Money for old folk: The relationship between ageing and inflation is not as simple as economists assume

WHEN it comes to the economic impact of demography, Japan is the wizened canary in the world’s coal mine. It has become older faster than any other big country: its median age went from 34 in 1980 to 46 today, and will continue rising for decades. But it will soon have plenty of greying company, from wealthy countries such as Finland and South Korea to developing giants, including China and Russia. Economists generally agree that the ageing of populations leads to slower growth, because a country’s potential output tends to fall as its labour force shrinks. They also expect heavier fiscal burdens, with governments providing for more pensioners from a smaller tax base.

Until recently, though, there had been little research into how demography affects inflation. The Japanese example of persistent deflation over the past two decades was seen as evidence enough that prices fall when countries age and their growth slows. Shinzo Abe, Japan’s prime minister, has sought to disprove that, espousing massive monetary easing to get prices rising. With inflation slumping far below the Bank of Japan’s 2% target in recent months, it is tempting to conclude that ageing is too powerful a force to overturn. But a new body of research* gives advocates of Abenomics a bit of support, at least on the demographic front. It shows that deflation is not the preordained outcome of ageing.

The problem lies not in identifying the possible links between ageing and prices, but in working out which way they cut. Consider the factors of production. When growth slows businesses rein in investment, so the cost of capital may decline. Yet wages ought to rise when the supply of workers falls. In the realm of fiscal policy, some indebted governments may make painful cuts as pensioners multiply, leading to slow growth and sluggish inflation. But others may opt to monetise their debt, pushing inflation up. (Some suspect this is the ultimate aim of Abenomics.)

How to disentangle these possibilities? In a recent working paper, Mitsuru Katagiri of the Bank of Japan and Hideki Konishi and Kozo Ueda of Waseda University distinguish between the ageing caused by a falling birth rate and that brought on by increased longevity. The main effect of fewer births would be a shrinking tax base; that might prompt the government to embrace inflation to erode its debts and thus stay solvent. But longer lives would cause the ranks of pensioners to swell; their increased political influence, in turn, would augur for tighter monetary policy to prevent inflation eating into savings.

In the case of Japan the authors estimate that the ageing process has led to deflation of about 0.6 percentage points a year over the past 40 years—a huge cumulative impact. That, they believe, is because the big surprise in Japanese demography has been ever-increasing longevity. Fertility rates are close to the levels projected in 2002, but the government has steadily revised up its estimates of lifespans. It is unexpected longevity, not simply ageing, that has been deflationary in Japan.

What about the impact of ageing on financial assets? Economic theory—“the life-cycle hypothesis”—holds that people smooth their consumption over their lifetimes, going into debt when young, buying assets when their earnings peak and selling them to pay for retirement. That, in theory, should lead to lower asset values as countries enter their dotage, but the empirical record is mixed: house prices often fall, but stocks sometimes rise.

An important variable is whether assets sold by pensioners are domestic or foreign. Derek Anderson, Dennis Botman and Ben Hunt of the International Monetary Fund looked at the decrease in Japan’s net savings rate from some 15% of disposable income in the early 1990s to about zero in 2011. What stands out is that many of the liquidated savings had been invested in foreign assets. When Japanese pensioners sold stocks and bonds abroad and repatriated the funds, they fuelled an appreciation in the yen—a consistent problem until 2012. This in turn contributed to deflationary pressure, by lowering the cost of imports. But the researchers also reckon that strong monetary easing combined with a credible commitment to an inflation target would have been sufficient to negate the effect of ageing. In other words, they believe Japan needed Abenomics long before it got it.

Greyflation

A recent paper by Mikael Juselius and Elod Takats for the Bank for International Settlements offers a very different take on how ageing affects inflation, suggesting that Japan may not be typical after all. They look at 22 advanced economies from 1955 to 2010. Japan is, after all, not the only country to have experienced deflation. Sure enough, they find a steady correlation between deflation and demography, but just the opposite of what is commonly assumed. A larger share of dependents—both young and old—is associated with higher inflation, whereas having more people of working age is linked to lower inflation. Their explanation, albeit tentative, is straightforward. Countries with more people consuming goods and services than producing them are liable to have excess demand and thus inflationary tendencies. Those with more producers than consumers will, by contrast, have excess supply and a deflationary bias.

That raises the question of why prices in Japan have fallen for so many years, given its rapidly ageing population. There are several potential culprits: the damaged balance-sheets left by the popping of the asset bubble of the 1980s, say, or the hesitant monetary policy before Mr Abe. But if the paper’s thesis holds true, an ageing population could yet lead to rising prices in the coming years. As the Bank of Japan seeks to vanquish deflation, demography may turn out to be friend, not foe.

Source: http://www.economist.com/ageing15

The on-demand economy

Workers on tap

IN THE early 20th century Henry Ford combined moving assembly lines with mass labour to make building cars much cheaper and quicker—thus turning the automobile from a rich man’s toy into transport for the masses. Today a growing group of entrepreneurs is striving to do the same to services, bringing together computer power with freelance workers to supply luxuries that were once reserved for the wealthy. Uber provides chauffeurs. Handy supplies cleaners. SpoonRocket delivers restaurant meals to your door. Instacart keeps your fridge stocked. In San Francisco a young computer programmer can already live like a princess.

Yet this on-demand economy goes much wider than the occasional luxury. Click on Medicast’s app, and a doctor will be knocking on your door within two hours. Want a lawyer or a consultant? Axiom will supply the former, Eden McCallum the latter. Other companies offer prizes to freelances to solve R&D problems or to come up with advertising ideas. And a growing number of agencies are delivering freelances of all sorts, such as Freelancer.com and Elance-oDesk, which links up 9.3m workers for hire with 3.7m companies.

