Tag Archives: Financial Advisors

Alice in Wonderland Economics

The book that I would recommend to anybody wishing to understand the economy is Lewis Carroll’s ‘Alice in Wonderland’. Not as a book to replace all the books that can be found in the economics section of any library, but as a first text which to give a good grounding in all things economic. What any budding economist needs to know about the economy is that things are not as they appear.  Alice is able to get through a door for which she is to tall by drinking from a bottle labelled ‘drink me’. After drinking that she shrinks in size to such an extent she is now able to walk through the door. She can be both giant and of normal stature in Wonderland. Later in the book she meets the Cheshire cat, who not only can become invisible but is able to become visible in place other than that in which he first appeared.  What the good economist should do is to be prepared to surrender their belief in a world of common sense. Just as for Alice the rabbit hole is a portal to another world, so a public corporation can equally be a portal to a world in which strange behaviours predominate.

One good example of this strange new world of economics is the strange behaviour of Starbucks. I was puzzled when I read that Costa Coffee a British coffee shop chain was more profitable than Starbucks. Starbucks seemed to be everywhere and I could see no evidence from what I observed that the business was doing badly. Then on reading more I realised that is was yet another example of a company not wanting to earn profits. Yet all the textbooks state that all businesses are profit maximisers. Profits earned are subject to corporation tax, so companies will do all they can to minimise their profits and tax bills. This is usually done by having a head office located in a low tax country such as Eire and that head office then imposes such a high level of charges on the business (for services provided) that the profits are reduced to such  a low level that the company is either ceases to be liable for tax or it only has to pay a minimal amount.

However the process becomes stranger and stranger the more it is examined. Usually the ‘charges’ that are paid to the Head Office are through a chain of offshore companies remitted to the multinationals homeland. Yet the profits declared then are only small part of the companies income. Such companies sit on vast cash piles which are located in various tax havens. This cash pile increases the companies wealth and the price of its shares. Shareholders are in many cases happy to have a reduced dividend but a reduction more than balanced by an increase in the value of their shareholding. Banks recognise that the shares held in such as Starbucks, Apple. Google etc. are extremely valuable assets. They will then lend large sums of money to these people against the security offered by there shares. These loans which are rolled over from year to year and which can be increased in line with the increase in the value of these shares. Loans have the advantage of not being income and are therefore exempt from tax. Many shareholders are content to enjoy their income in this way. Although there are a significant number who would still want to enjoy a cash return from their investment.

There is a passage in ‘Alice in Wonderland’ where Alice comes across a group of the Red Queen’s servants painting white rose red. This because the Queen wanted red roses and they mistakenly planted white roses. They hope that the Queen won’t notice the red paint. Similarly there is the many thousands of financial advisers who role in life is to paint earned income as anything but earned income. Anything that is either not liable for tax or which is taxed lightly. Unlike the Red Queens gardeners they are very successful in that the tax authorities never see through the disguise.

Apple is described as the world’s largest business. Although they are  the company with the largest sales revenue are not necessarily the most profitable. Much of the profit earned is changed into something quite different, such as a charge to Head Office at least in all the European countries. What profit Apple declares is largely resting in some offshore tax haven beyond the reach of the US tax inspector.

What any economist needs to realise is that to understand the behaviour of multi-national companies,is that the economics textbook is of little use. The book describes the behaviour of an ideal and imagined company, not a real one.

I could go further and relate other features of the book to the real economy. There are frequent examples in the book of nonsense verse, such as the song of the Walrus and the Carpenter. What the economist needs to know is that in the real world economy there are plenty such similar examples. All too often when a company goes bankrupt it is usually one that has received a successful audit. The auditors seem unable to notice those gaping black holes in the company accounts. This is because they use a set of industry agreed accounting conventions when analysing the companies accounts, conventions that serve to conceal rather than reveal mismanagement and a shortage of funds. While company accounts are not nonsense verse, they are often intended to deceive as often as they are intended to reveal the true state of a company’s affairs.

Politicians come the nearest to uttering nonsense verse on the economy. They are found of uttering what seem to be profound mantras on matters of the economy, but which are in fact meaningless phrases. Phrases such as the country has ‘maxed out its credit card’ a phrase uttered by a politician, when his government was doing all it could to encourage a borrowing binge to kick start the economy back to life.

Why I recommend Lewis Carroll’s book for any budding economist is that it reveals to the reader a strange world that is and is not ours. It prepares for them recognising the unfamiliar and strange amongst the familiar and it is often the strange and unfamiliar that make seemingly inexplicable behaviour explicable. Conventional or bad economists are unable to see beyond the fog that is the received economic wisdom. This is why these economists were unable to see the financial crash of 2008 looming in front of them, when all the danger signals were showing red.

