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The Biggest Avoidable Policy Disaster in British Politics - John Kay
I prefer true but imperfect knowledge, even if it leaves much indetermined and unpredictable, to a pretence of exact knowledge that is likely to be false. The credit which the apparent conformity with recognized scientific standards can gain for seemingly simple but false theories may, as the present instance shows, have grave consequences. Friedrich von Hayek, Prize lecture in Stockholm on receiving the 1974 Nobel Prize in Economics. 1974 was also the year I thought about pensions for the first time, although, like most people in their twenties, not for long. The long-standing provision of defined contribution pensions for university staff was replaced by a defined benefit scheme, USS. This was an era in which most large employers and many small ones were making similar moves. After a long political debate, Barbara Castle presided over the bipartisan introduction of an earnings-related tier to the state pension scheme, with provision for good occupational schemes to “contract out”. Following the establishment of the ‘cradle to grave’ welfare state in the decades immediately after the Second World War, this extension of defined benefit occupational pension schemes was perhaps the greatest success of British social welfare policy. The system was not without problems. I recall in the 1980s helping Sir David Walker organise a seminar at the Bank of England to discuss issues in the governance of occupational pensions and their relationship to corporate balance sheets. But as schemes matured, the beneficial results of the growth of occupational pensions became apparent. In 1995, more than 60% of pensioners had below median incomes. By 2010 the distribution of pensioner incomes was in line with that of the working population, as the architects of defined benefit schemes had envisaged. Old age was no longer a major cause of poverty. But then the foundations of defined benefit provision began to crumble. Famously, the scale of Robert Maxwell’s theft from Mirror Group Newspapers pension funds was revealed when he was found dead in the sea near Madeira in 1991. It became evident, as we had recognised at that Bank of England seminar, that more needed to be done to promote the security of pension promises and this led to the Goode Report in 1993. Less dramatically, in 1997 Exley, Mehta and Smith delivered a seminal address which introduced a generation of actuaries to modern financial economics. I had once been startled to find that actuaries knew little of finance theory – soon I would come to think they knew too much or at least took it too seriously. Accounting practice was shifting from historic cost to ‘fair value’ assessment of balance sheet values, with possible implications for the treatment of pension liabilities, which became a reality with the adoption of new accounting standards – in particular, FRS 17 in 2000 and IAS 19 in 2001. The outcome of these events was a stream – then a torrent, then a flood – of fresh complexity and regulatory intervention. There were several components to the economic contribution to actuarial analysis. It had long been recognised that money in the future is worth less than money today. This idea was systematised in the calculation of discounted cash flow (DCF) valuations, which enabled a present value to be attached to a stream of prospective cash flows. Subjective expected utility (SEU) valued uncertain returns by reference to their variance and the ‘risk aversion’ of an agent, with such ‘risk aversion’ deduced from the second derivative of the function relating utility to income or wealth. Modern portfolio theory (MPT) and the capital asset pricing model (CAPM) emphasise that the uncertainty attaching to an investment portfolio depends not just on the uncertainties (variances) associated with returns on individual assets but on the covariances between them. Finally, the efficient market hypothesis (EMH) expressed the idea that market prices reflected all publicly available information. (Importantly, the empirical observation that historical equity returns substantially exceeded levels readily explicable by these models, described in 1985 by Rajnish Mehra and Edward Prescott as ‘the equity premium puzzle’, still lacks good explanation within this theoretical framework.) This analytic framework was extensively developed in the 1950s and 1960s and contributed to the transformation of the world of finance from one in which well-bred gentlemen exchanged inside information with each other over long alcoholic lunches, to the professional activities of today that sweep many of the most able students of mathematics into the City of London and Wall Street (or Greenwich, Connecticut). And Nobel Prizes were awarded to Harry Markowitz (MPT), William Sharpe (CAPM) and Eugene Fama (EMH) for their contributions; LJ Savage (SEU) had died in 1971 aged only 53. These models have been indispensable tools in developing our understanding of financial markets. But Hayek’s 1974 lecture gave prescient warning of the dangers of their misapplication. He observed “I regard it in fact as the great advantage of the mathematical technique that it allows us to describe, by means of algebraic equations, the general character of a pattern even where we are ignorant of the numerical values which will determine its particular manifestation. We could scarcely have achieved that comprehensive picture of the mutual interdependencies of the different events in a market without this algebraic technique. It has led to the illusion, however, that we can use this technique for the determination and prediction of the numerical values of those magnitudes; and this has led to a vain search for quantitative or numerical constants…” He continued: “…compared with the precise predictions we have learnt to expect in the physical sciences, this sort of mere pattern predictions is a second best with which one does not like to have to be content. Yet the danger of which I want to warn is precisely the belief that in order to have a claim to be accepted as scientific it is necessary to achieve more. This way lies charlatanism and worse. To act on the belief that we possess the knowledge and the power which enable us to shape the processes of society entirely