The on-demand economy is small, but it is growing quickly (see article). Uber, founded in San Francisco in 2009, now operates in 53 countries, had sales exceeding $1 billion in 2014 and a valuation of $40 billion. Like the moving assembly line, the idea of connecting people with freelances to solve their problems sounds simple. But, like mass production, it has profound implications for everything from the organisation of work to the nature of the social contract in a capitalist society.

Baby, you can drive my car—and stock my fridge

Some of the forces behind the on-demand economy have been around for decades. Ever since the 1970s the economy that Henry Ford helped create, with big firms and big trade unions, has withered. Manufacturing jobs have been automated out of existence or outsourced abroad, while big companies have abandoned lifetime employment. Some 53m American workers already work as freelances.

But two powerful forces are speeding this up and pushing it into ever more parts of the economy. The first is technology. Cheap computing power means a lone thespian with an Apple Mac can create videos that rival those of Hollywood studios. Complex tasks, such as programming a computer or writing a legal brief, can now be divided into their component parts—and subcontracted to specialists around the world. The on-demand economy allows society to tap into its under-used resources: thus Uber gets people to rent their own cars, and InnoCentive lets them rent their spare brain capacity.

The other great force is changing social habits. Karl Marx said that the world would be divided into people who owned the means of production—the idle rich—and people who worked for them. In fact it is increasingly being divided between people who have money but no time and people who have time but no money. The on-demand economy provides a way for these two groups to trade with each other.

This will push service companies to follow manufacturers and focus on their core competencies. The “transaction cost” of using an outsider to fix something (as opposed to keeping that function within your company) is falling. Rather than controlling fixed resources, on-demand companies are middle-men, arranging connections and overseeing quality. They don’t employ full-time lawyers and accountants with guaranteed pay and benefits. Uber drivers get paid only when they work and are responsible for their own pensions and health care. Risks borne by companies are being pushed back on to individuals—and that has consequences for everybody.

Obamacare and Brand You

The on-demand economy is already provoking political debate, with Uber at the centre of much of it. Many cities, states and countries have banned the ride-sharing company on safety or regulatory grounds. Taxi drivers have staged protests against it. Uber drivers have gone on strike, demanding better benefits. Techno-optimists dismiss all this as teething trouble: the on-demand economy gives consumers greater choice, they argue, while letting people work whenever they want. Society gains because idle resources are put to use. Most of Uber’s cars would otherwise be parked in the garage.

The truth is more nuanced. Consumers are clear winners; so are Western workers who value flexibility over security, such as women who want to combine work with child-rearing. Taxpayers stand to gain if on-demand labour is used to improve efficiency in the provision of public services. But workers who value security over flexibility, including a lot of middle-aged lawyers, doctors and taxi drivers, feel justifiably threatened. And the on-demand economy certainly produces unfairnesses: taxpayers will also end up supporting many contract workers who have never built up pensions.

This sense of nuance should inform policymaking. Governments that outlaw on-demand firms are simply handicapping the rest of their economies. But that does not mean they should sit on their hands. The ways governments measure employment and wages will have to change. Many European tax systems treat freelances as second-class citizens, while American states have different rules for “contract workers” that could be tidied up. Too much of the welfare state is delivered through employers, especially pensions and health care: both should be tied to the individual and made portable, one area where Obamacare was a big step forward.

But even if governments adjust their policies to a more individualistic age, the on-demand economy clearly imposes more risk on individuals. People will have to master multiple skills if they are to survive in such a world—and keep those skills up to date. Professional sorts in big service firms will have to take more responsibility for educating themselves. People will also have to learn how to sell themselves, through personal networking and social media or, if they are really ambitious, turning themselves into brands. In a more fluid world, everybody will need to learn how to manage You Inc.

 Source: http://www.economist.com/news/leaders/21637393-rise-demand-economy-poses-difficult-questions-workers-companies-and

 

The future of work: There’s an app for that  

HANDY is creating a big business out of small jobs. The company finds its customers self-employed home-helps available in the right place and at the right time. All the householder needs is a credit card and a phone equipped with Handy’s app, and everything from spring cleaning to flat-pack-furniture assembly gets taken care of by “service pros” who earn an average of $18 an hour. The company, which provides its service in 29 of the biggest cities in the United States, as well as Toronto, Vancouver and six British cities, now has 5,000 workers on its books; it says most choose to work between five hours and 35 hours a week, and that the 20% doing most earn $2,500 a month. The company has 200 full-time employees. Founded in 2011, it has raised $40m in venture capital.

Handy is one of a large number of startups built around systems which match jobs with independent contractors on the fly, and thus supply labour and services on demand. In San Francisco—which is, with New York, Handy’s hometown, ground zero for this on-demand economy—young professionals who work for Google and Facebook can use the apps on their phones to get their apartments cleaned by Handy or Homejoy; their groceries bought and delivered by Instacart; their clothes washed by Washio and their flowers delivered by BloomThat. Fancy Hands will provide them with personal assistants who can book trips or negotiate with the cable company. TaskRabbit will send somebody out to pick up a last-minute gift and Shyp will gift-wrap and deliver it. SpoonRocket will deliver a restaurant-quality meal to the door within ten minutes.

The obvious inspiration for all this is Uber, a car service which was founded in San Francisco in 2009 and which already operates in 53 countries; insiders say it will have sales of more than $1 billion in 2014. SherpaVentures, a venture-capital company, calculates that Uber and two other car services, Lyft and Sidecar, made $140m in revenues in San Francisco in 2013, half what the established taxi companies took (see chart 1), and the company shows every sign of doing the same wherever local regulators give it room. Its latest funding round valued it at $40 billion. Even in a frothy market, that is a remarkable figure.