A reply to Michael Gove and all those who think the study of economics is of little value

What prompted this post was a comment from a friend to whom I was talking to over coffee. He informed me, politely of course, that my opinion as an economist on economic matters was of little value as it was no better than the common sense opinion of the man in the street. I was as an economist a self interested individual who was only interested in advancing the truths of my subject regardless of the truths of the real world. This friend I should add was a distinguished retired academic from one of our most prestigious of universities. Without trying to sound too paranoid it does seem to be open season on economists. We are one of the most discreditable of professions it seems. Whatever we do we cannot distinguish truth from the fiction.

This discrediting of the profession of economics was set in train by Michael Gove, a former senior politician in the UK and now a columnist. He said in reference to economists in the EU referendum debate ‘that people were fed up of experts telling them what to do’.  He was referring to a Bank of England report which stated that leaving the EU would have a substantial negative impact on the British economy. A report that was considerably over egged by his opponent George Osborne to discredit the pro-leave campaign. Whatever Michael Gove’s reasons, his was essentially a statement of British philistinism something which never lurks too far below the surface in any public debate.

What I will do is accuse Michael Gove and all his like minded followers of hypocrisy. This I can sum up in the following phrase, ‘they are happy to have Barney the Bear managing the nations finances but not managing their own’. Michael Gove as a MP and journalist has an income of several hundreds of thousands a year. Although I don’t know him, I imagine he invests part of his income in various fund management schemes. He will no doubt have a financial adviser who recommends the best possible schemes in which to invest. These various investment funds will be managed by people who employ economists. Investment funds and banks of various kinds vie to employ the best and brightest economists who leave our universities. They employ these economists to inform them about matters economic and more importantly to predict future trends in the EU and world economy. Then with this information they are best informed as to where invest their clients money. Michael Gove would expect his fund managers to be the best informed of people, yet he believes that being well informed on economic affairs is not a necessary qualification for a politician who manages the economy. For him as with many of his colleagues all that is required is old fashioned British common sense for the post of Chancellor of the Exchequer. I imagine my friend who although he disparages me for being an economist, does defer to experts such as myself when it comes to investing his savings.

I should add that this nation has a habit of employing Barney the Bear to manage the nations finances. A knowledge of economics is not required of those who become Chancellor of the Exchequer. In the past these Barney Bears were well informed people who took advice from the economists employed by the Treasury before making any decision. Now these Barney’s are likely to be single minded ideologues who having read Hayek and Ayn Rand at university believe that they have acquired the essentials of economic knowledge. Any further that knowledge of economics is a mere ‘gilding of the lily’ and unnecessary for a successful career in politics.

Some economists who have contributed to this disparaging of the profession, through their own arrogance and overestimation of their abilities. These are those economists who can be best described as the ‘forever after economists.’ Just as in the children’s fairy tale where the participants will forever live in a state of happiness and bliss, these economists believe that if their economics is adopted the people will forever after live in a state of happiness and bliss. I can identify three such economists who fit this category, Friedrich Hayek, Milton Friedman and the novelist Ayn Rand. While the latter never called herself an economist, she is seen by many contemporary politicians as written the Bible of Economics. What these three people have in common is the failure to recognise that the economy is a human construct which is as fallible as its makers. By ignoring this most basic of truths they could claim that if politicians followed there prescriptions they would create the ‘best possible of all economies’. The very many failures of the economies in which their ideas have been adopted, has demonstrated that the falsity of their ideas.

What is lacking in Britain is any real understanding of the economist and their work? If I was asked to describe what I thought was the role of the economist, I would say it is the reading and interpreting of the economic runes. Reading the economy is much like reading the runes, although the individual symbols are understood  there is some uncertainty about the exact message conveyed by the runes. Uncertainty because a contemporary historian cannot exactly replicate the in themselves the thinking of the rune carver. All of us are aware the individual happenings in the economy, such as increases or reductions in unemployment, businesses closing and opening; but only a specialist in economics can put all these individual happenings into context and explain their meaning. Since economics as with rune reading is subject to some uncertainty individual interpretations can differ, although not usually to any significant extent. Economists after reading the economic runes largely agree that Brexit will have a negative impact on the economy, what they disagree about is how great will be the negative impact. There are always a minority of economists who will misread the economic runes and give a very different interpretation of the message. They should be given exactly the same credence that those very few scientists who deny the reality of global warning are given.

Michael Gove will seize on the fact that a minority disagree with the large majority to say that are no economic truths as economists disagree as to what they might be all they can do is to state their own opinion which may have more or less value.  However as with climate change denying scientists very compelling evidence can be produced to prove them wrong. Similarly there is compelling evidence to suggest that those economists claiming that Brexit will benefit the economy are wrong. What Michael Gove needs to understand is that knowledge, even some knowledge is better than none. Ignorance is never bliss even in politics