Just how rich is Tottenham Hotspur, really? Not very.

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Daniel Levy

With the virus having suspended football, this seems like a good moment to finally sit down and look at exactly how “rich” Tottenham Hotspur is as a football club, and therefore think about the question of how much we can afford to spend.

The Swiss Ramble recently performed its annual analysis of Spurs’ finances, and it is an exercise I like and admire very much since it attempts to put into perspective the club’s performance and context amongst the elite. Yet it has a major limitation, which is that it focuses almost exclusively on “profitability”, as this excerpt shows:

Swiss Ramble

Source: Swiss Ramble twitter account

The problem, of course, is that profitability tells us very little about cash available, since the items on the P&L (including the profits after taxes) are mostly not real cash items. Instead they are filled with such concepts as depreciation and the gains recognized on the sale of players as assets. Essentially, these are accounting items. And I find it a dangerous way to look at a football club because it raises false expectations about how “rich” we are and therefore how much we should be able to pay for transfers.

I prefer to apply a financial perspective by looking at football clubs as one would any other business, through the company’s balance sheet and cashflow statements. The balance sheet gives us a sense of how indebted the company might be. But more importantly I like to look at the cashflow statement for a few reasons:

  1. Real cash items – the cashflow statement gets rid of non-cash items such as depreciation and replaces it with real cash such as capex
  2. Transfers – it more accurately captures the actual money going in and out on transfers including all hidden costs as well as payments spread over time – a £60m fee paid over three years should be seen as such and not lumped into one number
  3. Stadium investment – it captures all hidden costs but also allows for financing raised against the project, ending the “the stadium pays for itself” speculation.

Helpfully most financial accounts break down transfer spending in quite some detail, which in turn allows for me to get to my core concept: the pre-transfer free cashflow (“PTFCF”). For this I take the net cash inflow / outflow, and add back transfer spending which I assume to be discretionary. This brings us to a calculation which tells us how much “spare” money we would have available to spend in a given year, if we had wanted to.

Taking the June 2019 figures, this metric then allows us to judge – somewhat – our performance in the transfer window.

Pre-Transfer Free Cashflow by club for year ended June 2019 (£m)

PTFCF 2019

We can see from this analysis that Tottenham came a fair way off Man Utd, Chelsea and Liverpool (and one assumes Man City, who do not publish a cashflow statement or give any notes to their Intangible Fixed Asset investments). Arsenal were the big losers of last year given their Europa League participation, and Chelsea show themselves as doing well despite not qualifying for the Champions’ League. To be clear, generating a negative cashflow (just like generating a loss) does not mean you have no money to spend; only that you must do so unsustainably out of your “savings”, which will show up on the net debt (which we will get to).

If we look at the year prior, this becomes even more stark, and highlights the fact that Tottenham, contrary to some assertions, was under real financial pressure during the stadium building process starting in 2017.

Pre-Transfer Free Cashflow by club for year ended June 2018 vs net transfer investment for the following year (£m)

PTFCF 2018

Note: Since transfer spending runs July-June and mostly occurs during the summer transfer window, a June 2018 year ending is best contrasted with the June 2019 transfer spending.

At this point, Spurs were actually incurring a substantial negative PTFCF due to stadium costs, not least since much expenditure for large capital projects is paid up-front, for land acquisition and so on. Man Utd and Chelsea spent far more than they were generating – one might say generously, “investing for the future”; Liverpool were spending about as much as they might expect; and only Arsenal were spending significantly below their capacity, buoyed no doubt by the knowledge that they were not in the Champions’ League. Indeed Tottenham’s tiny net expenditure of ~£3m was quite flattering under the circumstances.

In fact, if we look at how Tottenham have performed on average against the rest of the Top Six (excluding Man City), we have had a tenuous few years.

Three-year rolling average Pre-Transfer Free Cashflow (£m)

PTFCF 2015-2019

On a rolling three-year average, the other clubs have managed a PTFCF of around £80m per year over the last five years, whereas Tottenham, having clawed our way into contention by 2016, have actually seen the gap widen again in the subsequent years. In other words, we really are not that well-off, are some way behind the other Big Six teams, and cannot spend the money on transfers that some fans seem to believe we now should. The stadium remains a massive gamble and has to succeed as a standalone business for us to begin making up the difference with the other clubs.

To cap things off, let us just look at the “savings”. A net debt position is typical of most companies and football clubs are no exception. Furthermore, the ratio of that debt to net assets or ‘shareholders’ funds” shows the relative indebtedness of a business.

Top Six clubs net debt (£m) and gearing for year ended June 2019

Gearing and net debt

On both measures, Tottenham are more precarious than our peers. Not only is net debt larger in absolute terms, carrying with it the funding for the stadium; but alone amongst the Big Six, our gearing is at more than 100%. No doubt much of the stadium borrowing is ring-fenced to a degree, and probably operates on a project finance basis; nonetheless the cost of the debt will weigh Spurs down through interest payments for some time – and the analysis gives a sense of how much better off Man Utd really are than us, for instance. Daniel Levy, who is no stranger to this situation, will clearly not be minded to let spending get out of hand.

Some of this will be well-known and obvious to observers. The reason I raise it is the danger of football fans demanding spending beyond what is possible – and Spurs have been particularly under the microscope for this. The Swiss Ramble’s analysis – whilst perfectly legitimate and technically correct – conveys a very misleading impression over our financial clout. Headlines about record revenues and profits on the P&L, lead to questions (from those who should know better) of “where has all that money gone?”. In the end, Spurs just are not yet that big a club, and whilst I am confident that we will reach our goals, it will still take some time before we can splash out.

 

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Browsing the internet after posting, I came across the University of Liverpool’s football finances website, which has recently just posted about Premier League club values for 2018-2019, which, whilst doing some equally interesting things,  has rather fallen rather into the same trap. Their proprietary “Markham Multivariate Model” is based on net profit adjusted for one-off items, but unadjusted for non-cash items. The formula is quite off-the-wall in other aspects too but I will let that lie for now.

Nonetheless it leads to what I think is just as unhelpful an output (below), saying:

Spurs overtook both Manchester clubs at the top of the table on the back of reaching the Champions League final, a fourth-place finish in the Premier League and a wage bill barely half that of Manchester United.