Bashing Uber has become an industry in its own right; in some circles, though, applying its business model to any other service imaginable is even more popular. There seems to be a near-endless succession of bright young people promising venture capitalists that they can be “the Uber of X”, where X is anything one of those bright young people can imagine wanting done for them (see chart 2). They have created a plethora of on-demand companies that put time-starved urban professionals in timely contact with job-starved workers, creating a sometimes distasteful caricature of technology-driven social disparity in the process; an article about the on-demand economy by Kevin Roose in New York magazine began with the revelation that the housecleaner he hired through Homejoy lived in a homeless shelter.

This boom marks a striking new stage in a deeper transformation. Using the now ubiquitous platform of the smartphone to deliver labour and services in a variety of new ways will challenge many of the fundamental assumptions of 20th-century capitalism, from the nature of the firm to the structure of careers.

The young Turks

The new opportunities that technology offers for matching jobs to workers were being exploited well before Uber. Topcoder was founded in 2001 to give programmers a venue to show off. In 2013, it was bought by Appirio, a cloud-services company, and now specialises in providing the services of freelance coders. Elance-oDesk offers 4m companies the services of 10m freelances. The model is also gaining ground in the professions. Eden McCallum, which was founded in London in 2000, can tap into a network of 500 freelance consultants in order to offer consulting services at a fraction of the cost of big consultancies like McKinsey. This allows it to provide consulting to small companies as well as to concerns like GSK, a pharma giant. Axiom employs 650 lawyers, services half the Fortune 100 companies, and enjoyed revenues of more than $100m in 2012. Medicast is applying a similar model to doctors in Miami, Los Angeles and San Diego. Patients order a doctor by touching an app (which also registers where they are). A doctor briefed on the symptoms is guaranteed to arrive within two hours; the basic cost is $200 a visit. Not least because it provides malpractice insurance, the company is particularly attractive to moonlighters who want to top up their income, younger doctors without the capital to start their own practices and older doctors who want to set their own timetables.

The Los Angeles-based Business Talent Group provides bosses on tap for companies that want to tackle a specific problem without adding another senior executive to the payroll: Fox Mobile Entertainment, an online-content provider, turned to it for a temporary creative director to produce a new line of products. Creative companies add a twist to the model: they demand ideas, rather than labour and services, and give a prize or prizes only to the ones they find interesting. Innocentive has applied the prize idea to corporate R&D; it turns companies’ research needs into specific problems and pays for satisfactory solutions to them.

A job for the afternoon

Tongal does the same thing with its network of 40,000 video-makers. In 2012 Colgate-Palmolive, a consumer-goods company, offered $17,000 to anyone who could make a 30-second advertisement for the internet. The ad was so good that the company showed it at the Super Bowl alongside blockbuster ads that cost hundreds of times more. Members of the Quirky network post their product ideas on the company’s website. Other members vote on the attractiveness of each idea and come up with ways of turning it into reality. Since its birth in 2009 the company has acquired over a million members and brought 400 products to the shops.

Perhaps the most striking of all the on-demand services is Amazon’s Mechanical Turk, which allows customers to post any “human intelligence task”, from flagging objectionable content on websites to composing text messages; workers on the site choose what to do according to task and price. The set-up uses to the full most of the capabilities and advantages that make on-demand business models attractive: no need for offices; no full-time contract employees; the clever use of computers to repackage one set of people’s needs into another set of people’s tasks; and an ability to access spare time and spare cognitive capacity all across the world.

The idea that having a good job means being an employee of a particular company is a legacy of a period that stretched from about 1880 to 1980. The huge companies created by the Industrial Revolution brought armies of workers together, often under a single roof. In its early stages this was a step down for many independent artisans who could no longer compete with machine-made goods; it was a step up for day-labourers who had survived by selling their labour to gang masters.

These companies introduced a new stability into work, a structure which differentiated jobs from one another more clearly than before, thus providing defined roles and new paths of career progress. Many of the jobs were unionised, and the unions fought to improve their members’ benefits. Governments eventually built stable employment along these lines into the heart of welfare legislation. A huge class of white-collar workers enjoyed secure jobs administering the new economy.

For a while after the second world war everybody seemed to benefit from this model: workers got security, benefits and steady wage rises; companies got a stable workforce in which they could invest with a fair expectation of returns. But the model started to get into trouble in the 1970s, thanks first to deteriorating industrial relations and then to globalisation and computerisation. Trade unions have lost power in the private sector, particularly in America and Britain, where legislation has reduced their ability to take action (see chart 3). Companies kept stricter control of their labour costs, increasingly contracting out production in industrial businesses and re-engineering middle-management. Computerisation and improved communications then sped the process up, making it easier for companies to export jobs abroad, to reshape them so that they could be done by less skilled contract workers, or to eliminate them entirely.

This has all resulted in a more rootless and flexible labour force. Pensioners and parents wanting or needing to spend more time on child care swell the ranks of students and the straightforwardly unemployed. A recent study by the Freelancers Union, a pressure group for freelance workers, suggests that one in three members of the American workforce (and a higher proportion of younger people) do some freelance work.

The on-demand economy is the result of pairing that workforce with the smartphone, which now provides far more computing power than the desktop computers which reshaped companies in the 1990s, and to far more people (see chart 4 on next page). According to Benedict Evans of Andreessen Horowitz, the new iPhones sold over the weekend of their release in September 2014 contained 25 times more computing power than the whole world had at its disposal in 1995. Connected to each other and to yet more data and processing power in the cloud, these devices are letting people design or find ad hoc answers to all sorts of business problems previously solved by the structure of the firm.

Coase and effect

The way economists understand firms is largely based on an insight of the late Ronald Coase. Firms make sense when the cost of organising things internally through hierarchies is less than the cost of buying things from the market; they are a way of dealing with the high transaction costs faced when you need to do something moderately complicated. Now that most people carry computers in their pockets which can keep them connected with each other, know where they are, understand their social network and so on, the transaction costs involved in finding people to do things can be pushed a long way down.

