Winner-takes-all digital economy poses risk for capital markets

Concentration of business among small number of players presents significant challenge

Philip Stafford

AI Artificial intelligence, Machine learning, Big data analysis and automation technology in business and industrial manufacturing concept on virtual screen.

The trend of human tasks being replaced by algorithms is a perennial and understandable focus for the debate about how technology is changing capital markets. 

Policymakers, however, are already focusing on a longer-term trend: how the benefits of scale in digital industries will concentrate activity among a smaller number of investment providers.

The digitisation of capital-markets tasks traditionally done by humans, such as trading equities, is well advanced. Technology has also facilitated new investment strategies, in particular algorithmic trading. 

Computer-driven funds that scour the market for signals such as momentum — the idea that stocks that have done well recently will continue to beat the average — collectively account for a fifth of US equity assets under management, according to JPMorgan. 

Last week, the US House of Representatives held a subcommittee meeting to discuss the future impact of artificial intelligence on capital markets. But its chairman, Congressman Bill Foster, a former scientist, kept coming back to a related challenge — the implications of a concentration of business among the most powerful players in the market. Scale will allow the biggest investment firms to process more data, find more correlations and thus improve their returns, he said. 

“It’s a reflection of the winner-takes-all nature of digital economies,” added Mr Foster. “As more of finance becomes digitised, you’re going to see more and more of the rewards go to a smaller and smaller number of dominant players.”

He is not alone in this view. In a speech this month Mark Yallop, chair of the FICC Markets Standards Board, and a former executive at interdealer broker ICAP, tackled the same problem. 

The way in which machine-learning models improve — by accessing more data — will benefit those who have the biggest budgets, said Mr Yallop. This “may well in turn create very high barriers to entry for new firms”, he added.

We have already seen glimpses of this future. New technology helped high-frequency traders to break open banks’ dominance of share trading. Their algorithms are able to fire off millions of deals a day without human intervention. The race to be the fastest and smartest has squeezed out all but a handful of big players such as Virtu Financial, XTX Markets and Citadel Securities.

Markets have also fundamentally changed in the past decade, as improving technology cuts transaction costs. The Bank for International Settlements illustrated on Sunday the extent to which investment managers were becoming active players in the repo and interest rate derivatives market, a world traditionally dominated by investment banks. 

Gross derivatives positions for asset managers and leveraged funds in three-month eurodollar contracts on the CME, the most liquid global interest rate benchmark, grew 37 per cent in the three years to April. By comparison, banks’ positions rose 18 per cent.

Some fear that a greater degree of computer-driven trading will lead to crowded trades. Mr Yallop warned that the rise of algorithms will “make markets more fragile to unforeseen shocks and more interconnected, as multiple users depend on a limited number of underlying data relationships”. And those users will depend on a limited number of banks to act as market buffers. 

The past decade has also seen many investment banks drastically curb their daily trading activity, affecting even the most liquid securities. An academic study published last week by Albert Menkveld and Boyan Jovanovic found that even for the SPDR S&P 500 ETF Trust — an exchange traded fund that is the world’s most-traded equity security — liquidity has suffered on some measures since the financial crisis.

Meanwhile, the number of banks and other intermediaries active in various markets has dropped sharply, Mr Menkveld and Mr Jovanovic found. In 2007, about 50 institutions were willing to facilitate trading in that S&P ETF. By 2018, the number had dwindled to just 10.

Market “depth” for the security, judged by the number of shares available within half a per cent of the best bid price, declined from more than 2m shares in 2007 to under 200,000 in 2018. Mr Menkveld highlighted the impact of the Volcker rule, which prevents banks trading on their own account. “Regulation does seem to matter, even in what supposedly is a perennially liquid security,” he said.

Collectively the BIS and academics’ findings raise the question of where the big computer-driven investors of tomorrow will turn when they need a counterparty to their trades — and what happens in the market if that source is suddenly switched off.

The BIS hinted that these conditions affected US repo in September, where rates fluctuated rapidly. That should be a warning to the wider capital markets. As digital trading evolves, the balance between competition, market stability and liquidity will be a critical test — for hedge funds, investment banks and regulators alike.

Brexit Is Going to Get Done. But on Whose Terms?

Boris Johnson’s victory has drawn in millions of former Labour voters whose vision of Brexit is far different from the Conservative establishment’s.

By Mark Landler


In a victory speech on Friday, Prime Minister Boris Johnson of Britain said his Conservative Party “cannot, must not, must not” let down its new supporters.Credit...Neil Hall/EPA, via Shutterstock


LONDON — Prime Minister Boris Johnson’s landslide election victory Thursday clarifies British politics in one important respect: Efforts to reverse the Brexit referendum are now dead. Britain will leave the European Union next month. But on what terms it will do so remains unclear, perhaps even more so in the wake of the election.

