Did the OECD Composite Leading Indicators see it coming?

CLI working paperRoberto Astolfi, OECD Statistics Directorate

To some Professor Luis Garicano of the London School of Economics is a leading expert in the fields of productivity and industrial organisation, but to many he’s the man Queen Elizabeth asked “Why did no one see it coming?”; “it” being the crisis. In retelling the story, Pr. Garicano pointed out that he welcomed the question as it provided an opportunity to cite many that did see it coming, including Messrs, Krugman and Volcker. Was the OECD among them?

At the OECD, we use a number of techniques to determine what the data are telling us is happening now and what might happen in the future. Dave Turner from the OECD Economics Department describes some of those approaches here. One additional technique used by the OECD Statistics Directorate, is the system of Composite Leading Indicators (CLIs). Simply put, the CLIs combine individual indicators for a given country to anticipate when economic expansion starts entering a downturn, or when growth starts to return. A relevant question in this context therefore is:

How useful were the OECD CLIs just before the crisis?

Perhaps the simplest way to answer the question is by reference to the headline messages announced in each of the monthly CLI Press Releases over the crisis period.

The first indication of potential trouble ahead came in September 2007 (Figure 1) where the headline assessment moved from ‘Mixed outlook’ to “Moderating outlook”. With each successive bulletin, the announcements became more pessimistic. “Weakening outlook” in the months that followed gave way to “Downswing” in January 2008, and even February 2009’s “Lowest level since 70s” was followed by “New low” in March 2009.

From today’s estimates we know that the CLI for the OECD area as a whole reached its pre-crisis high in June 2007, six months before the actual GDP peak that we now locate in December 2007 (vertical solid red line and black dotted line, respectively, in Figure 1).

Using the most recent statistical information, (in other words, including any revisions that may have been made in the interim) Gyomai and Guidetti in 2011 concluded that the “CLI was able to anticipate the downturn in the real economy at least 5 months ahead of its initial materialisation” (detailed results are available in the Statistics Newsletter).

A more stringent approach is to review the performance of the CLI at the time of the crisis using only the statistical information that was then available, as we do in the recently published Statistics Working Paper.

Figure 1: Evolution of CLI Press Release headlines during the Great Recession, OECD area

CLINote: The vertical lines identify the turning points detected by the CLIs for the OECD area as a whole (peak in June 2007 and trough in February 2009, marked in red) and GDP (marked in dotted black, with a peak in December 2007 and a trough in May 2009).

This approach is more ‘severe’ as formal identification of the turning points can only ever be confirmed some time after they manifest. Nevertheless, even with this more severe examination the latest results confirm the leading properties of the CLI while also indicating that the statistical and methodological revisions that have occurred since the crisis have not shifted CLI turning points to earlier dates, nor have they artificially improved the CLI performance.

Overall then, the OECD CLIs proved to be a robust tool in anticipating the crisis some months before GDP reached its pre-crisis high watermark, and so, perhaps they can be added to the list of illustrious names that can be quoted the next time somebody asks ‘why did no-one see it coming’. Moreover, although, by their very nature and design, CLIs are not able to quantify the magnitude of slowdowns or upturns, and, so, could not quantify the severity of the crisis, the increasing downbeat tone of assessments that followed the first warning in September 2007 provided strong pointers.

Useful links

OECD work on leading indicators and tendency surveys

OECD System of Composite Leading Indicators

The use of short-term indicators and survey data for predicting turning points in economic activity – A performance analysis of the OECD system of CLIs during the Great Recession

Yes, they do know it’s Christmas, but it’s Ebola they’re worried about

I hope he'll be OK
I hope he’ll be OK

Would you like to smell like Zinedine Zidane? A few years ago, a French perfume maker thought many of us would, and paid the football star to sell its manly mixture. Apparently many of us wouldn’t, and the ads soon disappeared. If you get the right person sending the right message though, stars can be very useful. On Monday, I moderated a panel discussion here at the OECD on “communicating in a crisis”, and one of the panellists described a successful campaign in Côte d’Ivoire using another football hero, Didier Drogba, to convince people to wash their hands and take other elementary precautions to stop the Ebola virus spreading. This worked because Drogba is a local boy and clearly knows and cares about the cause he was promoting. When he was criticised by some media for not going to the national squad’s match, he said he thought fighting Ebola was more important than a football game.

