Posts in category FINANCE


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Recent tax reforms in America will hurt charities

DESPITE its oft-professed pro-market orthodoxy, America has always had an unusually large non-profit sector. Americans gave $390bn to charity in 2016, with the bulk of contributions coming from individual donors. Historically, revenues at non-profits tend to track GDP growth. The recent tax reforms imply that despite strong economic growth, charitable contributions in America are poised to fall for the first time since the financial crisis.

The most significant threat to charities comes from changes to income tax. American taxpayers can choose either to “itemise” specific expenses, such as charitable gifts or mortgage payments, or take a “standard deduction”. In an effort both to simplify the tax code and to lower overall tax rates, the Republican-led Congress almost doubled the standard deduction to $12,000 for individuals and $24,000 for married couples. This will make filing taxes a lot easier for many. But it also means that far fewer Americans will have a financial incentive…Continue reading

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The markets still have plenty to fret about

BULL markets always climb a wall of worry, or so the saying goes. For much of 2017, the main concerns were political and the markets seemed to surmount them as easily as a robot dog opens doors (the latest internet sensation).

But February has shown that the market is still vulnerable. The immediate trigger seems to have been the fear that inflationary pressures would cause bond yields to rise and central banks to push up interest rates; this week’s surprisingly high American inflation numbers will only add to the worries. In a narrow sense, that makes bonds look cheaper, compared with equities. In a broader sense, it increases the discount rate investors apply to future profits, lowering the present value of shares. (A caveat is needed: if higher rates reflect stronger growth, then estimates of future profits should rise, offsetting the discount-rate effect.)

The immediate effect has been to create uncertainty for investors about the direction of central-bank policy, after many years in which it could reliably be assumed that rates would stay low. This translates into a more volatile market, as illustrated by the sharp jump in the Vix, or volatility index, in early February.

The danger is that many investors seem to have treated volatility as an asset class, and have organised their portfolios accordingly. Eric Lonergan of M&G, a…Continue reading

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China’s stockmarket plunge: this time it’s different

A CHINESE new-year message from the American embassy in Beijing looked innocuous. It welcomed the Year of the Dog on Weibo, a microblog, with photos of the embassy staff’s pooches and a video greeting from the ambassador and his wife, each with a dog in hand. But it soon attracted 10,000 angry responses. The post had become an unlikely lightning rod for public discontent about the stockmarket.

A plunge on February 9th had left Chinese shares down by 10% on the week, their steepest fall in two years. Some punters found solace in blaming the American embassy for the rout, which started on Wall Street. For others it was a matter of convenience, because their real target, the Chinese securities regulator, knew to disable comments on its Weibo account on such a grim day for stocks.

Even so, their protests seem to have been heard. Before the market reopened this week, Chinese officials urged big shareholders to buy stocks to restore confidence. The Shanghai Stock Exchange warned…Continue reading

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Insider trading has been rife on Wall Street, academics conclude

The joy of knowledge

INSIDER-TRADING prosecutions have netted plenty of small fry. But many grumble that the big fish swim off unharmed. That nagging fear has some new academic backing, from three studies. One argues that well-connected insiders profited even from the financial crisis.* The others go further still, suggesting the entire share-trading system is rigged.**

What is known about insider trading tends to come from prosecutions. But these require fortuitous tip-offs and extensive, expensive investigations, involving the examination of complex evidence from phone calls, e-mails or informants wired with recorders. The resulting haze of numbers may befuddle a jury unless they are leavened with a few spicy details—exotic code words, say, or (even better) suitcases filled with cash.

The papers make imaginative use of pattern analysis from data to find that insider trading is probably pervasive. The approach reflects a new way of analysing conduct in the…Continue reading

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Wells Fargo suffers a rare punishment—a cap on assets

ON HER way out, Janet Yellen, who stood down as the Federal Reserve’s chair on February 2nd, paused to add yet another sanction to those already imposed on Wells Fargo for foisting unwanted insurance and banking products on clients. The latest punishment is a highly unusual one. Wells will be blocked from adding assets to the $2trn held on its balance-sheet at the end of 2017. Two other regulators had already imposed fines and penalties soon after the shenanigans began emerging in 2016. The bank has gone through a big reorganisation. The Fed’s belated response presumably took into account not only the errant conduct but also the political fallout. The government, as well as the bank, had been embarrassed.