Mr. Johnson’s Conservative Party rode a wave of frustrated working-class voters to a decisive majority in Parliament, radically realigning British politics and reshaping Britain’s oldest party. Crucially, that new coalition of voters may also shape the trade agreement that Mr. Johnson must now negotiate with Europe — and hence, the nature of his Brexit.

The voters who gave Mr. Johnson the largest Conservative majority since Margaret Thatcher share few of the free-trade or deregulatory instincts of the Brexiteers who masterminded Mr. Johnson’s campaign or filled his last cabinet. These voters want safe jobs, protection from imports and the restoration of a Britain that vanished in the contrails of the global economy.

That is worlds away from the agile, economically open, lightly regulated Britain that Mr. Johnson’s Downing Street brain trust envisions — Singapore-on-Thames, to use their preferred marketing slogan. Reconciling those two models will be difficult, if not impossible, even for an ideologically flexible prime minister.

“It’s the abiding conundrum of Brexit,” said Tony Travers, a professor of politics at the London School of Economics. “The Conservatives have now become the party of those left behind by the forces of globalization while also being the party of free trade. All Boris Johnson has to do is satisfy both.”

Mr. Johnson appeared to grasp the challenge. In his ebullient victory speech on Friday morning, the prime minister said he recognized that his new backers across the old Labour heartland in Britain’s Midlands and north were not natural Tories. They are better described as a disaffected rump of Labour Party loyalists, many of whom backed Brexit in 2016 and only “lent” the Conservatives their votes this time around as a way to get the job done.

The prime minister promised to govern as a big-tent Conservative, forsaking the austerity of his Tory predecessors in favor of a social democratic-style spending binge, earmarking billions of pounds to bolster Britain’s schools and the National Health Service, hire 20,000 police officers and build vast public works projects.

“In winning this election, we have won votes and the trust of people who have never voted Conservative before, and people who have always voted for other parties,” Mr. Johnson told a cheering crowd in suburban London. “Those people want change. We cannot, must not, must not, let them down.”

Spending money is likely to be the least of Mr. Johnson’s challenges. He is a political chameleon with few fixed principles and an instinct, honed during his years as the mayor of London, to govern from the center. There is support across the political spectrum for an end to austerity, even at the price of ballooning deficits. But the coming negotiation with Brussels will force him into painful trade-offs that cannot be papered over with promises of more money for schools and hospitals.

“Johnson’s entire pitch domestically is the antithesis of Singapore-on-Thames,” said Thomas Wright, director of the Center on the United States and Europe at the Brookings Institution. “He doesn’t have a mandate to eviscerate regulation, and they’ve never faced that contradiction before.”

The Conservative Party has united around a vision of Brexit that would deepen those contradictions by diverging sharply from the European Union. Mr. Johnson’s withdrawal agreement, which will now sail through Parliament, hews to a hard-line version of Brexit, eschewing participation in the European single market or customs union. The idea is for Britain to develop its own free market.

Mr. Johnson has until the end of 2020 to hammer out a trade deal with the European Union, an almost impossibly brief time to fashion a bespoke agreement. If he continues to refuse to ask for another extension, as he vowed during the campaign, Britain could yet end up having to trade with Europe on World Trade Organization terms — the equivalent of a no-deal Brexit.

Such a scenario, experts said, would devastate Britain’s automakers, not to mention other manufacturing industries. That would reverberate through the industrial strongholds that the Conservatives carried on Thursday.

The new members of Parliament from those districts insist they will be able to curb Mr. Johnson’s worst impulses. “We can hold their feet to the fire,” said Lee Anderson, a Conservative who won a longtime Labour seat in the Midlands district of Ashfield. “A Tory candidate in the south is not a Tory candidate in the north.”

That could set up an intraparty battle with an intellectually muscular contingent of Brexiteers who have spent years sharpening their ideas. Some of those people belong to the European Research Group, a hard-line faction that once exerted outsized influence over Mr. Johnson, holding him to his pledge not to extend negotiations with Brussels.

In his last government, Mr. Johnson surrounded himself with ministers who codified their free-market, deregulatory principles in a 2012 book, “Britannia Unchained.”

But the election results have changed the dynamic in Parliament. Fortified with a 79-seat majority, Mr. Johnson can now afford to brush aside the hard-line Brexiteers in his party, should he so choose. A major indication of his intentions could come when he shuffles his cabinet after Christmas.

If, for example, he replaces ministers like Dominic Raab, a co-author of “Britannia Unchained” and the current foreign secretary, with more centrist figures, it could suggest that Mr. Johnson will pursue a softer Brexit.