Côte d’Ivoire doesn’t have any Ebola cases, but its neighbours do, so it makes sense to be careful. Does it make sense to announce you’re stopping flights to Nairobi, because of Ebola? Or to cancel filming in Morocco in case Superman and Batman catch the disease? Both of these places are half a continent away from the affected areas, as far as Los Angeles from Guatemala. As one panellist pointed out, it’s as if you closed Paris airports because of fighting in the Ukraine.

The panel discussion was part of the annual meeting of the DevCom network, organised by the OECD Development Centre. The meeting gives the heads of communication of government ministries and others working on development the chance to share their experiences. The discussions covered broad issues such as communicating on the UN’s Sustainable Development Goals (SDGs) the new set of goals that will replace the UN’s Millennium Development Goals (MDGs) after 2015; and day-to-day questions like how much to spend on social media and should you pay vloggers (yes).

For an outsider like me, the jargon can be an obstacle to understanding, but since these were experts talking to each other, it’s probably not an issue in this kind of meeting. Even so, when one speaker introduced herself as coming from NORAD, I initially thought she was from the North American Aeorospace Defense Command, whose job is to combat intercontinental ballistic missile attacks and track Santa.

The speaker was doing neither, but she did tell us about the Norwegian Agency for Development Cooperation’s efforts to combat stereotyping. They helped fund a charity single and video featuring singers cooing about the less fortunate. In this case Africans urging their citizens to help cold, miserable Norway. If you haven’t seen it, here it is:

The video is hilarious, but it makes a serious point about how a certain perspective dominates the media. Most people here don’t know much about what’s happening in developing countries (or practically any other country either) except for a few sensational stories or something that might affect them directly. The same is true in the developing countries too, but given the mistrust of the authorities and national media, stories reported by foreigners can have a disproportionate impact. When, for example, local officials are saying not to ostracise Ebola victims but the radio reports that in the US a person cured of the disease was forced to stay at home for weeks, or that in Spain they shot the dog of a nurse who was also cured, you have to start trying to convince people all over again.

Some actions cost little or nothing, changing an Ebola-linked programme’s name from “Dead body disposal” to “Safe and dignified burial” for instance, but around the room, everybody agreed that in times of budget cuts, one of the hardest arguments for development communication was convincing the taxpayer that they should be spending money abroad rather than at home. Britain’s Daily Mail ran this headline the other day: “As Somerset faces new floods, we’re set to pay £600m for Third World flood defences… Tory MPs’ fury at new aid giveaway”. And yet, support for development aid does not seem to have been damaged as much as you might expect by the crisis, even though it has declined in some countries. In Ireland for instance, one of the countries hardest hit by the 2007 financial meltdown, a poll in August this year showed that 75% of respondents agree that “people in Ireland have an obligation to invest in overseas aid, even in times of economic recession”; and that 77% of people feel that “it is important for Ireland’s reputation that we keep the promise that 0.7% of national income should be invested in Overseas Aid”, an increase of 4% from 2013 results.

The Irish survey, and similar ones in other countries, also show that most people don’t know how much they’re actually spending on aid. On average, the Irish thought the government was spending 20 times more than it actually does. But even among experts, what you know and what you think is important can vary significantly. One DevCom member told us that some foundations and other philanthropic institutions who are investing hundreds of millions of dollars in development projects don’t pay much attention to the SDGs mentioned above.

One of the aims of the DevCom annual meeting was for members to decide on what they want to do over the next year or so and what resources they will provide to do this. I hope they reach a satisfactory agreement, so they can succeed in their main purpose, helping “strengthen public engagement and communication about development”. Especially when you see that among the alternatives are the likes of Sinead O’Connor telling people who don’t agree with her about the Do they know it’s Christmas charity single to “Shut the f*** up”, and presumably do what the pop stars and other loud mouths tell them.

