Risk and Return: Snookers

Snooker players have to be very good at maths. When building breaks, it helps them if they can determine how many points remain on the table when making a choice of next shot (and subsequent ones). When in deficit, maths is all important in terms of how many snookers a player needs.

What is perhaps less well appreciated is the strategy involved, and the attitude towards risk. Every decision has some risk attached to it, but also some potential return (with some probability). Each pot could be missed, each positional shot could turn out badly. The more difficult the pot, the less likely that the next position the player finds themselves in is a good one.

Ronnie O’Sullivan, one of the most successful, controversial and flamboyant players of our generation, is being criticised for a sensible decision when faced with risky options. Having built a large break (putting the frame beyond doubt) of solely reds and blacks, Ronnie had the choice between a tricky black and an easier pink. Taking the black would keep him on course for a maximum break of 147, a highly prized outcome. Taking the pink would remove the 147 as an option, but leave him on for a 146, still overwhelmingly likely to be the highest break of the tournament (thus gaining him a prize – financial reward).

Hence this decision was one about relative risks and returns. Wisely, O’Sullivan asked about the reward for a 147 relative to a 146. He found it to be £10,000, with £2,000 for the highest break. Either pink or black potted would almost certainly get the £2,000, so it was the £10,000 that was at stake. Take a riskier black, risk getting nothing with a higher probability than taking an easier pink which yielded a higher probability of £2,000.

The moral of the story is: if we want to reward risky behaviour (which the fans and viewers love), it has to be rewarded adequately to reflect the risks involved. Rather than criticising Ronnie, we should be applauding his decision not to be recklessly risky for small rewards, something we criticised the bankers for in 2008.

Government Investment

One common criticism by those sceptical of the role of government is that attempts by governments to influence economic activity suffer from excessive delays. Hence the term “shovel ready” has quickly become part of the political vernacular since the financial crisis and economic downturn in 2008.

Today gives a great example of a project that is anything but “shovel ready”: the expansion of London (and by extension the UK’s) airport capacity. This is basically a decision on whether to build a third runway at Heathrow Airport, and as the BBC article points out, this has been being discussed now for 25 years, and commission after commission have reported on the issue. Nonetheless, the government is about to announce that yet another review is necessary, and a decision that might have been made around about now will instead happen in six months’ time.

Conveniently enough, after the forthcoming London Mayor elections.

Understandably, the Confederation of British Industry (CBI), a group that represents the interests of UK businesses, is highly frustrated by this. Yet further uncertainty on the back of 25 years of uncertainty is something that is unwelcome for business. We’ll cover investment next term, but one thing that is generally cited as a reason for firms choosing to invest is the absence (or otherwise) of uncertainty. Will firms, British or otherwise, choose to invest less in the UK at the moment given there’s still no clarity on whether or not a third runway will be built at Heathrow?

Today’s Conversation: China and FDI

Image from the Guardian 🙂

Today’s Conversation in Economics is on Chinese infrastructure investment in the UK. Last week the main announcement during an official visit to the UK of Chinese president, Xi Jinping, was a one third stake in the development of a new nuclear plant at Hinkley Point. This follows on from other recent investments, or expressions of interest, in parts of the UK’s rail network (HS2), and other infrastructure projects.

There is so much to discuss about these investments; many question why it is necessary to secure funding from China for large investment projects, particularly as interest rates remain very low (c.f. Corbyn’s People’s QE which attempts by a different (and inflationary) method to do the same thing).

It is clearly a reflection of the emerging economic power of China, which became the world’s largest economy in 2014. In addition, its regular and massive trade surpluses have left it in a position with lots of “cash in the bank”, so to speak.

With regard China’s investments in the UK (we’re 8th on its list of favourite places to invest), another criticism is that it’s nationalisation – just by China, rather than the UK: “The government will indeed put some of our most vital infrastructure under state control – but the states in question will be France and China.” Of course, the reality that China takes a one-third stake in Hinkley Point is ignored. Also ignored are the huge costs and uncertainties involves in investing such an epic amount of money (£24bn!), without knowing what the outcomes will be in however many years it is until the plant is operational.