This has a range of knock-on consequences, all of which are becoming key features of the on-demand economy. One is further division of labour. Thomas Malone, of the MIT Sloan School of Management, argues that computer technology is producing an age of hyper-specialisation, as the process that Adam Smith observed in a pin factory in the 1760s is applied to more sophisticated jobs.

Another is the ability to tap underused capacity. This applies not just to people’s time, but also to their assets: to drive for Lyft or Uber, you do need a car. The on-demand economy is in many ways a continuation of what has been called the “sharing economy” exemplified by Airbnb, a company which turns apartments into guesthouses and their owners into hoteliers. For people with few assets, though, on-demand labour markets matter more.

And new areas are being opened to economies of scale. SpoonRocket prepares its food in two central kitchens in San Francisco and Berkeley. It delivers food quickly because it keeps a fleet of cars, equipped with thermal bags to keep the food warm, roaming the streets of San Francisco. “We’re like a gigantic cafeteria serving all of San Francisco,” says Anson Tsui, one of the company’s founders.

Scheduling success

The aim of the on-demand companies is to exploit low transaction costs in a number of ways. One key is providing the sort of trust that encourages people to take a punt on the unfamiliar. Customers worry about the quality of their temporary employees: nobody wants to give the key to their apartment to a potential burglar, or their health details to a dud doctor. Potential freelances, for their part, do not want to have to deal with deadbeats: about 40% of freelances are currently paid late.

On-demand companies like Handy provide customers with a guarantee that workers are competent and honest; Oisin Hanrahan, the company’s founder, says that more than 400,000 people have applied to join the platform, but only 3% of applicants get through its selection and vetting process. The workers, for their part, can hope for a steady flow of jobs and prompt payment with minimal fuss. Handy’s computer system also tries to schedule each worker’s jobs in such a way as to minimise travel time.

Despite these capabilities, Handy is not necessarily looking at huge success, any more than the other Ubers-of-X are. There are three reasons for scepticism about their chances.

The first is that on-demand companies trying to keep the costs to their clients as low as possible have difficulties training, managing and motivating workers. MyClean, a cleaning service based in New York City, tried using purely contract workers, but discovered that it got better customer ratings if it used permanent staff. The company thinks that better services justify higher labour costs. Uber drivers complain that the company pays them like contract workers while seeking to manage them like regular employees: they are told to take regular rather than premium fares, but are not reimbursed for their fuel. America’s gathering economic recovery may make it harder for companies to attract casual labour as easily as they have done in the past few years.

The second problem is that on-demand companies seem likely to be plagued by regulatory and political problems if they get large enough for people to notice them. American on-demand companies are terrified that they will be stuck with retrospective labour bills if the courts force them to reclassify their workers as regular employees rather than contract workers (a classification which is not always consistent from jurisdiction to jurisdiction, raising the level of anxiety). Handy at one point included a clause in its contracts imposing any such retrospective costs on its clients, though it has now withdrawn it.

Faced by the threat of Uber, established taxi companies around the world have organised strikes, filed lawsuits and leant on regulators. In the Netherlands Uber has been banned; South Korea is treating it as an illegal taxi service. In Germany anti-Uber feeling has nurtured a broader criticism of “Plattform-Kapitalismus”; its perceived readiness to reduce all aspects of people’s lives, from spare rooms to spare time, to assets to be auctioned off is seen as deeply dehumanising. But such protests often act as advertising for the services they are aimed against. And a recent study revealed that American politicos spend more on Uber than on regular taxis when campaigning, a strong indication that the road ahead is likely to remain clear.

The third issue is size. The on-demand model obviously has network effects: the home-help company with the most help on the books has the best chance of providing a handyman at 10:30 sharp. Yet scaling up may be difficult when barriers to entry are low and bonds of loyalty are non-existent. It will be hard to get workers to be loyal to just one middleman. A number of Uber drivers also work for Lyft.

In many service industries it is hard to see obvious economies of scale on a national or global level. Being the best dry-cleaning service in Cleveland does not necessarily offer a killer edge in Cologne. And taste can be fickle, especially with companies that often look like positional goods that trade, at least in part, on the cachet that they confer to their consumers. Many of the people who currently regard SpoonRocket as cool may drop it if it becomes a national brand. On-demand companies may find themselves stuck in a world of low margins, high promotional costs and labour churn as they struggle to attain the sort of market dominance that locks in their network advantages. Alfred, a subscription service, is already aggregating the work of specific on-demand companies such as Instacart and Handy to offer its Boston members a one-stop shop; such aggregation could drive down prices for the basic on-demand providers yet further.

Everyone a corporation

Even if the eventual on-demand victors do carve out profitable domestic-service businesses, many observers doubt that their model is more broadly applicable. Some critics argue that on-demand companies like BloomThat and Handy may be capable of delivering flowers or cleaning houses, but when it comes to companies in the main flow of the knowledge economy they are destined to remain marginal. This objection, though, is not very convincing. The sort of people currently using Uber are subject to the same forces as the people who drive them from place to place.

The knowledge economy is subject to the same forces as the industrial and service economies: routinisation, division of labour and contracting out. A striking proportion of professional knowledge can be turned into routine action, and the division of labour can bring big efficiencies to the knowledge economy. Topcoder can undercut its rivals by 75% by chopping projects into bite-sized chunks and offering them to its 300,000 freelance developers in 200 countries as a series of competitive challenges. Knowledge-intensive companies are already contracting out more work to the market, partly to save costs and partly to free up their cleverest workers to focus on the things that add the most value. In 2008 Pfizer, a pharma company, undertook a huge self-examination under the heading PfizerWorks. It realised that its most highly skilled workers were spending 20% to 40% of their time on routine work—entering data, producing PowerPoint slides, doing research on the web. The company now contracts out much of this work.

