give hope that business can accelerate progress towards the pervasive adoption of the circular economy in the long term. But in the meantime, policy intervention is needed to incentivise action through taxes and subsidies, positive advocacy and proscriptive rules and regulations.

 

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The Great Disruption

PS cover 2019

The Great Disruption is the apposite title of Project Syndicate’s magazine for 2019. It explores the implications of the political fallout out from the financial crisis, globalisation, technological change and rising inequality. I was privileged to step into the panel debate at the recent launch event in London, chaired by Larry Hathaway and featuring Ngaire Woods and Lucrezia Reichlin. You can now listen to this on the Project Syndicate website here.

Here’s my contribution to the magazine, in which I explore how companies might deal with the Great Disruption:

Doing Business in the Great Disruption

Asset prices leave financial markets vulnerable to destabilising setbacks

A decade ago, the global financial crisis cast a spotlight directly on financial institutions; but that scrutiny has since morphed into a more general scepticism about corporate behaviour. While the tech giants that are driving the digital disruption have become the centre of attention, no company should assume that the Great Disruption will be a mere passing storm. A prudent outlook would accept that today’s polarization could get worse before it gets better. After all, populists have been on the march in the midst of a sustained economic upswing and falling unemployment. Just think what will happen when the next recession arrives. Though forecasters are not ringing alarm bells about a recession in 2019, high asset prices leave financial markets vulnerable to destabilizing setbacks. And while the current crop of populists might not fare well in the next recession, they could well be replaced by others with even more radical ideas.

Moreover, while politicians come and go, other key elements of the Great Disruption will endure. The new-technology genie is out of the bottle. The rapid deployment of digitalization and artificial intelligence (AI) will be hard to stop, owing not only to the pervasive benefits these technologies bring but also to the competition they have spurred between countries – led by the United States and China – to be the winner that takes all. Similarly, the environmental challenges of climate change and resource usage are not about to go away. If anything, they will intensify as a result of populist climate denial, delay, and prevarication. Accordingly, companies should think of themselves as polar explorers, whose top priority is always to avoid freezing to death.

To survive the Great Disruption, companies first need to be careful what they say. Policy advocacy risks triggering a backlash and boycotts, and one critical presidential tweet can send share prices tumbling. In an era of social media and fake news, active but sensitive reputation management is more challenging than ever.

Foreign companies must be attuned to local cultural diversity

Second, recognizing that trust in big business is fragile, corporate leaders need to understand not just populist politicians but also the motivations and desires of the people who support them. Foreign companies, in particular, must be attuned to local cultural diversity. And ensuring the privacy and security of client data is another critical ingredient in building and maintaining trust.

Third, companies need to be better prepared to weather shocks, by de-risking their operations and balance sheets. Scenario and contingency planning, along with stress testing, are crucial for building the resilience and flexibility needed for survival. In particular, complex international supply chains and lean inventory-management techniques can be caught out by capricious political decisions and other shocks. Once companies have built up resilience, they can start to look for opportunities that the Great Disruption may offer.

To that end, multinationals should start behaving more like ‘multi-locals’ With countries so internally divided, companies will need to pay more attention to the nuances of local interests when serving their customers. Looking beyond urban elites, there are profitable opportunities in catering to less advantaged segments of the population. These cohorts’ concerns are what governments – populist or not – are under increasing pressure to address.

A major focus in the months and years ahead will be the tension between the US and China

Moreover, digital technologies and AI are creating new possibilities to serve disadvantaged groups with segmented and personalized products. Already, policymakers in Europe and elsewhere have begun to look for ways to address the dominance of US and Chinese tech companies. If that increased attention leads to tax, data, and privacy policies which level the competitive playing field, there could be new business opportunities for others.

Companies also should consider adopting a “barbell” investment strategy: having made their core businesses resilient to polarization, they can reserve a small proportion of their investment budgets for bets that promise high pay-offs. This calls for agility because companies will need to respond quickly to changing circumstances. But so long as they keep bigger buffers and reserves, they will be able to pounce on bargains after negative shocks. Today’s stretched asset valuations suggest that such shocks are becoming more likely. But even if they don’t materialize in 2019, companies can start thinking through their options. A major focus in the months and years ahead will be the tension between the US and China, which may depress asset prices, presenting attractive entry points for the booming Chinese and intra-Asian regional markets.

Companies should play the long game on environmental sustainability

Finally, companies should play the long game on environmental sustainability. Populism and nationalism may be weakening cooperation on these global challenges, particularly now that

President Donald Trump has withdrawn the US from the Paris climate agreement. But this means that there will be an even greater need for action in the long run. Alternatively, the populists themselves may come to see the attraction of shifting taxation from workers – especially their core voters – toward fossil fuels.