Hence, an alternative take here is that actually, the UK does well. We get other countries to stump up the finance for a cripplingly expensive infrastructure project. The Chinese see it as beneficial, as must the UK government, else one party of the two negotiating would not agree to it, and the trade would not occur.

Two Thought Provoking Articles

In and amongst the madness of a given work day, interesting things to flash before you. Here’s two I came across today.

1) Selling Britain by the Yuan On the provocative side, but well worth thinking about. When borrowing costs are so low, why is the UK involving China in the financing of various parts of its public infrastructure? There must be an awkward question here for a Prime Minister who has described the Leader of the Opposition as a threat to the security of this nation…

2) Making the old even better off at the expense of the young is morally bankrupt Written by a Conservative (before I’m accused of bias), and makes a series of important points about the direction current government policy is moving, and the impacts it has on different generations.

What is this “Fiscal Charter”?

The main news this morning is overtly political: Labour have apparently performed a U-turn and now oppose the Fiscal Charter than the Chancellor, George Osborne, has proposed. While the U-turn is obviously a political story, and Labour is a political party with plenty of problems at the moment, the Fiscal Charter is something that very much invokes economics, and economic analysis.

What is this Fiscal Charter? Here’s what George Osborne said in his Summer Budget Speech back on July 8 2015:

Today I publish the new Fiscal Charter that commits our country to that path of budget responsibility.

While we move from deficit to surplus, this Charter commits us to keeping debt falling as a share of GDP [Gross Domestic Product] each and every year– and to achieving that budget surplus by 2019-20.

Thereafter, governments will be required to maintain that surplus in normal times – in other words, when there isn’t a recession or a marked slowdown.

Only when the OBR [Office for Budget Responsibility] judge that we have real GDP growth of less than 1% a year, as measured on a rolling four-quarter basis, will that surplus no longer be required.

So in “normal” economic times, governments must run a budget surplus – something that will be enshrined in law should it be passed through parliament this Autumn.

The budget surplus is the difference between government receipts and government spending: T-G, in econ-maths-speak. It is different from government debt, which can crudely be thought of as the cumulation of previous budget deficits – when (T-G)<0.

It seems eminently sensible that when the economy is growing, governments should not be running deficits: in the good times, governments do not need to stimulate economic activity via tax cuts and extra spending projects, and indeed they collect more in various taxes: income tax, corporation tax, VAT, and so on.

However, this next graph suggests that UK governments for centuries have not been very good at this:

gov-surplus-1700

Going back to 1700, looking at 315 years of data, in only 83 of those has the UK government run a surplus; less than a third of the time. A casual glance also shows that the positive/negative split bears no resemblance to which party, left or right, has been in power; for almost all of the 1960s and 1970s, when both major parties had spells in power, the government almost exclusively ran deficits.

Of course, this doesn’t mean that Osborne’s charter is a bad thing: if it forces governments to run surpluses, this must be a good thing for the national debt? There’s loads to say about this, and we’ll say a lot more come the Spring in EC114, but for now it’s worth pointing out that the national debt (the cumulated overspends of UK governments) is not only reduced by running a surplus; despite the UK running deficits for much of the post-WW2 period, the following graph shows that UK national debt fell from 238% of GDP in 1948 to 42% by 1980:

ukgs_line

 

So a budget surplus is not essential for reducing the national debt burden. Indeed, many argue it may even hinder this; after all, the UK economy has performed well over the last 315 years despite predominantly having a government operating a deficit. In part, this is because governments invest in public infrastructure projects that can facilitate growth: transport and telecommunications networks, for example.

And this is where Labour appears to be in a muddle about the Fiscal Charter. The Fiscal Charter as Osborne outlined makes no room even for investing in public projects, focussing only on the budget as a whole. Often we split the budget into that for current consumption and that for investment: the part for current consumption (things we spend now: benefits mainly) is referred to often as the structural balance. Labour wants to still be able to spend on infrastructure projects in the good times, whereas Osborne’s Fiscal Charter rules even that out.

More in the Spring 🙂