Thus more and more of the routine parts of knowledge work can be parcelled out to individuals, just as they were previously parcelled out to companies. This could be bad news for the business models of professional-service companies which use juniors to do fairly routine work—thus providing the firm with income and the juniors with training—while the partners do the more sophisticated stuff. As on-demand solutions and automation prove applicable to more and more routine work, that model becomes hard to sustain. InCloudCounsel undercuts big law firms by as much as 80% thanks to an army of freelances that processes legal documents (such as licences, accreditation and non-disclosure agreements) for a flat fee.

The key role that cutting things up into routines plays in both spheres suggests that the interaction between the on-demand economy and automation will be a complex one. Gobbetising jobs with the aim of parcelling them out to people who don’t see or need to see the big picture is not that different from gobbetising them in a way that allows automation. Often the first activity may prove a prelude to the second; it is easy to see Uber as a forerunner to an eventual system that has no drivers at all. In other cases, though, the cost-efficiency of contracting out may reduce the incentives to automate.

What sort of world will this on-demand model create? Pessimists worry that everyone will be reduced to the status of 19th-century dockers crowded on the quayside at dawn waiting to be hired by a contractor. Boosters maintain that it will usher in a world where everybody can control their own lives, doing the work they want when they want it. Both camps need to remember that the on-demand economy is not introducing the serpent of casual labour into the garden of full employment: it is exploiting an already casualised workforce in ways that will ameliorate some problems even as they aggravate others.

The on-demand economy is unlikely to be a happy experience for people who value stability more than flexibility: middle-aged professionals with children to educate and mortgages to pay. On the other hand it is likely to benefit people who value flexibility more than security: students who want to supplement their incomes; bohemians who can afford to dip in and out of the labour market; young mothers who want to combine bringing up children with part-time jobs; the semi-retired, whether voluntarily so or not.

Megan Guse, a law graduate, says that the on-demand model allows her to combine a career as a lawyer with her taste for travel. “A lot of my friends that have gone the Big Law route have these stories about having to cancel weddings, vacations and miss family events. I can continue working while being in exotic places.” Flexibility is also valuable for elite workers who want to wind down after decades of selling their soul to their companies. Jody Greenstone Miller, the founder of Business Talent Group, says that her company’s comparative advantage lies in rethinking corporate time: by breaking up work into projects, she can allow people to work for as long as they want.

A limited Utopia

The on-demand economy is good for outsiders and insurgents—and for entrepreneurs trying to create new businesses using such people. Matt Barrie, the founder of Freelancer.com, links the fate of two groups of potential winners: entrepreneurs in the rich world who have few resources will be able to link up with workers in the poor world who have little money. In Europe the labour market drives a wedge between insiders who have lots of protections and outsiders who don’t; on-demand arrangements may give outsiders a chance of breaking in. Thus in countries such as France, Italy and Spain, on-demand companies may improve the job chances of the young unemployed.

If this seems attractive, it is also a measure of the way that the on-demand economy will contribute to pressure to reduce labour rights in all sorts of situations; a growing abundance of on-demand employees with no normally accepted rights such as sick-pay and overtime will give employers at firms with more standard structures an incentive to cut back. The more such pressures spread, the more protests against “Plattform-Kapitalismus” the world is likely to see.

The on-demand economy will inevitably exacerbate the trend towards enforced self-reliance that has been gathering pace since the 1970s. Workers who want to progress will have to keep their formal skills up to date, rather than relying on the firm to train them (or to push them up the ladder regardless). This means accepting challenging assignments or, if they are locked in a more routine job, taking responsibility for educating themselves. They will also have to learn how to drum up new business and make decisions between spending and investment.

At the same time, governments will have to rethink institutions that were designed in an era when contract employers were a rarity. They will have to clean up complicated regulatory systems. They will have to make it easier for individuals to take charge of their pensions and health care, a change which will be more of a problem for America, which ties many benefits to jobs, than Europe, which has a more universal approach. They will also have to encourage schools to produce self-reliant citizens rather than loyal employees.

One of Gilbert and Sullivan’s oddest operettas, “Utopia Limited—or the Flowers of Progress”, focuses on an exotic South Sea island which, under the influence of Victorian industrialism, sets about turning all the inhabitants into limited companies. It is rarely performed today, in part because the targets of its on-the-nose-in-1893 satire seem remote. But perhaps, after a century in which companies were vast things, such a satire of corporate individualism is due for a revival or two. If so, the piece will be easier than ever to stage: if there are not already on-demand services that can provide Polynesian props, semi-retired set designers and down-on-their-luck tenors at the swipe of a screen, there soon will be.

Source: http://www.economist.com/news/briefing/21637355-freelance-workers-available-moments-notice-will-reshape-nature-companies-and

Sovereign bonds: Oat cuisine

FIFTEEN years ago Western government bonds were regarded as being like porridge: stodgy but easily digestible. Investors knew returns would be modest but perceived the asset class as risk-free, an important concept in both financial theory and portfolio construction. And bond markets were seen as all-powerful, capable of imposing discipline on governments by pushing up borrowing costs in the face of irresponsible policies. James Carville, an adviser to President Bill Clinton, spoke with awe of their intimidatory power.

Things are different now. The bond vigilantes seem less frightening. They were asleep at the wheel as debts mounted in the euro zone, waking up in time to provoke the latest crisis but not avoid it. Private-sector bond investors in Greek sovereign debt face losses of around 70%, making the idea that government bonds are risk-free laughable.

The most powerful investors in many government-bond markets are not profit-maximising fund managers but central and commercial banks, which are buying bonds for all sorts of reasons. Other investors need to be like Kremlinologists, guessing what central banks will do next.