Mr. Johnson also has to contend with resurgent nationalist movements in Scotland and Northern Ireland, both of which fiercely oppose Brexit and could use that as grounds to break away from the United Kingdom.

Irish nationalists won more seats in Westminster than the pro-Britain unionists of Northern Ireland did. A vocal proponent of Brexit, Nigel Dodds of the Democratic Unionist Party, lost his seat. In Scotland, the Scottish National Party won 48 of 59 seats, leading the party’s leader, Nicola Sturgeon, to demand powers to call another referendum on Scottish independence.

The prime minister could be swayed as well by the fact that, however resounding his parliamentary victory, Britain remains deeply divided about Brexit. Indeed, parties that either oppose Brexit or want to rethink Britain’s departure won 52 percent of the total votes cast, while the Conservatives and other pro-Brexit parties won only 46 percent.

For the hundreds of thousands who thronged the streets of London to demand a second referendum, this election will be a bitter pill to swallow. Although the groups that campaigned for a do-over never found a narrative to counter Mr. Johnson’s call to “Get Brexit Done,” they are likely to mutate into some kind of “rejoin movement” that will continue to agitate.

Some analysts, however, are skeptical that Mr. Johnson will reverse course on Brexit. For one, agreeing to a closer alignment with the European Union would impose economic costs on Britain that would make it politically unpalatable for the Conservative Party. Moreover, Mr. Johnson is unlikely to pick a fight with his party’s establishment.

“Boris is part of the establishment,” Mr. Wright of Brookings said, “and Brexit is largely a Conservative establishment project.”

In his victory speech, Mr. Johnson voiced little sympathy for those who pined for a second referendum.

“This election means that getting Brexit done is now the irrefutable, irresistible, unarguable decision of the British people,” he declared. “I think we’ve put an end to all those miserable threats of a second referendum.”

Still, while Mr. Johnson made it clear what he is against, he has not clarified exactly what he is for when it comes to Brexit.

“We don’t know what he wants, which is remarkable after such a hard-fought election,” said Anand Menon, a professor of European politics at King’s College London.

Economic Growth Is the Answer

While rising inequality – a problem that the data suggest is real but overstated – has moved to the center of public debate, the key issue is that living standards are not improving fast enough among those who are falling behind. It is this fact that is fueling much of the political tension across advanced economies today.

Michael J. Boskin

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STANFORD – December is usually a time for looking back on the past year and forward to the year ahead. In 2019, we have witnessed rising political extremism (on both the left and right) and polarization, increased government instability, and growing tensions between central and subnational governments.

Each trend will continue in 2020. Almost everywhere one looks, there is a growing gap between what people demand of governments and what governments can deliver. The reasons vary, but a significant underlying cause explains many of the grievances: sluggish economic growth.

While rising inequality – a problem that the data suggest is real but overstated – has moved to the center of public debate, the key issue is that living standards are not improving fast enough among those who are falling behind. In the United States, the policies being proposed to address this issue include much higher marginal income-tax rates, a large tax on wealth, and massive new entitlements and subsidies, implying larger deficits and far more government control of the economy.

Unfortunately, this policy mix promises to reduce, not increase, living standards. To expand the economic pie, allowing people and firms to interact freely in markets is a much better option than relying on government planners or bureaucrats. The government’s role should be limited to setting and enforcing fair rules of the game.

In the US, per capita after-tax income is 50% higher than that of the Scandinavian social democracies, which fund their welfare states through high regressive consumption taxes on the middle class. Unwilling to accept that reality, commentators on the left claim that inequality itself is the cause of slow growth. Noting that the wealthy tend to save a greater proportion of their income, they argue that more downward redistribution would boost consumption and therefore growth.

But this argument is a minor consideration applicable only in the context of a long-running recession. In a fully employed economy, savings are needed to finance investment, which in turn boosts productivity – output per work hour – and wages. Moreover, there are other ways to increase low incomes that do not impair the savings-investment engine; prime examples include investments in education and job training.

President John F. Kennedy famously quipped that “A rising tide lifts all boats.” Obviously, that claim is somewhat hyperbolic; but even if growth cannot lift all boats all the time, it clearly lifts the most, and leaves the fewest stranded or sunk. In today’s context, stronger US growth has tightened the labor market, such that wages for low earners are rising faster than those of any other cohort. Unemployment is at a five-decade low, and at an all-time low for African-Americans and Hispanics.

Nonetheless, we need even stronger economic growth to alleviate the pressure for radical economic and political reform. There is an ongoing debate about whether the slowdown in productivity growth of the past 15 years reflects long-term structural forces or something else.

The pessimistic camp – which includes, most notably, Northwestern University economist Robert J. Gordon – argues that the productivity-enhancing effects of recent technological advances fall far short of those associated with earlier technologies such as electricity, indoor plumbing, and the automobile.