To the Lighthouse - John Kay
As fireworks marked the beginning of 2023, Virginia Woolf’s novel To the Lighthouse was finally released from US copyright. To mark the occasion I reprise a lightly edited and amplified version of a column which first appeared in the Financial Times in 2002. The year is 1927, and Virginia Stephen is talking to her husband, Leonard Woolf, over the cornflakes in their elegant Bloomsbury home. VIRGINIA: Darling, I am thinking of writing a novel called To the Lighthouse, based on experiences in my family childhood, and set on the Isle of Skye. It will be a masterpiece of 20th-century fiction. LEONARD: What a good idea, darling. With the Great Depression about to start, the royalties will come in handy. We will not only be able to afford the groceries, but enrich the children and grandchildren of our nephew. The following morning: VIRGINIA: Leonard, my agent tells me that under British law, copyright in my new work will expire 50 years after my tragic suicide in 1941. Wordsworth Editions will then be free to produce copies of To the Lighthouse and will sell them for as little as £1. Students will even be able to buy annotated editions to help them with their exams. (Both aesthetes grimace in horror at the prospect.) LEONARD: What a blow to our finances! But what can we expect in a country governed by men such as Ramsay Macdonald and Stanley Baldwin, with no understanding of the economic needs of creative people? A week later: VIRGINIA: Leonard, my agent has just learned that a European directive which will be approved in 1993 will extend copyright in my work for 20 years. And – what joy – Congress will pass a law in 1998 prolonging my US rights for 75 years after initial publication. I am to be spared the degradation of my books appearing in Walmart until two decades of the next millennium! LEONARD: Wonderful news, Virginia. And how fortunate that our friend Maynard Keynes is coming for dinner. He is a director of the Midland Bank and I am sure that as well as warning us about the impending depression and the collapse of the gold standard, he can arrange a loan on the security of the royalties you will earn between 1991 and 2022. I will pop out to the stationer and buy you pen and ink right away. And so British novelists and composers who died more than 50, but less than 70, years ago were able to leave their footprints in the sands of time. But for the prospect of retrospective copyright extension we could so easily have lost not just To the Lighthouse, but 1984 (published 1949, Orwell died 1950) and The Grapes of Wrath (published 1939, Steinbeck died 1968). How fortunate we are that Jane Austen, Herman Melville and DH Lawrence were not deterred from writing by the short copyright terms prevailing when they wrote! Copyright on The Grapes of Wrath, perhaps the greatest novel of 1930s depression America, will expire in the US in 2034 and in Europe in 2038. The Great Gatsby, the iconic novel of the roaring twenties, entered the public domain only last year. In 2003 the US Supreme Court decision upheld the 1998 extension of copyright (legislation officially called the Sonny Bono Copyright Act after the chart topping singer – I’ve Got You Babe – turned Representative from California, but more widely known as the Mickey Mouse Copyright Act after the Disney Corporation lobbied vigorously for its passage.) Dissenting, the sadly missed Justice Stephen Breyer noted the minimal present value of earnings 95 years in the future and asked “What potential Shakespeare, Wharton, or Hemingway would be moved by such a sum? What monetarily motivated Melville would not realize that he could do better for his grandchildren by putting a few dollars into an interest-bearing bank account?” Has any company’s discounted cash-flow calculation ever incorporated returns more than 75 years from now? The retrospective nature of the change in the law shows that the object is not to stimulate new creative activities but to enrich owners of the rights to old ones. Breyer observed that the Constitution allowed Congress to pass legislation to “promote the Progress of Science . . . by securing for limited Times to Authors . . . the exclusive Right to their respective Writings. That was not the motive which prompted the Mickey Mouse Act. (However the Majority on the Court took the view that the meaning of ‘limited Times’ was a subject within the proper scope of Congressional judgment.) Now there is something in the argument that a single powerful company is the best means of securing investment in, and development of, products and activities. But the experience of modern market economies is that innovation and consumer interests are almost always better served by competition than monopoly. Creative industries differ only in that diversity and experiment are even more important in art and literature than in oil and water supply. Shakespeare’s legacy might be better protected and developed if his works and characters could only be used under license from the Royal Shakespeare Corporation. Such an agency could prohibit bad productions and ensure that annotated texts properly reflect the consensus of the corporation’s approved scholars. But the history of totalitarian art gives little grounds for optimism that this would stimulate creativity. Rather the opposite.
The Corporation in the Twenty First Century(US Edition) - John Kay
The US edition of John Kay’s newest book, The Corporation in the Twenty First Century, was recently released and is available to purchase via Amazon at the following link: https://us.amazon.com/Corporation-21st-Century-Everything-Business/dp/B0DR4NWF3B.