The market is also much bigger than it was. According to Bank of America Merrill Lynch, there were some $11 trillion-worth of government bonds in issue at the end of 2001; by the end of 2011, that figure had risen to more than $31 trillion (see chart 1). And although some euro-zone countries have been cut off from the markets, the story is very different in other places. The British and American governments are enjoying the lowest borrowing costs they have seen for decades, despite big deficits.

The implications of all these changes are still being worked through. The risk-free rate has historically been the rock around which a financial system is built. Other borrowers, such as banks and corporations, pay a premium over their domestic government’s cost of debt. This is still true for companies that are tied to a local economy, such as utilities. But multinational firms can, in theory, move to economies where growth prospects are better and taxes lower. Some, such as Johnson & Johnson or Exxon Mobil, may thus now be seen as better bets than their governments.

Thanks to the European Central Bank’s lending activities, banks in several European countries can also now borrow more cheaply than their governments—a heavy irony given that it was the banking sector’s problems that ushered in the current sovereign-debt crisis. Indeed, investors have learned that simply studying the ratio of government debt to GDP is not enough. Both Ireland and Iceland entered the crisis with very low ratios. But the collapse of their banking sectors meant that private-sector debt was assumed by the government, causing the ratio to balloon.

Modern bond investors have to worry about other contingent liabilities, too—the pensions promised to public-sector workers, say, or the rising costs of Medicare as America’s baby-boomers retire. Governments might easily decide that such promises have a better claim on tax revenues than the rights of foreign creditors. The negotiations in Greece have shown that official creditors deem themselves to have a greater claim on a government’s revenues than private-sector creditors. The more official aid a country receives, the bigger the eventual write-off private bondholders may suffer.

The rise of official creditors is not new. It was first noticed in the 2000s when Asian central banks began to plough their massive foreign-exchange reserves into Treasury bonds. Alan Greenspan, the then chairman of the Federal Reserve, talked of the “conundrum” that bond yields were falling even as the Fed was pushing up short rates, a shift from the usual pattern.

The reason was that central banks were pretty indifferent to low yields, being content to park their reserves in the relative safety and liquidity of Treasury bonds as a way to manage their currencies’ level versus the dollar. More recently, central banks have been buying up their own government’s debt through quantitative easing (QE). It is debatable whether yields are set by economic fundamentals or by the anticipated buying patterns of central banks.

Of course, central-bank policy has always had an effect on the bond markets. One way of viewing long-term bond yields is as a forecast of future short-term rates (sometimes there is an additional premium for tying up your money). On that basis, says Eric Lonergan, a fund manager at M&G, the current level of Treasury-bond yields is quite rational. The average of American short rates over the past ten years is around 2%, almost exactly the level of the ten-year Treasury-bond yield now.

Rates are likely to remain low for some time. The Fed recently indicated that it expected rates to stay near zero until late 2014. Add in the effect of QE and the Fed may be the dominant influence on yields all the way out to bonds with maturities of five years. There is talk of a third round of QE from the Fed, and the Bank of England was set to add to its £275 billion ($437 billion) pile of gilts at a February 9th meeting, held after The Economist went to press.

Rates low, bond mountains high

Analysts argue about the precise impact of QE on yields but the presence of an ever-willing buyer must have some effect. In particular, it must make private-sector investors cautious about betting on higher yields. “Bond crashes become very unlikely, unless they are accepted by central banks,” says Patrick Artus of Natixis, a French bank. “Long-term interest rates could remain very low for a long time.”

Less clear is how central banks will ever dispose of these bond mountains. In practice, it makes no difference whether central banks try to sell their holdings or simply let the bonds mature (since maturing bonds have to be refinanced). Either way the private sector will have to absorb the extra supply on top of the new bonds being issued that year. If central banks are correct in arguing that QE has driven bond yields down, then logically a reversal of QE might drive yields up, in effect tightening monetary policy. It may be a long while before the economy is sufficiently robust to absorb the impact. Large central-bank holdings of government bonds may be a semi-permanent feature of the landscape.

Central banks are not the only distorting presence in the market. In Britain pension funds have been eager buyers of long-dated securities as a way of matching their liabilities (a promise to make pension payments for 25-30 years is equivalent to a debt). Since many pension benefits are linked to inflation, this has sparked a particular enthusiasm for inflation-linked debt. Insurance companies are also heavy buyers of government debt, in large part because of solvency requirements that push them into owning “safe” assets.

And then there are the banks. One feature of the early days of the euro was convergence. Short-term interest rates are the same across the zone. Since government-bond yields are related to expectations for future levels of short rates, bond yields equalised across the region. This was immensely beneficial for countries like Italy and Greece, which saw their borrowing costs fall. It also meant that banks happily owned regional, rather than merely national, government-bond portfolios.

Now that trend is reversing. Banks are suddenly conscious of the credit risk involved in holding another country’s bonds. When the crisis broke French banks were “encouraged” to hold on to their Greek bonds by their government and suffered losses as a result. Now it seems they are willing to buy only their own government’s bonds, and those of Germany; they are far less keen on holding Italian or Spanish debt. “It is almost if the euro zone has already broken up,” says Andrew Balls of PIMCO, a fund-management group.

Domestic banks, however, may well figure that holding the debt of their own sovereign is a “double or quits” bet. If their government defaults the banking system will collapse anyway, so they might as well own its bonds. That incentive has been reinforced by the ECB’s provision of virtually unlimited three-year loans. As President Nicolas Sarkozy of France has hinted, banks can borrow cheaply from the ECB and invest the proceeds in government debt, earning a higher yield in the process.

This is an approach to boosting bank profitability that has been tried before. In the early 1990s the Federal Reserve held rates very low (by prevailing standards) to help the banks recover from the savings-and-loan crisis. Banks were able to earn a “carry” by borrowing at 3% and buying ten-year Treasuries yielding almost 7%.