UoL club valuations

Even from the eyes of a purely financial investor, this cannot be true. Spurs’ true hidden value, if you want to see it this way, is the stadium value and its future earnings but as far as I can see this has not been captured by Markham. If you strip that out, however well managed our wage bill is, a DCF of Tottenham vs the other clubs would not come to this conclusion. My opinion: head in hands.

What Covid-19 mortality might look like if we all counted like the Germans

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Germany Covid

One of the less covered aspects of the Covid-19 crisis has been the wildly differing ways in which countries – and within the US even states – count the dead. This in turn has made comparability between countries almost meaningless, with very little to be learned between the numbers of deaths in Italy for instance, and those in Sweden. And by the time you bring China into the discussion, comparability ceases even to be mentioned. The singular failing of the WHO is not failure to combat the virus (which it has little power to do), but failure to at least coordinate consistent numbers. On this basis alone, the WHO has been a fiasco.

The problem is that how one counts deaths, even though it sounds like it should be scientific process, is actually an art. There will always be huge amounts of subjectivity in interpreting whether a virus like Covid-19 constitutes the “primary cause” of death, or whether it is merely a “contributary factor”. The discipline with which a group of medical practitioners understand and stay within guidelines on this reflects all sorts of local conventions and culture. Generally, one might assume that the more technocratic a society is, the more strict they would be.

Step forward Germany. Throughout recent months, German numbers have been hailed as an example of what good governance should look like, with early testing being seen as key. Yet if you look at the details, a puzzle is presented: although German total deaths are much lower than that of France, for instance, its total numbers of infections are almost the same.

Total Covid deaths

Note: mortality rate defined as reported Covid deaths as % of total infections “Non-German Europe” are countries coloured in red; Source: Worldometer.info

All the good governance in Germany would, one assumes, mostly have led to lower deaths through lower infections, yet this has not occurred. Rather, the gap between total deaths is partly filled by the differences in counting methodology. In fact broadly speaking “Greater Germany”, encompassing Austria, Switzerland and Denmark, together average a mortality-to-infection rate at around one-third that of Non-German Western Europe (and this is already distorted by the fact that in Switzerland, non-German cantons are reporting much higher mortality than their German brethren).

So what is going on? Whilst I have no doubt that the Germans are doing better, they are not doing that much better. But at present, if there is a difference in counting methodology, I also have no doubt that I would lean towards the German over the non-German way. What then would the UK and other countries’ mortality rates look like under the German system?

First, I have assumed a simple re-basing of these mortality rates to the Greater German average, creating a like-for-like “Germanic deaths” number for each country. This lowers them substantially. “But”, I hear you cry, “is the German healthcare system not better?” Well, perhaps it is – though in fact there does not appear to be much consensus on this from various authorities. But let us say for the sake of argument that there is a qualitative difference, we might use a simple proxy such as the number of hospital beds per capita to readjust this number and make it more apples-for-apples.

Greater Germany Covid

Source (for beds): Nationmaster.com

Greater Germany does have a better-than-average provision of hospital facilities, particularly in Austria and in Germany itself. Taken together, the Germanic average of hospital beds per capita is higher than most other Western European countries, although France is also quite high. If we then adjust the “Germanic deaths” number upward again, by the number of beds, we have an indicator of what German-style Covid-19 death counts might look like.

European Covid like for like

Note: “adjusted” figures adjusted for hospital beds per capita compared to Greater Germany

Despite making this adjustment upwards, non-German Covid-19 deaths, whilst higher than Germany’s (and almost certainly correctly so), are still substantially below the current reported numbers. In other words, if the UK used German-style death counting, its numbers of Covid-19 deaths might be about half the current number and possibly well below. The same applies to all other countries in the region. I would posit that this is the basis of real comparability, not the published statistics.

Of course, this is all back-of-the-envelope stuff and many will complain that this does not take into account all the nuances of each country’s policies and virus reactions. But there can be no doubt that:

  1. Each country is counting in a different way;
  2. If the UK were counting along German lines, reported deaths would be much lower; and
  3. Conversely, if Germany were counting along UK lines, their numbers would be higher.

However taking into account what has been happening in each country, if I were to guess at who’s numbers are a better and more accurate representation of the real situation, I know where my money would be. But then, I am Austrian.

 

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(For reference I did the same analysis incorporating the Asian OECD statistics, which seem remarkably similar to Germanic numbers. China in particular, whatever else is may have covered up, has a stringent policy of how it reports Covid deaths and the region as a whole would likely be similar. However the outcomes from this analysis did not move the needle enough to start having to justify commonality between Asia and Europe)

Asia OECD Covid

How Labour continue to be over-represented

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As an addendum to my previous post, I have been poring over the numbers again and it struck me as notable that the Tories, despite never having dropped below 30% of vote share in modern times, have often won fewer than 200 seats whereas Labour, despite having dropped below 30% on at least two occasions (1983 and 2010), have never breached this psychological nadir. This year, again, they were forecast initially by the exit poll to weigh in at around 191 seats, but somehow managed to scrape in at 202 in the end.

In any first-past-the-post system, the winners will always benefit disproportionately and this is as true of the US electoral college as it is of Canadian ridings or British constituencies. For instance, people complain about Trump’s electoral college over-representation in the last presidential election in 2016 but forget that Obama benefited from a vote-to-college exaggeration twice before him, as did Bush and Clinton etc. This is simply an inherent function of this kind of system, and might be considered a sort of “winner’s dividend”. However what also appears to be true is that in Britain, the Tories have traditionally always had to “work harder” for their majorities than Labour, the result of a structural and psephological imbalance between the two parties’ support.

To highlight this, I have looked at how many votes per seat each party has had to win for their large majorities, comparing the Tory landslides under Thatcher and Boris, vs the Labour landslides under Blair. Even adjusting for total vote (in 2019 terms), the Tory majorities were much harder to come by:

Number of votes required per seat won by landslide winners (thousands, 2019 basis)

Majority winners

Note: in order to create a like-for-like comparison, I have adjusted the raw votes per seat upwards to the 2019 total vote numbers since the electorate has grown larger in absolute terms over time

To turn this around, if we look at how poorly the losers of those elections fared, one can see how under-represented or not they are in defeat. Again, the numbers show Tory defeats being much worse than Labour ones, which manifests itself in how the Conservative Party was at below 200 seats for the whole period between 1997 – 2010, something even Michael Foot and Jeremy Corbyn have not managed.