At first glance, Wells is an odd target for such treatment. During the financial crisis it proved itself the best of the big banks, with relatively high underwriting standards and manageable losses. The scandal was huge—millions of clients were pushed into unwanted products. But the financial costs…Continue reading

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South-to-South investment is rising sharply

AT A meeting in Namibia last month Zimbabwe’s finance minister, Patrick Chinamasa, made a pitch to lure African investors to an economy ruined by Robert Mugabe. That he did so first in Windhoek, not London or New York, is telling. Although flows through tax havens muddy the data, 28% of new foreign direct investment (FDI) globally in 2016 was from firms in emerging markets—up from just 8% in 2000.

Chinese FDI, a big chunk of this, shrank in 2017 as Beijing restricted outflows and America and Europe screened acquisitions by foreigners more closely. But the trend of outbound investment is widespread. Almost all developing countries have companies with overseas affiliates. Most of their investment goes to the West. But in two-fifths of developing countries they make up at least half of incoming FDI. In 2015-16 the ten leading foreign investors in Africa, by number of new projects, included China, India, Kenya and South Africa.

A World Bank survey of more than 750 firms with FDI in developing countries found that those from…Continue reading

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Passive funds tracking an index lose out when its make-up changes

IS THERE hope for fund managers after all? Conventional “active” managers, who try to pick stocks that will beat the market, have been losing ground to “passive” funds, which simply own all assets in a given sector in proportion to their market value. The main advantage of the latter group is that they charge a lot less.

William Sharpe, a Nobel prizewinning economist, argued in 1991 that the “arithmetic of active management” means that the average fund manager is doomed to underperform. To understand why, assume that there are equal numbers of active and passive managers and, between them, they own all the market. The market returns 10%. How much will the passive managers earn? The answer must be 10%, before costs. The active managers own that bit of the market the passive managers don’t. But that proportion of the market must, thanks to simple arithmetic, also return 10%, before costs. Since the costs of active investors are higher, the average active manager must underperform. These…Continue reading

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Bitcoin and its rivals offer no shelter from the storm

THE “biggest bubble in human history comes down crashing,” tweeted Nouriel Roubini, an economist, gleefully. After an exhilarating ride skywards in 2017, investors in crypto-currencies have been rudely reminded that prices can plunge earthwards, too. In mid-December the price of bitcoin was just shy of $20,000; by February 6th, it had fallen to $6,000, before recovering a little (see chart).

And bitcoin is not the only digital currency to have fallen. Figures from CoinMarketCap, a website, show that the total market capitalisation of crypto-currencies has fallen by more than half this year, to under $400bn. This slide has taken place amid a flurry of hacks, fraud allegations and a growing regulatory backlash.

Perhaps the most damaging allegations surround Tether, a company that issues a virtual currency of the same name. Tether allows users to move money across exchanges and crypto-currencies without converting it back into “fiat” (central-bank-backed) money first. In theory, each…Continue reading

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The markets deliver a shock to complacent investors

EVERY good horror-film director knows the secret of the “jump scare”. Just when the hero or heroine feels safe, the monster appears from nowhere to startle them. The latest stockmarket shock could have been directed by Alfred Hitchcock. The sharp falls that took place on February 2nd and 5th followed a long period where the only direction for share prices appeared to be upwards.

In fact the American market had risen so far, so fast that the decline only took share prices back to where they were at the start of the year (see chart). And although a 1,175-point fall in the Dow Jones Industrial Average on February 5th was the biggest ever in absolute terms, it was still smallish beer in proportionate terms, at just 4.6%. The 508-point fall in the Dow in October 1987 knocked nearly 23% off the market.

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Bets on low market volatility went spectacularly wrong

THE Cboe Volatility Index, or Vix, known as the “fear gauge”, spikes when markets are most jittery. When Sandy Rattray, now at Man Group, an asset manager, worked on the Vix in the early 2000s, he and his team considered launching an exchange-traded product (ETP) linked to it, but concluded that it would be a “horror show” because of poor returns. Now, however, Vix-linked ETPs are a big industry, with around $8bn in assets. Formerly niche investments, they served vastly to exacerbate this week’s market turmoil, which saw the Vix’s largest ever one-day move, when it more than doubled on February 5th.