The carry trade is not the only reason why banks might buy government bonds. In the wake of the 2007-08 crisis, when banks were suddenly cut off from the wholesale markets, regulators have been urging banks to own a “liquidity cushion” of safe assets. Banks can use government bonds as collateral for loans with each other, and with central banks.

The result has been a big expansion in banks’ sovereign-bond purchases, very handy when governments have lots of bonds to sell. In Britain, data from the Debt Management Office show that banks and building societies owned just £26 billion-worth of gilts in the last quarter of 2008; by the end of 2011 they owned £131 billion, or around 10% of the total (see chart 2).

How would you like your loss?

The role that credit risk is now playing in the euro area highlights another great change in the government-bond markets: the influence of exchange-rate regimes. For decades countries struggled to cope with the constraints of fixed exchange-rate systems, whether the gold standard or Bretton Woods, in part because this approach would reassure foreign creditors. “Who would be prepared to lend with the fear of being paid in depreciated currencies always before his eyes?” asked Georges Bonnet, a French finance minister of the 1920s.

But the euro crisis has shown the perils for international investors of a fixed-rate regime. Denied the option of devaluation, Greece is being forced, in effect, to default on its debts. In contrast America and Britain, with their floating exchange rates, have the freedom to expand their money supplies and depreciate their currencies. Although this may still result in losses for foreign investors, they are likely to be far smaller than the Greek write-offs. As Mr Balls puts it, countries with floating rates are the “least dirty shirt” in the markets.

Emerging markets have also changed their role. Historically, developing countries defaulted often and had high inflation. They had to borrow in dollars and to pay high yields. But now the finances of many developing countries are better than those of the rich world (see chart 3). Brazil and Mexico pay yields of less than 2% on five-year dollar-denominated debt.

It all adds up to a completely changed investment landscape. For the 25 years from 1982 to 2007, owning rich-world government bonds was almost a no-brainer. Yields fell steadily in line with inflation and there was no question of default. Now the market is much more complex. The players are more diverse and their motives more varied. The balance between risk and reward has also shifted against investors. In the past bondholders have not made money buying Treasury bonds on yields as low as 2%. At current levels of inflation, bond investors are getting negative real yields.

That may be the idea. Carmen Reinhart, Jacob Kirkegaard and Belen Sbrancia, three academics, have suggested that governments may use “financial repression”—forcing debts down the throats of captive buyers and keeping real rates negative so that inflation eliminates their debts. This trick worked after the second world war. The presence of “forced buyers” in the market such as central banks and commercial banks may enable it to be repeated.

But could governments really pull it off? Or are rich-world bond markets signalling that Japan is the more likely template? Ten-year yields there have been around 1% for much of the past decade, thanks to persistent deflation and slow growth.

This is a vital issue since a sudden surge in bond yields might wreck government finances, economic prospects and the outlook for other asset markets. “The unknown question is how much inflation central banks are willing to tolerate. Until that is settled, one cannot be sure about the outlook for bonds or other asset markets like equities,” says Manoj Pradhan at Morgan Stanley. For a supposedly risk-free asset it all adds up to a lot of risks.

Source: http://www.economist.com/node/21547245

Low rates: the drug we can all do without

Low interest rates and novel forms of monetary accommodation, such as quantitative easing, have become seen as a panacea for economic ills. The US Federal Reserve has committed to holding rates around zero for the foreseeable future. Faced with deep-seated economic problems, other central banks are likely to follow.

Financial markets have generally reacted positively to low rates, pushing up asset prices. However, low rates point to a worrying lack of economic growth and the increasing risk of deflation. Indeed, the relationship between rates and economic activity is tenuous. The cost of funds is only one factor among several complex drivers of demand.

In the housing market, demand depends on many things – the level of deposit required, existing home equity (the price of a house less outstanding debt), the ability to sell a current property, income levels and employment security.

And businesses, in the absence of growing demand for their products, are unlikely to borrow to invest in new capacity based purely on the low cost of debt.

In reality, low interest rates create economic distortions, especially where real interest rates (nominal rates adjusted for inflation) are low or negative.

Low cost of debt encourages substitution of labour with capital in the production process. Given that 60-70 per cent of activity in developed economies is driven by consumption, this shift reduces aggregate demand as employment and income levels decrease.

Low rates favour borrowing, encouraging substitution of debt for equity in financing structures and increasing financial risk. Where companies and nations are overextended, incentives to reduce debt decrease. In fact, low rates, which lower coupon payments, are economically identical to a disguised reduction of the principal amount of the loan.

Low rates discourage savings, creating a disincentive for the capital accumulation that would reduce overall debt levels. Lower earnings on savings should encourage spending, stimulating economic activity, but may perversely encourage greater saving to provide for future needs, reducing consumption and demand. For an individual saving for retirement, a drop in interest rates from 5 per cent to 4 per cent requires an 18 per cent increase in savings each year to reach the same target sum over 30 years.

Low rates also increase the funding gap for defined benefit pension funds. In the US, for every 1 per cent fall in rates, pension fund liabilities increase by about $180bn.

Low rates also feed asset price inflation. Low costs of borrowing encourage investors to seek investments with income, feeding demand for shares that pay high dividends and for low-grade debt. A resurgence of structured products, where investors take on additional risk, which they have not fully understood, to generate higher income, is driven by low rates. In previous cycles, this has led to large losses and costly disputes between investors and dealers. In this way, low rates encourage mispricing of risk, creating asset bubbles.

Minimal opportunity costs allow investors to hold assets that pay no income in the hope of price increases, evidenced in demand for commodities and alternative investments such as art works. Money tied up in non-productive investments reduces the flow of capital and economic activity.