Number of votes required per seat won by landslide losers (thousands, 2019 basis)

Majority losers

Lastly, I look at the “tipping point”, in other words how the parties fare when close to each other – for instance in the two hung parliaments that we have had this decade. Extraordinarily, in both cases the Tories, despite being the winners of each election, still had to accumulate more votes per seat than the defeated Labour Party, turning the entire concept of a “winner’s dividend” on its head. By way of comparison, John Major’s slender absolute majority in 1992 only just saw the Tories needing fewer seats than Labour.

Number of votes per seat required in close elections (thousands, 2019 basis)

Close elections

At the very least this shows that the tipping point is well above the natural 50/50 threshold between the two parties. With the Tories having won a swathe of seats across the northern Labour heartlands, and with the impending promise of boundary changes, this could evolve somewhat; until it does though, Labour can relax in the knowledge that as a starting point, the electoral system still somewhat favours them.

The long arc of Tory progress (and why the SNP can be ignored)

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Cameron Boris

On election night, I – unlike some around me (they know who they are) – was not losing my head. I had reasonable confidence of a substantial Tory majority, and had even put my money where my mouth was – being a buyer of a Tory majority at 44 in the spread betting markets. I had one central thesis: that the British electorate does not produce hung parliaments when there is a clear choice before them. Rather, hung parliaments only occur when the parties cannot distinguish themselves from one another (1974, 2010), or when they are unknown quantities (2017, pre-war). By this logic, Boris was in a good position to win outright.

This was despite the best attempts by the media to misread the polls. Like sub-par generals, journalists are always doomed to fight the last war, and the pollster who did “best” last time always exercises a disproportionate influence on their discourse the next time around. This year it was the YouGov MRP’s turn for lazy writers to place too much faith in, never remembering that no one pollster has ever been the “most accurate” twice in a row. In the event, the polls-of-polls were all broadly correct.

Of course there are other points of note about the Tory performance. On the one hand, there can surely be no denying Theresa May her contribution to breaking the Red Wall, and perhaps it really needed two heaves to get there; on the other hand, the media narrative on Boris being unpopular was I think well wide of the mark. Amongst key voter demographics, Boris was a positive, not a negative, and not just in contrast to Corbyn. Anyone who witnessed the acceptance speech by Ian Levy, the winning candidate in Blyth Valley, or to the reactions in Workington or Darlington, cannot doubt how central Boris was and how well he played on the doorstep as a loveable scamp who transcended class in his determination for Brexit.

Yet hidden amongst all the shock and turmoil lies a more profound truth: the Tories have been quietly improving their standing amongst the electorate for the last twenty years. Indeed the party have improved on their share of the vote at every election since 1997. They have also improved on their absolute numbers of votes since 2001 (the one surprise here being the considerable popularity of John Major even in 1997).

Conservative Party vote share and vote totals since 1997

Tory progress

This has not always translated into increased numbers of seats, due to the vagaries of the electoral system. 2017 saw Theresa May lose seats even as she surged to the highest vote share since Thatcher’s first election in 1979. William Hague, too, managed only a single net gain in 2001 despite a whole percentage point increase in votes. But set against this is the extraordinary fact that the party have now managed twice, in three elections, to work its way out of a hung parliament and back into a majority – a particularly difficult feat.

The cherry on the cake, of course, is that for those of us who lived through the dark days of the 1990s, we live to see a Tory government now likely to rule for at least fourteen years, and maybe nineteen. And whereas every other administration has won their biggest victories at or near the beginning (1945, 1966, 1983, 1997) only to see a long slow decline, somehow we have endeavoured to our greatest moment so far at the fourth time of asking, after a decade of being in power and all the scrutiny that comes with it. This is unprecedented and we are I think, allowed just a moment of self-satisfaction.

Majorities won by successive single party governments since 1945

Majorities

The one dark cloud being touted is Scotland. It will prove impossible for Boris not to yield to the SNP for a second referendum, they say. Yet for my own part, I reject this media interpretation. We should be clear that the SNP, whilst doing well in absolute terms, underperformed their own expectations and their previous results, and ended the night a slightly disappointed party. At 45%, their vote share was notably lower than the milestone 50% that they achieved in 2015, at the height of their post-referendum popularity. In seats, too, they failed to obtain the psychologically important 50 seats which they had set for themselves, and which would have cost Ruth Davidson a chilly outing in Loch Ness.

SNP and Conservative Party vote shares since 2015 vs support for Scottish independence

SNP

Source: Scottish independence polling from YouGov / The Times

Reading overlying themes onto partisan performances has its limitations. Reading Brexit results onto Tory or Labour support is impractical, for instance. But this is less so for one-issue parties such as the SNP or the Brexit Party. Their secular decline in their vote share since 2015 reflects the commensurate decline in popularity of the Scottish independence proposition over the same period. Much as the SNP have made headlines with the help of simplistic reporting, they are actually worse off than they have been in the recent past.

And here, given the success of my previous theory, is my second one: the popularity of independence in Scotland correlates directly with the efficacy of government in Westminster – not the nature of that government or its political colours, just plain ability to govern. Hence why the build up to 2014, with a coalition in place, led to one peak; the minority of 2017-2019 another (as were the mid-to-late 1990s). But I predict that as Boris gets his feet under the table and gets on with life, Brexit included, Scottish sentiment will begin to recede. Boris need not pay such calls for independence any heed, and all credit to him, he seems to be headed this way.

Support for Scottish independence (1978 – 2012)

Westminster effifacy

The progress that the Conservative Party has made since the mid-1990s is a tribute to various leaders, each in their way: William Hague for his “night shift”; Michael Howard, the man who arguably saved the Conservative Party with his performance in 2005; David Cameron and his decontamination; May and the recognition of the new tectonic plates of class and economics; and finally Boris, who with his ambiguity over Brexit somehow captured the skeptical but generous spirit of the age. Even Iain Duncan Smith was a useful placeholder. The fact is that this 80 seat majority is a tribute not just to Boris’ political skills, but rather to a long, slow, and painful rebuild which for all its highs and lows, has seen indomitable progress towards power. Just what the Conservative Party has always been about.

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A slightly self-congratulatory update (2 Jan 2020)

First, it seems this theme of long term progress has been picked up by various commentators, such as Martin Kettle at the Guardian, who notes that:

“The Tories have now formed four governments in a row. Remarkably, they have increased their share of the vote for the last six elections. They have 200 more MPs today than in 1997. Those who sit for seats in the north and Midlands have got most of the attention, and rightly so. But the tightening Tory grip in parts of the south that were once marginal also matters. The Tory advance across Wales is dramatic. And they remain a player in Scotland, something Labour can barely claim. They are UK-wide again. And they now have a new generation of MPs who can shape their party.”