Useful links

Engaging with the Public: Twelve Lessons from DAC Peer Reviews

Venture philanthropy in development from netFWD, the OECD-hosted Global Network of Foundations Working for Development.

Information on Ebola from SWAC, the OECD Sahel and West Africa Club

The first clinical tests on an Ebola treatment will be starting in Médecins sans frontières (Doctors without bordes) projects in December. MSF can pay for two beds in their treatment centres for 150 euros.

The International Federation of Red Cross and Red Crescent Societies Ebola response

Inequality, the crash and the crisis. Part 2: A model of capitalism that fails to share the fruits of growth

Click to see the book

Today we publish the second of three articles on inequality and the crisis by Stewart Lansley, visiting fellow at The Townsend Centre for International Poverty Research, Bristol University and the author of The Cost of Inequality: Why Economic Equality is Essential for Recovery, Gibson Square, 2012. He was one of the speakers at the 2012 OECD Forum session: How Is Inequality Holding Us Back?

The driving force behind the widening income gap of the last thirty years has been a shift in the distribution of “factor shares” – the way the output of the economy is divided between wages and profits. In the first two decades after the Second World War, a transformed model of capitalism emerged – across the rich world – in which it was accepted that the fruits of growth should be more evenly shared than they had been in the pre-War era. In the US, the share of output allocated to wages rose and stayed high. In the UK the “wage-share” settled at between 58 and 60 per cent of output, a higher rate than achieved in the pre-war era and the Victorian age. It was this elevated wage share that helped drive the “great leveling” of the post-war decades.

From the late 1970s, the capitalist model underwent another transformation, one characterised by a backward shift in the way the proceeds of growth were divided. By 2007, the share of output going to wages had fallen to 53 per cent in the UK. In the US, the fruits of growth became even more unevenly divided, with the workforce ending up with an even smaller share of the economic cake. There were similar, if shallower trends in most rich nations.

This process of decoupling wages from output has led to a growing “wage-output gap”, with a very profound, and negative, impact on the way economies function. This is for three key reasons. First, by cutting the purchasing power needed to buy the extra output being produced, the long wage squeeze brought domestic and global deflation. Consumer societies started to lose the capacity to consume.

The solution to this problem – which would have brought a prolonged recession much earlier – was to allow an explosion in private debt to fill the demand gap. In the UK, levels of personal debt rose from 45 per cent of incomes in 1981 to 157 per cent in 2008. In the US, debt reached a third more than national income by 2008. This helped to fuel a domestic boom from the mid-1990s but was never going to be sustainable. Far from preventing recession, it just delayed it.

The same factors were at work in the 1920s. The 1929 Crash was preceded by a sharp rise in inequality with the resulting demand gap also filled by an explosion in private debt. In 1920s America, the ratio of household debt to national income rose by 70 per cent in less than a decade.

Second, the intensified concentration of income led to the growth of a tidal wave of global footloose capital – a mix of corporate surpluses and burgeoning personal wealth. According to the pro-inequality theorists, these growing surpluses should have led to a boom in productive investment. Instead, they ended up fuelling commodity speculation, financial engineering and hostile corporate raids, activity geared more to transferring existing rather than creating new wealth and reinforcing the shift towards greater inequality.

Little of this benefitted the real economy. Of the £1.3 trillion lent by British banks between 1997 and 2007, 84 per cent was in mortgages and financial services. The proportion of lending going to manufacturing halved over the same period. It was this combination of the erosion of ordinary living standards and the accumulation of massive global cash surpluses that created the bubbles – in housing, property and business – that eventually brought the global economy to its knees. Again there are striking parallels with the 1920s when swelling surpluses in the US were poured into real estate and the stock market creating the bubbles that triggered the 1929 Crash.

Third, the effect of these trends has been to intensify the concentration of power with wealth and economic decision-making heavily concentrated in the hands of a tiny minority. In the US, such is the concentration of income, 5 per cent of earners account for 35 per cent of all consumer spending. A new elite has been able to exercise their muscle to ensure that economic policies work in their interest. Hence the inaction on tax havens, the blind-eye approach to tax avoidance and the scaling back of regulations on the City and Wall Street, policies that have simultaneously accentuated the risk of economic failure.