Low interest rates also provide an artificial subsidy to financial institutions, allowing them to borrow cheaply and then invest in higher yielding safe assets such as government bonds. Assuming bank deposits of $6tn and a difference between borrowing costs and government bond rates of 2 percentage points, this equates to a transfer to the US banking sector of about $120bn.

Low rates do not necessarily increase the supply of credit. Risk aversion and higher returns on capital encourage banks to invest in government securities, eschewing loans. In the US, bank holdings of cash and government securities currently exceed the outstanding volume of commercial and industrial loans.

Internationally, low interest rates distort currency values, and encourage volatile and destabilising short-term capital flows as investors search for higher yields.

A sustained period of low rates, such as the one the world is experiencing, makes it difficult to increase the cost of borrowing. Levels of debt encouraged by low rates rapidly become unsustainable when they increase, as is evident in Europe. This reinforces the financial distortions implicit in the policy.

For the moment, policymakers are relying on the advice of actress Tallulah Bankhead: “Cocaine isn’t habit forming. I should know – I’ve been using it for years.” But reliance on low interest rates, like all addictions, is dangerous. It is also ineffective in addressing the real economic issues.

Source: http://www.ft.com/intl/cms/s/0/372a405c-480e-11e1-b1b4-00144feabdc0.html#axzz1l0bJLxBP

Bond Bulls May Yet Have Reason for Cheer

The bond-market limbo act goes on. At the start of 2011, bond-fund giant Pimco bet against U.S. Treasurys when the 10-year note was yielding about 3.3%. But Treasury yields ended the year under 2%, along with yields on German and U.K. government bonds, extending further a 30-year bull market for bonds. There might be further to go yet.

Central-bank bond purchases, known as quantitative easing, will play a part. While earlier rounds of QE pushed up yields on hopes that this would support recovery, repeat operations may have diminishing effects. In the U.K., yields have continued to fall despite a new £75 billion purchase operation. The Bank of England is widely expected to increase that program early this year, and many speculate that the U.S. Federal Reserve may engage in a third round of QE. Former European Central Bank board member Lorenzo Bini Smaghi has suggested that even the ECB could make use of the policy if monetary conditions demand it.

Such central-bank purchases may coincide with a reduction in the stock of securities still regarded as "safe" due to potential ratings downgrades in the euro zone. That could have a dual effect. Yields could be kept down as investors question the effectiveness of QE in generating economic growth. But buyers who have little choice about investing in bonds due to regulation may be forced to compete with central banks for paper.

Banks are being required to hold greater liquidity buffers. Central-bank reserve managers, particularly from Asia, are likely to remain core buyers of government debt. And despite deep concerns about the euro, many investors within the currency bloc have no choice but to invest in euro-denominated bonds. Even those struggling with the effects of low yields, such as pension funds, need to match assets with liabilities. Rather than shunning low-yielding bonds in countries like the U.K and Germany, funds that expected yields to rise may be forced to accelerate purchases to reduce the mismatch in their portfolios.

Many advanced economies are entering a multiyear period of paying down debt. That will likely weigh on growth and on domestic inflation, as it has in Japan, boosting the allure of government bonds over risk assets. This process may cause periodic outbreaks of panic about banking systems, as in 2011, driving yields lower. As the panic fades, yields may rise—but so far, they have risen to a lower peak each time.

This environment also creates a challenge for governments. Germany in November saw investors balk at buying new 10-year bonds at yields below 2%. But with two-year bond yields anchored at 0.3% or below by zero interest-rate policies, investors will have to buy longer-dated bonds to generate any return.

That means long-dated yields could go lower and for longer than many thought possible. Just look at Japan, where 10-year yields ended 2011 at 1%.

Source: http://online.wsj.com/article/SB10001424052970203550304577138101578099224.html?mod=WSJ_Heard_LEFTTopNews

Bond Buying Proves Poisonous for Pensions

Today's economic medicine carries harmful side effects.

Bond buying, known as quantitative easing, or QE, may have boosted growth and lowered corporate borrowing costs, according to a Bank of England analysis. But it is playing havoc with pension funds. Deficits have ballooned by £74 billion ($116 billion) as a direct result of the BOE's bond-buying program, estimates Pension Corp., an insurer.

The problem for pension funds is QE's design, not its rationale. The BOE's gilt purchases drive up prices and push yields down, a particular problem now that the scale of the BOE's bond buying is forcing it to buy longer-dated gilts of over 25 years in maturity, popular with pension funds. While quantitative easing boosts the value of pension assets, it lowers investment returns and increases estimates of future liabilities. Because typical defined-benefit plans are only 70% funded and face liabilities several years longer than their assets, that leads to wider deficits.

The BOE had hoped the bond-buying program would encourage pension funds to sell gilts and buy stocks and corporate bonds. Instead, many pension plans are doing the opposite: derisking and buying more gilts in the hope of closing shortfalls sooner. That isn't only exacerbating deficits but accelerating a move out of stocks, reducing a major source of long-term risk capital.

Some cash-strapped firms facing demands to plug QE-related deficits are petitioning the U.K. regulator to allow them more than 10 years to make up shortfalls. Another approach might be to discount liabilities at a higher rate than government or double-A corporate-bond yields. The Treasury uses a rate of 3% above consumer inflation for public-sector pensions.

But many trustees say the best response would be for the BOE to stop buying long-dated gilts and buy bank bonds instead. Not only would this ease bank funding difficulties, and thereby improve the supply of business loans, it would allow gilt yields to rise.

So far, the BOE has ruled this out, fearing credit risk and accusations it is subsidizing banks. But given the scale of the crisis, it may be time to take a less doctrinaire approach.

Source: http://online.wsj.com/article/SB10001424052970203686204577116573609854972.html?mod=WSJ_Heard_LEFTSecondNews