Secondly, there was an interesting graphic from the Financial Times talking about the Tories and the working class:

However whilst the FT was trying to make the point about Tory inroads, much of this graphic simply demonstrates the underlying improvement in performance, which would naturally eat into traditional Labour voters since Conservative success basically equates to Labour decline. Either way, the choice of 1997 as the starting point is notable and the story a component of what I outlined above in the original post.

Pochettino, Rationalism and St John the Baptist

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“There was a man sent from God, whose name was John. The same came for a witness, to bear witness of the Light, that all men through him might believe. He was not that Light, but was sent to bear witness of that Light. That was the true Light, which lighteth every man that cometh into the world.”

John 1:6-13

The news of Pochettino being “relieved of his duties” was one of those events which, while an enormous shock at the time, with every passing day become more and more comprehensible; such that having had a couple of weeks to digest, it now seems the most natural thing in the world. Then Mourinho arrived so quickly that, as the Taoist saying goes, “if you use a sharp enough knife, the cow does not even know it is dead”.

The reason that a certain section of the fans – the majority, I suspect – were so saddened at Poch’s departure was because of how much we had all bought into “the Project”. Almost five and a half years is a life time in football today, and for parts of that, it really did seem that he was the one who had come to lead us to the Promised Land: a new stature, a new stadium, and an end to the trophy drought. Yet it had been clear for a long time that Pochettino also had limitations – limitations which, frankly, may yet prevent him from really becoming a top class manager anywhere else, even if he were to have more resources.

First amongst them was that he never really displayed tactical nous, and was instead a system manager. He belonged, in his way, to a tradition which places the system above all else, a tradition which can be traced from Guardiola, Bielsa and Wenger, all the way through Poch down to the likes of Eddie Howe and Ralph Hasenhüttl. System managers – perhaps we can call them “Rationalists” – when they are right, are irrepressible: their teams play throughout the season as a single unbroken line, constantly possessing, attacking and scoring, not punctuated by the mere whistle of referees starting and ending matches. The end of one game and the beginning of the next is seamless. This is what makes them so resilient and machine-like – scoring against them does not really achieve anything more than insects hitting the windscreen of an onrushing car. When it works, individual moments of adversity make no impact on a team’s mentality or emotion.

Against these Rationalists are the Empiricists, the school of management which takes each match as it comes and deals with them one at a time, often with tailored tactics for specific parts of the pitch or even windows of time. In this tradition belongs Mourinho above all others, the man who makes double substitutions at half-time and who famously defeated Pep’s Barcelona in 2010 with ten men. But there are others: Ancelotti, Allegri and Conte for instance; Marco Silva and, I would guess, even Big Sam. Italy was always the home of tactical men such as Lippi and Trap, with little acceptance of outsider Rationalists such as Sacchi. With them, the moment and the match are everything: these teams win cup semi-finals and finals, derbies, and top-of-the-table clashes. By and large, a siege mentality is useful; but so, too, is the ability to discard players when needed. In a sense, it favours a little bit of the under-dog.

The problem for the Rationalists is that when trying to make the system work, there is a fine line. Success is magnified by compounded success; but loss is likewise exaggerated. There is no “middle”. For an Empiricist, your last game can prove you right; for the Rationalist, only success over a long period can justify the seemingly rigid adherence to the system. Poch did not make substitutions. He did not, until near the end, introduce formational changes. He remained loyal to players at all times. More than anything, he was not good at incorporating new players and needed the constancy of his core group, pressing them repeatedly to come up with the same goods, game after game, season after season.

And this would have been fine, if players had rotated. But the iron law is that either the players have to be freshened up … or the manager does. But there was a further dichotomy with Poch which was that he was so dogmatic that he struggled to bring in new players at all. I believe there is every truth to the claim that he rejected new signings during the summer of 2018, because he did not feel they would fit. Additionally, he did not have a great track record of new signings anyway after the departure of Paul Mitchell in 2016. His teams were always thrown by resets such as summer breaks and even normal international breaks – form was always randomised after such events like the dice in a game of Boggle. Yet at the same time he refused to introduce new talent, meaning the squad was tired out. It was intensity without any possibility to refresh.

Which brings us to what Pochettino should be seen as: not as the Saviour, but as St John the Baptist, crying out in the wilderness before the coming of the real thing. Poch understood that for a few seasons he had to ignore the noise of fans and media and demands for silverware, and just concentrate on stature. The rest would come. He was specifically the right man for bringing Tottenham out of being a probable-top-six club to a regular-top-four one – a role he may be destined to repeat, since if he were to join either Man Utd or Arsenal, they would rightly want this particular trick repeated. His five years at Spurs were a necessary time and place, and he leaves a platform ideal for the next step, whether that be under Mourinho or anyone else. He fit that stage of Levy’s development plan perfectly, and in retrospect, it was never likely to be anything more. Much like Bielsa, he may be destined to never achieve true greatness; and much like St John, he may not himself be the True Light, but rather be destined for undignified decapitation.

Pochettino

Nonetheless St John has his retinue of true followers and believers, and good luck to them. There are those who might want the Rationalist system despite the tactical rigidity and squad management. These are perhaps the purists, though they are destined to be as tangential as the Mandaeans. For myself, despite the initial shock, I am all for the man who may well turn out to be the True Light.

In nomine Domini, Amen

Of China, Brexit, and Consumption Downgrade

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Britain China

“Consumption downgrade” has been a term bandied around the China-watching community for over a year now. The idea is that slowing income growth has begun to restrict middle class spending, whether it be on luxuries or the day-to-day. Analysts point to disappointing results from JD.com and NIO, the growth of lower-class commerce platforms such as Pinduoduo and VIP.com, and even the rise of social media such as Toutiao in support of this assertion. The anecdotal reporting, accurate as ever, interprets this as households actively downgrading: yesterday buying a Mercedes, tomorrow buying a Geely.