Optimists, meanwhile, point to nanotechnology, precision biomedicine, and artificial intelligence as likely harbingers of a new era of technology-driven gains. The next “killer app,” they argue, may be impossible to predict, but history suggests that one will emerge, as it always has.

Besides, the main commercial value derived from a new technology is not always what the inventor had in mind. James Watt’s original intention was not to usher in steam-driven railroads, but to create a method for pumping water out of coal mines. Guglielmo Marconi sought to compete with the telegraph in the domain of point-to-point communication, without envisioning that his efforts would lead to broadcast radio. Legend has it that Thomas Edison sued to prevent the phonograph from being used to play music (its original intended purpose was to help the blind).

Another complication concerns the measurement of productivity, real (inflation-adjusted) GDP, and inflation. Consider the US, where an ever-larger share of the economy – 70% of the private sector – comprises hard-to-measure services, rather than goods production. For decades, well-documented changes in quality, new products, and substitution biases have understated growth and overstated inflation. And improvements by statistical agencies have only partly overcome this problem.

The proliferation of (putatively) free services – social media, video calls, search engines, email – pose new measurement issues. GDP captures the total value of goods and services at market prices. But if the market price is zero, that value goes uncounted, unless one uses an alternative measure, such as the advertising revenue that subsidizes the service.

What would consumers be willing to take as compensation for doing without a given free service?

To answer such questions, Erik Brynjolfsson of MIT and Erwin Diewert of the Vancouver School of Economics conduct experiments in which participants are asked whether they would give up a service in exchange for a low-probability chance of winning some modest amount of money.

In the case of Facebook, Brynjolfsson and his colleagues conclude that the value of the service – based on an estimated “marginal willingness to go without” – is three times the company’s advertising revenue. Obviously, such estimates are preliminary. Abstaining from a service for a month in exchange for something similar to a lottery ticket offers a reasonable approximation of value only under very strong assumptions. In the meantime, academics and government statistical agencies will continue working on methods to improve existing measures.

In any case, it is still unclear whether the value of new technologies is being undercounted more than it was in the late 1990s, when a commission I led estimated that quality improvements and new-product biases accounted for about three-quarters of one percentage point (of a total of 1.1%) per year in overstated cost-of-living increases.

Of course, one hopes that the optimists are correct. But if productivity gains are and will remain meager, as the pessimists warn, economic policymakers at the national and international levels should act accordingly. Achieving faster long-run growth must be the top priority.


Michael J. Boskin is Professor of Economics at Stanford University and Senior Fellow at the Hoover Institution. He was Chairman of George H. W. Bush’s Council of Economic Advisers from 1989 to 1993, and headed the so-called Boskin Commission, a congressional advisory body that highlighted errors in official US inflation estimates.

The Parasite Devours Its Host, Part 2: French Pensions

by John Rubino



Criticizing the “public sector” is tricky, because teachers, firefighters, cops and bus drivers are by-and-large great people doing hard things that benefit the rest of us.

But there’s this problem, which is that once a country’s public sector grows beyond a certain size, it takes on a life of its own, demanding more resources even as the money to fund that growth runs out.

Elected officials find that they have no choice but to increase pay and pensions and eschew reforms that might make those increases manageable. Taxpayers and financial markets eventually crack under the strain, and an epic battle ensues between public and private sectors that ends in some version of national bankruptcy.

Most developed countries are already beyond the point of no return, and the rest are headed that way fast. Which brings us to France with its 42 different government-funded pension programs, some which are truly sweet deals. Train drivers, for instance, can retire in their early 50s and collect a lifetime pension of around $40,000 per year. Say a typical driver starts working at 20 and retires 33 years later at 53, then lives into his 80s; he’ll have spent as much time on the taxpayer dime as he did working.

Pensions consume 14% of French GDP, crowding out spending that could otherwise go to roads, bridges, medical research and other productivity enhancements. Unfunded liabilities – funds the government doesn’t have but will have to come up with to make good on future promises – are soaring, which means the hole is getting deeper. Just based on these numbers, a systemic breakdown looks both inevitable and imminent.

French president Emmanuel Macron wants to rationalize the system by combining the current mess into a single universal government pension with benefits lower than the top current plans but higher than the bottom ones, and a retirement age more in line with other (still extremely generous) European countries.

Public sector unions want none of this and have taken to the streets, picking up where the Yellow Vest protestors (who by the end didn’t even know why they were out there) left off. Trains aren’t running, roads are closed, and the government is scrambling to find a quick solution.

Here’s how this ends: A deal of some sort gets done, both sides claim to be happy, but the debts keep mounting and the drift towards national bankruptcy continues.