Not only did the growing income divide help to drive the global economy over the cliff in 1929 and 2008 it is now helping to prolong the crisis. UK wage-earners today have around £100 billion less in their pockets (roughly equivalent to the size of the nation’s health budget) than if the cake was shared as it was in the late 1970s. In the bigger economy of the US the sum stands at £500 billion. In contrast, the winners from the process of upward redistribution – big business and the top one per cent – are sitting on growing corporate surpluses and soaring private fortunes that are mostly sitting idle. This is a perfect recipe for paralysis.

The economic thrust of the last thirty years – greater reliance on markets, the weakened bargaining power of labour and hiked fortunes at the top – was aimed at dealing with the crisis of the 1970s, a mix of “stagflation” (stagnation and rising inflation ) and falling productivity. It succeeded in squeezing out inflation but replaced these fault lines with an equally toxic mix – global deflation, rising indebtedness and booming asset prices – that eventually brought economic collapse.

Part 3 looks at the lessons to be drawn for these trends.

Useful links

Divided We Stand: Why Inequality Keeps Rising

Growing Unequal? Income Distribution and Poverty in OECD Countries

Inequality, the crash and the crisis: Part 1 “The defining issue of our times”

Click to see the book

Today we publish the first of three articles on inequality and the crisis by Stewart Lansley, visiting fellow at The Townsend Centre for International Poverty Research, Bristol University and the author of The Cost of Inequality: Why Economic Equality is Essential for Recovery, Gibson Square, 2012. He was one of the speakers at the 2012 OECD Forum session: How Is Inequality Holding Us Back?

Does inequality trigger economic instability? A few years ago this was a issue that did not register on the political Richter scale. Nor did it attract much attention amongst professional economists. As James Galbraith, the economist son of John Kenneth Galbraith, has put it, those few working in inequality research were in an economics “backwater”. Proving his point, the academic Journal of Economic Literature has no section examining inequality and economic instability.

There is one key reason for this lack of interest. For the last thirty years, the economic orthodoxy has been that inequality is a necessary condition for economic success. We can have greater equality or faster growth but not both. That orthodoxy emerged out of the global crisis of the 1970s when, it was claimed, the move towards more equal societies in the immediate post-war decades had gone too far and had led to economic sclerosis. What was needed to put economies back on an upward and sustainable path was a stiff dose of inequality.

Since the late 1970s that theory – for theory it was – has been put to the test in a real life experiment in both the US and the UK, and more latterly in a number of rich countries. As a result, the income gap in America and Britain has grown to levels last seen in the inter-war years. So has the experiment in “unequal market capitalism” worked in the way predicted by the theory? The answer appears to be no. The income gap has surged but without the promised pay-off of wider economic progress.

On all measures of economic success bar inflation, the post-1980 era of rising inequality has a much poorer record than the egalitarian post-war decades. In the UK, growth and productivity rates have been about a third lower since 1980 than in the post-war era, while unemployment has averaged five times the level of the 1950s and 1960s. The three post-1979 recessions have been deeper and longer than the shallow and short-lived ones of the two post-war decades. The main outcome for the countries that have embraced the post-1980 model of market capitalism most fully has been economies that are both much more polarised and much more fragile, culminating in the great crash of 2008 and today’s increasingly prolonged and intractable crisis.

So does this mean the theory is fundamentally wrong? Do high levels of inequality lead to economic collapse? Was rising inequality from the 1980s in fact a central player in driving the global economy over the cliff in 2008, and in the dogged persistence of the current slump?

The official view is that inequality played no part in the present crisis. The report of the bipartisan US Financial Crisis Inquiry Commission into the causes of the 2008-9 Crash, published in January 2011, for example, failed to mention “inequality” once in its 662 page report.