Yet I would posit a different theory. Whilst around the edges, some downgrade of consumption within individual households may hold true, by and large the evidence points the other way: luxury car sales are forecast to grow at a healthy clip of 9%, for instance, which whilst a slower than the previous decade (the market is clearly maturing) is hardly indicative of like-for-like belt-tightening. Rather, what we are seeing is a stratification of Chinese development, where the likes of Pinduoduo actually serve not the middle classes of today, but the newly emerging consumers of lower-tier cities – “the other 50%” as it were. And here, there is genuinely noteworthy, namely that it now appears many of these newer middle classes may never reach the same level of affluence as the pioneers in Shanghai and Beijing (sketched out theoretically below):

Consumption downgrade

Consequently it is the weighted average of the total incremental growth – in other words, of all the new consumption coming online – which is getting lower. Individuals however are still spending in-line with the past, and even still upgrading. The fact that lower-tier cities may not emulate the top cities is of course some cause for concern – but it is hardly unusual by OECD standards. It merely means that whilst luxury still has a market, mass premium and even mass common have more exciting times ahead. This is important, since is supports signs that Chinese growth remains surprisingly robust in the face of recent headwinds, and in particular that nominal GDP (at this stage in the cycle a far more relevant indicator than real GDP) is stubbornly consistent at 8%+.

On the other hand, “consumption downgrade” has been alive and well in OECD economies for some time now. One need simply look at the emergence of the sharing economy to see it in action: Uber, Airbnb and WeWork are all examples of capacity-sharing which reflect the fact that today’s younger people will never have what their parents had. However trendily dressed up as a “lifestyle” choice, it is not; if given the option, the majority of Uber users would rather have their own car; Airbnb customers would rather be able to afford a hotel; and WeWork tenants rather the funding needed to have their own office. Nobody has chosen to be reduced to this kind of life, although they are putting a brave face on it. It gave rise, in part, to Trump; it gave rise to Brexit; and it is a major driving force for the economy and innovation in the West today:

Social mobility

Source: The Fading American Dream: Trends in Absolute Income Mobility Since 1940 (Opportunity Insights, December 2016)

Which brings us to Brexit. Having long been a Remainer, I see Brexit being a self-inflected economy wound which is less than ideal. However, I have also always maintained that Brexit is a political debate, not an economic one; and it would and should be won and lost on the political questions and not on economic. On political grounds too, I am a Remainer. Nonetheless, it would be remiss not to see the opportunities that Brexit actually does present, not in terms of the fantasistic national resurgence posited by some on the fringes of the Conservative Party – let us call them the Liam Fox wing – but rather in acting as a test bed for innovation in consumption downgrade.

Because ultimately Brexit is a localized process which is only bringing forward long-term secular trends of declining middle-class income which are happening anyway, and which will be increasingly and universally visible across the OECD in the coming years. Britain will merely be ahead of its time. Therefore, any innovations that the British economy produces through this would be well-positioned for the broader decline across adjacent markets, ready to be rolled-out into the rest of Europe and America just as others too begin to experience their own downturns.

McKinsey consumption downgrade

Source: Poorer than their parents? A new perspective on income inequality (McKinsey, July 2016)

What will these innovations be? If I could tell you, I would have a substantially larger bank account; but my own sense is that it lies somewhere in areas such as consumer financing and potentially further changes in shared services. The irony is that the consumption curve for Gen Z will resemble something akin to a Giffen curve. For all the debate between ‘boomers on the one hand, claiming that the kids are “wasting their money on iPhones”, and young people on the other, lamenting that they will never be able to afford a home, the truth lies somewhere in between. The more that large capital investments such as housing feel unreachable, the more people will spend their remaining income on frivolous goods. The current younger generation can indeed be both poorer and more prone to disposable consumption at the same time – something I will for now label the Paradox of Chic Poverty (again, helpfully sketched out below):

Poor get poorer

In short, consumption downgrade is not what it seems (China), and at the same time has been with us for some time (Uber / WeWork / Airbnb) whilst potentially presenting a great opportunity (Brexit). Three cheers, then, for the rich getting richer!

Daily News – Hong Kong protests to emulate the success of King Cnut

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Joshua Cnut

In the latest bid for foreign recognition, protestors in the troubled city of Hong Kong have turned to 11th century monarch King Cnut. Organisers hope that Cnut’s influence may bring the movement credibility, and have rebuffed suggestions that the Norwegian’s policy of holding back the tide met with mixed success.

“Like King Cnut, these protests have supernatural powers that show we can in fact hold back history”, said a visibly emotional Joshua Wong, who has been courageously leading the protests from The Front Line, the name of a yacht currently anchored off Bermuda.

“Besides, if this all goes nowhere, just like Cnut some of us will also be able to sail to sea and avoid the consequences.” Speaking via Skype, Wong noted that he could “practically smell the grapeshot.”

“I have been assured that police brutality on the ground closely resembles what I can see online”, although he went on to note that he may have been confusing news reports with back episodes of Peaky Blinders which he has been catching up on.

Asked about Wong’s likeness to the long-dead Norwegian, one local store owner in Causeway Bay suggested that Wong may have chosen ‘Cnut’ only due to a misspelling. “They’ve burned down my only way home now so I guess I’m going to have to swim across to the New Territories. But that’s what real freedom is, right?” another said.

Unconfirmed reports suggest that the protest movement is also taking advice from Ned Ludd.

On the big picture, the Hong Kong protestors have got it wrong

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Even an effective government could not achieve what many assume would be the paradigm of a future in offshoring

HK protests

The protests in Hong Kong have had quite a few different narratives – the extradition treaty, democracy, police violence. Amongst one resolute strand of this riotous assembly, however, lies the optimistic idea that with a few tweaks here and redistribution there, the fundamental economic model of the city is a sustainable one. In that context, many protestors feel that it should be left well alone to prosper with its trade and rule of law. The only problem is, this is not true for at least two reasons, neither of them immediately do to with China.

The first is, as I have previously expounded upon, the changing shape of regional trade and the underlying end of entrepôts as they have historically existed. The vast majority of such centres’ lifeblood comes from a structure of trade which only exists in broadly imperial contexts. Nonetheless, even given that change, the world still sustains Bermuda, and Luxembourg, and Switzerland. The second point, therefore, is that Hong Kong could not emulate any of those examples, because ultimately it has too many people, and they are too poor.

To demonstrate the structural limitations of Hong Kong’s economic development, I have contrasted several key metrics against a selection of jurisdictions who represent, to a greater or lesser extent, paradigms of what an independent trade-based Hong Kong is supposed to look like. For this exercise, I look at Singapore, its long-standing regional counterpart which faces its own problems; three European examples of various sizes (Switzerland, Luxembourg and Malta); and finally the true offshore example of Bermuda although this has limited statistics.