The Vix was always intended as a basis for financial products as well as a gauge. Vix futures were launched in 2004 and options in 2006. “Long” Vix products, which Mr Rattray looked into, seek to mirror the index . The problem is that this means buying futures contracts, with buyers having to pay a constant premium over spot prices. So these ETPs tend to lose money over time, punctuated (but not fully made up for) by gains when the Vix spikes. The largest “long” fund, VXX, issued by Barclays, has lost over 99.9% since its launch in 2009.

So other ETPs were developed to “short”—ie, bet against—the Vix index. Until this week, they were doing handsomely. Amid a long spell of subdued volatility, investors piled in. In January, assets in…Continue reading

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Central banks should gamble on productivity-improving technology

IN 1996 Alan Greenspan began asking why the flashy information technology spreading across America seemed not to be lifting productivity. He was not the first to wonder. A decade earlier Robert Solow, a Nobel prizewinner, famously remarked that computers were everywhere but in the statistics. But Mr Greenspan was uniquely positioned, as the chairman of the Federal Reserve, to experiment on the American economy. As the unemployment rate dropped to levels that might normally trigger a phalanx of interest-rate rises, Mr Greenspan’s Fed moved cautiously, betting that efficiencies from new IT would keep price pressures in check. The result was the longest period of rapid growth since the early 1960s. Despite his success, few central bankers seem eager to repeat the experiment and many remain blinkered to issues other than inflation and employment. That is unfortunate. A little faith in technology could go a long way.

Central bankers are not known to be a visionary bunch. Turning new ideas into more…Continue reading

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A big Blackstone deal shows how private equity has changed

THE financial crisis a decade ago brought the glory days of private equity to a screeching halt. The debt-fuelled megadeals on which the industry had built its fame (or notoriety) seemed over. But on January 30th a group of investors led by Blackstone, the world’s largest private-equity firm, announced a $17bn deal to carve out Thomson Reuters’ financial and risk business (F&R), a financial-data provider. The deal would be Blackstone’s largest since the crisis. But if the megadeal is making a comeback, it is in a new guise.

In the mid-2000s, huge transactions abounded. Deals from 2006 and 2007 alone account for nine of the ten largest ever. But, looking purely at value, the only true drought in big deals was from 2008-12. Every year since 2013 has seen at least one buy-out of more than $10bn, according to the private-equity database of Thomson Reuters F&R itself.

But in many of these deals private-equity firms have taken the unfamiliar role of companions to corporate acquirers. In a $23.5bn deal in 2013 to acquire Heinz, Berkshire Hathaway, a conglomerate, split ownership equally with 3G Capital, a Brazilian private-equity firm. Even private-equity led acquisitions are today much more likely to involve institutional investors or corporations, rather than other private-equity firms. The consortium that Bain Capital cobbled together last year…Continue reading

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Cancer is a curse, but also a growth market for investors

CANCER is a grim sort of growth market. By 2030 there will be over 22m new cases a year, up from 14m in 2012, according to the International Agency for Research on Cancer. But as the world marks World Cancer Day, on February 4th, scientists are speaking of a revolution in the battle to beat it. Money managers’ ears have pricked up. Oncology investing is “hot”.

The most straightforward way to invest in treating cancer is through shares in companies that sell blockbuster drugs. Alternatively, biotech indices track a basket of companies, of which typically 40% are oncology-related. Big Pharma now buys rather than builds much of its innovation. So backing oncology startups can be an especially lucrative (if risky) approach. According to CB Insights, a research firm, equity investment in cancer-therapeutics startups has grown from $2bn in 2013 to $4.5bn in 2017. Take Juno Therapeutics, founded in Seattle in 2013 to develop immunotherapy drugs. It was acquired on January 22nd by Celgene, a Biotech giant, for a whopping $9bn.

Eric…Continue reading

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Might higher interest rates spoil America’s economic boom?

AMENDING a famous metaphor, Janet Yellen once said that the Federal Reserve would “keep refilling the punch bowl until the guests have all arrived”. This week investors began to wonder if Jerome Powell, who will shortly succeed Ms Yellen at the top of the Fed, might at last deem the party full. On January 29th the ten-year Treasury yield reached 2.7%, the highest since early 2014. The prospect of tighter money caused stockmarkets to sneeze. On January 30th the S&P 500 fell by 1.1%, its biggest decline since August, before recovering a tiny bit the next day. With unemployment low and tax cuts pending, investors are wondering whether inflation and interest rates might soon surge.