Two years ago the handful of economists who argued that inequality was the real cause of the current crisis were easily dismissed as an insignificant and heretical minority. The political consensus remained that inequality was not an economic issue. Yet gradually, opinion is beginning to turn. At the 2011 World Economic Forum in Davos, Min Zhu, former Deputy Governor of the People’s Bank of China and a special adviser at the International Monetary Fund, told his audience: “The increase in inequality is the most serious challenge facing the world.” In his economic address in Kansas last December, President Obama attacked the long period of stagnant earnings facing most Americans, or what he called the erosion of the “basic bargain that made this country great”. “But this isn’t just another political debate’, he continued, ‘This is the defining issue of our time.”

At the OECD’s annual conference in Paris last month, the packed agenda was dominated by the issue of the growing divide, while the IMF has produced several reports that question the orthodox explanation of the role of inequality. In one study, two IMF economists, Andrew Berg and Jonathan Ostry, argue that the 1970s theory – by Arthur Okun in his highly influential book Equality and Efficiency, The Great Trade-Off – has failed to stand up to real world application: “When growth is looked at over the long term, the [efficiency/inequality] trade-off may not exist. In fact equality appears to be an important ingredient in promoting and sustaining growth.”.

Not only has the rise in inequality failed to deliver on faster growth, history shows a clear association between inequality and instability. The great crashes of 1929 and 2008 and the deep-seated recessions that followed were both preceded by sharp rises in inequality. In contrast, the most prolonged period of economic success and stability in recent history – from 1950 to the early 1970s – was one in which inequality fell across the rich world and especially in the UK and the US.

Of course, association is one thing, causation is another. In part 2, we will look at the reasons why the link may run from inequality to crisis, at why economies that allow a small minority to colonise an increasing share of the economic cake hike the level of economic risk and the likelihood of implosion.

Useful links

Divided We Stand: Why Inequality Keeps Rising

Growing Unequal? Income Distribution and Poverty in OECD Countries

Defying fiscal deficits

Government budgets are under pressure as the recession and economic crisis continue to take a toll. The crisis has pushed public deficits and debt to unsustainable levels for many countries, OECD experts say, as weak economic activity causes tax revenues to dwindle, forcing crisis-embattled governments to borrow in a cautious market to pay for services and welfare, and in some cases, still limping banking sectors.


How’s the economy recovering? Sloooooooowly…

Pace of recovery slowing, says OECD. Hopes for a rapid rebound in the global economy receive another blow in the latest OECD economic update. It suggests that the pace of economic recovery is slowing, and by more than had previously been expected. But although the situation is extremely uncertain, fears of a double-dip recession look to be misplaced. “The uncertainty is caused by a combination of both positive and negative factors,” OECD Chief Economist Pier Carlo Padoan  said at the launch of the Interim Assessment in Paris this morning. “But it is unlikely that we are heading into another downturn.”

Those negatives include the possibility that consumers will continue to keep a tight hold on their purse strings, so reducing demand in the economy. The reasons for that vary: some people may be paying off debts while others may put off spending because of unemployment, or the fear of losing their job, and concerns over continued weakness in house prices. On the plus side, the OECD says corporate profits are “robust” and that levels of private investment are so low they can probably now only go in one direction – up. (A decline would take even more steam from the economy.)

The OECD also believes that the worst of the turmoil on financial markets may now be over, although risks remain, and notes that emerging economies like China and India are doing well, which should benefit the wider global economy. As for the hard numbers, the OECD sees the pace of economic growth slowing over the course of this year in the G7 countries. It cites GDP growth of 3.2% in the first three months of 2010 and 2.5% in the second quarter, and forecasts falls to 1.4% in the third quarter and just 1% in the fourth.

Useful links OECD work on economics

Insights: From Crisis to Recovery

A Bank account should be a human right

“Financial literacy is the new civil rights of today” says John Hope Bryant, Founder, Chairman and CEO of Operation HOPE.   Speaker at this week’s OECD Forum, Bryant insists that understanding the fundamentals of finance is a must for everyone. Fighting poverty and unemployment cannot be successful if we don’t give people that knowledge. Check out his contribution to OECD’s educationtoday

Useful links:  OECD work on financial literacy