One basic point is the city-state’s size: unlike other “offshore centres”, the population is of the same scale as Singapore and Switzerland. We will look at per capita numbers below but it should be remembered that absolute population size brings its own difficulties, not least in terms of proportionality between the offshore centre in question vs the large economies they seek to serve. Bluntly put, OECD economies can ignore Luxembourg, Malta and Bermuda as competitive threats; Switzerland, Singapore and Hong Kong they will keep a suspicious eye on – and have been closing in on for decades.

Total population (m)

HK chart 1

Population density (‘000 people per sq km)

HK chart 5

Source: CIA Factbook

So then onto the per capita numbers. We know that Hong Kong and Singapore are by far more densely populated than other “offshoring centres”. This has an inevitable knock-on effect of downward pressure on wealth (not least property) – median asset ownership per capita is significantly lower in Hong Kong and Singapore than Switzerland and Luxembourg, and only on a par with somewhere like Malta.

Median assets per capita (US$’000)

HK chart 2

Source: Credit Suisse Global Wealth Report 2018

Why does this matter? Well, there are two further calculations that arise from these figures. The first is the population size to asset base, which tells us whether a given country might be considered relatively over-populated. By this score, Hong Kong fares poorly, at more than double that of Switzerland and almost double Bermuda and Luxembourg. The wealth base of a country represents all the things it has accumulated over time and gives an indication of the future – ranging from capital assets such as production capability to softer things such as IP and skills. The higher this ratio, the more people there are dependent on a flimsy asset base and the more susceptible it is to the vagaries of neighbouring economies.

Ratio of population to asset base

HK chart 3

The second calculation is that of inequality. For this, I use my proprietary “Pang Coefficient” instead of the rather dated Gini numbers, where as a rough rule of thumb I look at the ratio of mean to median wealth per capita – the greater that ratio, the greater the inequality. (The antiquated use of Gini, which is based on incomes and therefore ever less relevant, is the subject of another discussion). In this, Hong Kong again stands out, being notably higher even than Singapore which is partly to do with Singaporean policy of public housing. And whereas Malta is even more over-populated than Hong Kong, this is mitigated somewhat by its equal spread of wealth.

Inequality as measured by ratio of mean to median asset distribution (the higher, the greater the inequality)

HK chart 4

When we put this together, we begin to see a picture of where Hong Kong lies in this landscape of offshore centres. It is the only one of these jurisdictions which suffers the double-whammy of being both over-populated and highly unequal – and the unrest it is encountering today is the result:

HK chart - full

Notes: inequality axis based on Pang Coefficient score +/- the average for the group; over-population score is based on population-to-asset ratios +/- the average for the group; size of bubble indicates total asset base.

Hong Kong did not exist two hundred years ago; and it will not exist in two hundred years from now – at least, not in the way it has thus far. The Asian entrepots are a curiosity of time and place, as a rent-seeking tolling gateway to an imperial trade flow which had fat margins during that structure. Those fat times led to an abnormally swollen population which, accepting inequality, were able to be live off the crumbs of the China through-trade. As those imperial structures receded, the margins have become thinner also, meaning that the number of people which can be sustained from that base will have to decrease.

It has been well-noted that house pricing is the most prominent driver of the current discontent – I have previously written on the “aspiration deficit” for young people in Hong Kong and Taiwan due to their comparative uselessness within the modern economy. But the reality is that even solving this through redistribution will only alleviate the problems for a while, not long term. Furthermore, the reliance on property rather than capital assets for wealth within the Hong Kong economy (it just does not and cannot “make” anything) severely limits the efficacy of this. Unlike redistributing the “means of production”, redistributing land is only going to reduce the value of the land leading to a division of misery all round. Any gains made in equality would be more than offset by a reduced asset base.

In other words, even a good, effective, popular, well-meaning government of an independent Hong Kong would not actually resolve the underlying issues from which the SAR is suffering. Bermuda does exist – because it is tiny and serves a niche that Hong Kong is far too big for now. Switzerland makes stuff – Hong Kong does not. There is nothing Carrie Lam or her successors can do about the diminishing role of entrepot states within the multi-polar post-colonial regional and world context. And here we face the other problem of Hong Kong: parochialism.

Those fat-margined imperial times also created a whole rent-seeking mentality amongst a (largely immigrant) population who are ill-equipped for the post-imperial age. The youth of Hong Kong are notably unadventurous and unenterprising; if they were offered steady civil service jobs which could lead to buying a small apartment, most would take it. Despite having the world’s third largest financial centre and the world’s second largest market on their doorstep, there are few startups of any scale and the lack of innovation is astonishing. Whereas 2m of Taiwan’s 13.5m working population is abroad, mostly in China, only a fraction of the same can be said of HK. Furthermore, overseas Taiwanese inhabit many Mainland startups and businesses in Beijing and Shanghai; I have yet to meet a single Honkie in the same position. Hong Kong was adventurous in its birth but is not as it approaches its death.

The travails of Cathay Pacific demonstrate in microcosm that Hong Kong’s destiny simply is not in its own hands; being a better airline does not save Cathay from the fact that people do not need to fly through Hong Kong to reach their destination. Furthermore, many wealthier Chinese actually prefer Chinese airlines, strange as that might seem, because ultimately mature markets will have their own localised preferences, and the outsider – however international they pitch themselves as – will never provide this as well. Of course, Hong Kong exercises a disproportionate position within the sentiment and consciousness of foreigners, because like locals, those foreigners need to believe that China would continue to need Hong Kong. If they do not, the role of foreigners and their comfortable if tenuous existence disappears also.

Arguably though, the end of that world was symbolised as long as ten years ago by the closure of the Far Eastern Economic Review, a journal valiantly propping up the viewpoints and pretences of the post-colonial 1.0 model. Looking forward, the people of Hong Kong will have to move on – either, optimistically into the GBA where house pricing and other pressures will be alleviated; or else through emigration or even lower birth rates. The positive version of this story is one where younger people embrace the opportunities in China and start making something of it; but having now lived and worked here, I would not hold my breath.