This may not be imminent in the US, where Trump has committed to propping up the coal industry. But the falling cost of renewable energy presents a longer-term opportunity to make the shift away from fossil fuels. Not only will less expensive renewables depress fossil-fuel prices, but, absent policy action, they will also stimulate a counterproductive rise in energy consumption. To prevent this, policymakers could raise taxes on energy generally and use the revenue to fund cuts in other taxes.

This article appears in ‘The Year Ahead 2019: The Great Disruption’ published by Project Syndicate, and also on ING’s THINK website, here.

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Forecasting is Fallible, But Necessary

In my first piece for Project Syndicate I build on my earlier post on the lessons for economic forecasters.  The subtitle of their post prompted some questions about the usefulness of big data. There’s no doubt that economic forecasters can benefit from machine learning, which provides powerful ways of spotting patterns in past (big) data. Nevertheless, this focus on past data means that is of limited use for forecasting in the midst of uncertainty and unprecedented structural change…

1d0d434192da6a466ded97fec170d6dc-2-1-super-1

 

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Future of Banking – digital disruption, digital diversity

In this video for Oracle, I discuss the future of banking. Digitalisation means that banks will have to figure out how to best use data and combine it creatively with external data sources to provide better and more holistic services to their customers. But platform companies are raising strategic questions for the banks to address. Can banks retain the customer relationship, or are they going to turn themselves into utilities, processing transactions in the background? The core of the banks’ profitability remains their savings and loan activities. In considering whether to pursue this balance sheet-led business model in the future, banks are likely to pursue a variety of strategies.

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Machine, Platform, Crowd – Book Review

Andrew McAfee and Erik Brynjolfsson have done it again. ‘Machine, Platform, Crowd’ is a lucid and timely exploration of three powerful trends unleashed by the digital revolution. They describe the ‘three rebalancings’: first, as machine learning either complements or supplants human minds, secondly , as platforms drive the selection, production and distribution of products and services, and thirdly, as on-line crowds increasingly augment or surpass the core functions of companies.

Although the authors don’t put it this way, there are essentially three economic drivers of the ‘triple revolution’. First, the “free, perfect and instant economics of digital information goods in a time of pervasive networks” which means that “the marginal cost of an additional digital copy is (almost) zero”. Second, the positive network effects from the growth in user interaction. As they put it, “Networked goods can become more valuable as more people use them. The result is ‘demand side economies of scale’, giving an advantage to bigger networks”.

The third driver is the distinctive ability of multi-sided platforms to subsidise one or more set of users in order to incentivise the participation of other sets of users. Digital technology allows many platforms to offer free or discounted services which draw in consumers. This encourages ecosystem growth by attracting more producers or advertisers who pay for the privilege, in turn making it more attractive for other consumers and users.

The book is clearly structured into three sections discussing the title themes, with handy summaries at the end of each chapter. Although the three themes are given equal billing, in the end what dominates is the potential for platforms to capitalise on machine learning and crowd mobilisation. Chapter 7 observes that platforms compete on drawing in users’ contributions and curating them effectively, “but it becomes much more difficult to build a vibrant platform if at least two are already in place”. Network effects and the reluctance of consumers to switch or use more than one platform (or “multi-home”) allows successful platforms to dominate their markets. McAfee and Brynjolfsson are curiously reluctant to use the word, but tendency of platforms towards monopoly is clear. The potentially negative effects of this on competition and innovation are left unexplored, although they would probably need another book to do them justice.

The book also glosses over another distinctive feature of the growth of platform companies: many of today’s giants spent years losing money. Investors have tolerated this, placing faith in the platforms’ ability to turn rapid growth in their user base into longer term profits. They perceive market dominance arising from investing in network effects has long term value. The problem for incumbent companies facing digital disruption is how to secure similar investor indulgence in seeking to transform themselves. The authors argue that there is room for incumbent companies to co-exist with platforms, but they leave little room to doubt that the momentum is with the latter.

The authors end on an optimistic note, saying that “the next few decades should be better than any other […] so far”, although they are careful to describe this as “possibility and a goal”. Indeed, they are suitably humble throughout about making predictions of the disruptive trend that they describe. Amusingly, while the publishers describe the book as a “toolkit” MacAfee and Brynjolfsson say at the outset that they are not offering a “playbook” and that “we suspect that people who offer such a playbook are kidding either themselves or their readers. There is simply too much change and […] uncertainty”. Nevertheless, they have done us all a great service in explaining some of the powerful trends that will shape our future.

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