Physics, philosophy and why people don’t want “Centrism”

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Physics & Philosophy

For a while, it seemed that “centrism” was back on the agenda. In the US, Howard Schultz, the “burnt coffee magnate”, was considering a run for Presidency and was only one of a long queue that included Beto O’Rourke and Michael Bloomberg (who has decided not to run). In Britain, renegade Labour and Tory MPs founded The Independent Group, designed to coral a fragmented anti-Brexit sentiment in into a movement, replete with the usual platitudes about a “new type of politics”. Every centrist potential presidential candidate is feted by the media as an answer to Trump and AOC; the TIG has actually had success in forcing policy changes from the Labour Party. It seems that, three years after the events that led to 2016, and two decades after the Third Way of Bill Clinton and Tony Blair, sensible politics was hoisting itself back into the public consciousness and relevance.

But here’s the problem: people don’t actually want “centrism”. Politicians on both sides of the Atlantic have taken onboard the very real desire for non-partisanship and somehow mangled this interpretation into support for centrism which is about as far from reality as they could be. It is unclear whether this misunderstanding is at least rooted in good faith about what ordinary people want, or whether it is part of a more sinister move to hijack the non-partisan agenda into something more appealing to those who only ever considered Trump and Brexit as aberrations. Indeed, from some parts of the spectrum supporters of these centrist trends are even preparing themselves for failure, by raising the red herring of “polarisation”. According to this, it is the public’s problem – they are too polarised these days to accept the logic of centrism. Shame on them.

There are two principal reasons why centrism is destined for failure, and none are the problem of the electorate. They are rooted in the two things which centrism stands for. First is compromise. There is some truth to the idea that the electorate is too polarised for compromise today; but this has always been the case. In politics, compromise has rarely been highly regarded since it inevitably results in the worst of all worlds, and usually are a by-word for kicking the can down the road. The Missouri Compromise or “Don’t Ask, Don’t Tell” come to mind for US history. The Barnett Formula, the EVEL answer to the West Lothian Question, and even the British opt-outs at Maastricht in 1992, are cases in point for Britain. The fact is that compromise is rarely satisfactory and tells of an inherently unstable equilibrium which as yet still needs to be resolved. Voters are quite tired of this given the questions thrown up by two decades of globalisation, automation and the 2008 financial crisis, and compromise is not going to answer them.

The second reason is that “centrism” above all (be it consciously or surreptitiously) is about defending the status quo – the exact opposite of popular opinion today. Whether Schultz or the TIG, advocates of the new politics are effectively trying to preserve a now discredited consensus around major issues of the day including free trade of the sort we have come to know, liberal immigration, a focus on GDP, the pursuit of “growth” and exports, keeping interest rates and inflation low and above all the protection of large corporates rather than SMEs. But that is from a pre-2016 world. Today the electorate, having been woke by the events of that year want something quite different – in a weird way, what they want is not centrism but extremism at both ends. Yes, they want to break the deadlock of existing parties, but they don’t want to return the consensus of old. Yes, they do not want the old “Left” vs “Right”, but neither do they want the compromise and consensus of the old “Centre”.

I have previously referred to what I call the Physics and Philosophy paradigm, and it is perhaps worth explaining more here. The problem with studying physics and philosophy is that each seems so different at the beginning and none of it makes sense until the loop completes at the end. Nothing makes sense until everything makes sense – whether in academia, business or anything else.

PhyPhi

Politics, too, is like this. At the beginning, one only sees things labelled for us as “Left” and “Right”, and the expanse of the political firmament is limited by lines of sight from traditional perspectives. Hence, at the beginning of 2016, this is what the American political world imagined it was seeing:

PhyPhi - pre 2016 politics

What we do not see at first glance is how these two ostensibly opposed directions may link up again at the other end of the circle. Yet if we tilt the planet up to peak behind, it is revealed what the political firmament had become by the end of the that year:

PhyPhi - post 2016 politics

Trump and Sanders were not, at the end, all too far away from each other in many of the crucial questions being posed on a number of areas such as trade, international companies and overseas cash-piles, and even infrastructure and healthcare. Both had moved right around the planetary orbit until they almost met again at the other side – the dark side of the planet invisible to the conventional commentariat sitting comfortably on the light side. And in that dark side are all the commonalities which are so hard to digest, principally amongst them the sense that the starting point for policy had to be the domestic and national, not the trade or people beyond the borders. In a sense, Trump and Sanders were in the “centre”, but a “centre” a world away from the “centre” prescribed by Bloomberg. The old centrists are wrong: their centrism was not being rejected due to cultural, regional and partisan polarization – it was not because the two sides were too different, but rather because they were too similar.

And this, ultimately, is where we are today. The TIG’s polling numbers have dramatically collapsed in the face of Nigel Farage’s new Brexit Party, declining from the mid-teens to low single digits since the party’s inception earlier this year. Bloomberg never ran. Howard Schultz has been non-committal about a presidential campaign and Democrats have been begging him not to run; the likes of known centrist Amy Klobuchar are failing to gain traction whilst complete outsiders like Andrew Yang are doing so. Yang, if anyone, is the 2020 heir to the 2016 dark-side-of-planet movement.

“Centrism” is an idea of a bygone age, one where the recent past was a story of success, where defending the status quo seemed like common sense and where just a small amount of compromise would be enough to navigate through foreseeable difficulties. But politics has changed in the last few years. Whether you are for or against Brexit, or whether you are for or against Trump or Sanders or Andrew Yang, the stasis engendered by the old “centre” is as irrelevant as defeating Communism or the Nazis. Although much of the mainstream media remain seduced by the familiarity of what was, voters on both sides have moved on; and most of them have now marched so far around the unseen side of the planet that only candidates who themselves see the future, will be positioned to reap its rewards. Centrism is dead; long live the Dark Side!

 

 

Out really means out – why Britain should reject the “WTO option” even under Hard Brexit

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brexit-trade-barriers-810x521

The sheer amount of ignorance in British public discourse about how trade works is one of the most disappointing lessons from the whole sorry Brexit drama. As a Remainer I have no qualms in picking out the likes of Dan Hannan as an example of this, whose comprehension of the subject (and of economics in general) seems to have been plucked from half-remembered A-level text books, or, at a stretch, incidental discussion from reading History at Oxford. Amongst his favourite refrains is that which tells us that “at least we will still have WTO to fall back on”. Yet of all the options, this is probably the very worst. In the event of Hard Brexit, Britain should actually reject the WTO too.

This is not the place to get into the minutiae of what the WTO actually is or how it works. There are plenty of people who have written in easier detail that I can about this. Instead there are two common misconceptions about the WTO which need to be digested before we even get onto whether it is good for Britain or not. The first is that the WTO is not actually about regulating tariffs; its core notion is that of making sure that everyone abides by the Most Favoured Nation (MFN) principle, meaning that however you structure your trade (higher tariffs, lower tariffs, no tariffs) you must at least treat everyone the same. Clearly, this is a starting point on lowering tariffs but it does not actually reduce tariffs in and of themselves. Secondly, the WTO is not a single set of regulations, but rather applies to each country differently depending on their schedules of entry. In other words, upon joining the WTO, each country basically agrees to its own unique set of tariffs and commitments.

The blog referred to above gives the helpful example of shoes – a sector in which the UK happens to be an exporter:

8% is charged by the EU on shoes imported from all other WTO members (except under a free trade agreement, such as EU-Japan, or preferences on shoes from developing countries). The import duty rate in other countries will be different. The US’s import duties on shoes vary from duty-free to around 10% or higher. Japan charges 20%–30% duty on many shoe imports.

In other words, the WTO does not set monolithic rules, even at a lowest common denominator, as many casual observers seem to believe. The reason I highlight this is to emphasise that the WTO is not some magic bullet for providing a minimum level of trade freedom. It is merely a mechanism for getting countries to discuss ways to lower tariffs. How much each country has to commit to upon entry to the WTO is, much like any other trade deal or indeed any other non-deal trading relationship (which is how most trade is done), dependent on their economic strengths. A larger economy, offering both greater consumption power and usually some irreplicable exports, will always get a better “deal” out of the WTO as a whole (or any other trade negotiation such as an FTA) than a smaller economy. With or without the WTO, with or without an FTA. That is just the way life works.

Moreover, the WTO largely does not cover services, which matters for Britain. After all according to the ONS, British services exports constituted 44% of total exports in the 2017-2018 fiscal year, representing a trade surplus of +£107bn (+€124bn) compared to the trade deficit of -£139bn (-€161bn) in goods. Contrast this with Germany, France and Italy for instance who have a trade surplus in goods and deficit in services. Yet if you delve into the WTO’s website to look at something like architectural services, something Britain has had some success at, you will find the following wording:

Currently, architectural and engineering services, like all services are included in the new services negotiations, which began January 2000. Principles of trade in architectural and engineering services are contained, like for all services, in the GATS.

In other words, nothing has been agreed. The same wording applies to everything else including finance, law, advertising and so on. GATS itself, the precursor to the services agreement, is essentially toothless. As a result, you might have noticed that prior to the Brexit referendum in 2016 nobody anywhere had been talking about the WTO for almost a decade. Instead, partly in order to cover services, most countries have gone on to think about regionally integrated trade deals like ASEAN, the TPP, APEC, the East African Union, Mercosur and, er, the EU.

The problem for Britain is that the WTO is an unfinished project. People seem to forget that the intention for global “free trade” was supposed to be a multi-step process, starting with the trade in goods before moving onto the trade in services, tackling non-tariff barriers and eventually encompassing freedom of labour and capital. The trade in goods came first, naturally, because in the era in which the GATT discussions commenced, most economies including the OECD were still ones that made stuff. There was no real asymmetry in economic structure at that time and if anything, GATT and WTO were forecast to open up emerging markets to developed nation goods such as industrial equipment whilst the latter continued to develop their basic industries such as agriculture and natural resources.

However over the course of time this changed. The OECD became notably more services-based, including in their export mix. On the other hand the emerging markets, led by China, came to dominate the manufacturing industry not just at the low end but increasingly at the higher ends too – Korean autos for instance, Chinese industrial equipment and so on. It was therefore imperative that the next phase of global “free trade”, that of services, was completed – but it never was. The Doha Round, in the back of everyone’s memories, collapsed ignominiously. China’s accession to the WTO in 2001 on these ossified terms has probably contributed significantly to its rise and America’s comparative decline. It certainly led to Trump. If you are a modern economy, the WTO is probably bad for you.

We have not even touched on the specifics of how and whether Britain could easily join the WTO and on what conditions. The likelihood is that Britain could join pretty quickly – if it did so exactly on the current EU schedules (ie the 8% tariff for shoes above). But as noted, each set of schedules was designed to suit a specific economy and the existent schedules suit the EU as a whole. With a focus on protecting agricultural exports for instance, they are probably not ideal for Britain. If it wanted to join on a different, bespoke set of schedules, this would require agreement from all WTO members which would almost certainly throw up objections both legitimate (British government subsidy for financial services for instance) and illegitimate (Russia or Argentina purposefully creating trouble). Furthermore this would require time, unlike the replication of the EU schedules – the shortest period of time for a WTO accession has been several years.

This brings us to the central conclusion that if Britain goes through with Hard Brexit, it would be better to reject the WTO altogether and act unilaterally. The WTO as it exists today suits some countries like Germany and China and Japan, but specifically ill-suits the UK given the commitments Britain would have to make on accepting manufactured goods but getting no such commitments on services in return. Neither is Britain a big enough an economy to enter into renegotiations to remake the rules in its own favour, as the Quadrilateral could. Moreover, rushing into the WTO would actually undermine Britain’s ability to strike independent trade deals as most of what it has to offer – a market for consumer goods – would be given up already. Leverage in bilateral negotiations by trading goods access for services access, would be eliminated including with the EU.

Indeed in recognition of Britain’s place as a middle-sized economy, it makes more sense to try and protect certain industries, even at the cost of near-term price increases.  Whilst signing up to the WTO does not restrict Britain’s ability to lower tariffs, it would prevent the country from strategically increasing tariffs where necessary, for instance incubating industries struggling to find their feet after seventy years in the wilderness. The fact is that a vibrant SME sector really only exists in economies that have reached a critical mass in exports such as the US, Germany and Japan. For all other economies, creating national champions is a better guarantee of long-term economic survival (more of this in future posts).

Brexit is a political, not an economic, debate. That political choice should be made on its own merits, but decisions about trading relationships need to be clear-headed afterwards. Relying on the WTO sounds like a short-cut for preserving some stability for British trade, but it is a false friend. The reason why nobody else pays attention to the WTO anymore is the same reason why Britain must abandon it too – if indeed it actually ends up with Hard Brexit come 29 March.