The economy grew by 2.5% in the year to the fourth quarter of 2017. According to Okun’s law, a rule of thumb relating unemployment to GDP, falling joblessness explains almost half of this growth. (The unemployment rate fell from 4.7% to 4.1% over the same period.) Early in the year inflation fell short, suggesting that fast growth could continue unabated. But pressure on prices has begun to build. Quarterly core inflation, which excludes volatile food and energy prices, was only just below the Fed’s 2% target at the end of 2017. Markets have recently come to believe rate-setters who say that they will tighten policy three times in 2018 (see chart), as happened in 2017.

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Cars block the road to a renegotiated NAFTA

ROBERT LIGHTHIZER, the United States Trade Representative, wants renegotiation of the North-American Free Trade Agreement (NAFTA) to speed up. When the sixth round of talks ended on January 29th with only three chapters agreed, he griped: “We owe it to our citizens, who are operating in a state of uncertainty, to move much faster.” But given the changes he wants, any more speed risks a crash.

One of the biggest fights is over Mr Lighthizer’s desire to rewrite NAFTA’s rules about cars. Seen one way, the deal has been a boon for the industry. Trade in vehicles and their parts accounts for a quarter of America’s two-way trade with Mexico and Canada. But NAFTA’s critics see it as a big reason for America’s trade deficit with Mexico, and for its falling share of car assembly (see chart). Rules riddled with holes should be rewritten, they think, to yank back American jobs.

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A safe asset is devised for the euro zone

THESE are bright days in the euro area. Preliminary figures say that the currency zone’s GDP grew by 2.5% last year, the fastest since 2007. But many of the faultlines in the zone’s financial system, as revealed by the financial crisis, remain. A proposal published on January 29th by a group reporting to the European Systemic Risk Board, a prudential supervisor, may mend one of the more troubling flaws.

Euro-area banks favour their home countries’ debt. A sample of 76 lenders examined by supervisors last year had exposures of €1.7trn ($1.9trn) to euro-area governments, of which €1.1trn was lent to their home states. That exceeded the banks’ common equity tier-1 capital, their cushion against losses, of €1trn. The fortunes of states and banks are thus bound in a “doom loop”. Suppose an economic shock raises the risk of a sovereign default. Banks’ balance-sheets start to crumble. They need propping up by the already wobbly state. And as they cut lending, the real economy weakens,…Continue reading

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Why sub-zero interest rates are neither unfair nor unnatural

DENMARK’S Maritime Museum in Elsinore includes one particularly unappetising exhibit: the world’s oldest ship’s biscuit, from a voyage in 1852. Known as hardtack, such biscuits were prized for their long shelf lives, making them a vital source of sustenance for sailors far from shore. They were also appreciated by a great economist, Irving Fisher, as a useful economic metaphor.

Imagine, Fisher wrote in “The Theory of Interest” in 1930, a group of sailors shipwrecked on a barren island with only their stores of hardtack to sustain them. On what terms would sailors borrow and lend biscuits among themselves? In this forlorn economy, what rate of interest would prevail?

One might think the answer depends on the character of the unfortunate sailors. Interest, in many people’s minds, is a reward for deferring gratification. That is one reason why low interest rates are widely perceived as unjust. If an abstemious sailor were prepared to lend a biscuit to his crewmate rather than…Continue reading

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Direct-lending funds in Europe

WHEN Caronte & Tourist, a Sicilian ferry company, needs a new ship, it is cheap and easy to borrow from a bank. But in 2016, when Caronte’s controlling families wanted to buy back the minority stake held by a private-equity firm, banks balked at the loan’s unusual purpose. Edoardo Bonanno, the chief financial officer, also worried that the €30m ($33m) in extra bank debt might make shipping loans harder to obtain from them in future. So he turned instead to a direct-lending fund run by Muzinich & Co, an asset manager.

Such funds are only about a decade old in Europe (and not much older in America, where they started). Assets under management at Europe-focused funds increased from a mere $330m at the end of 2006 to $73.3bn by mid-2017, which includes $27.9bn of “dry powder”, or funds yet to be lent out (see chart). In 2017 alone 24 direct-lending funds raised a record $22.2bn. Such funds do what they say on the tin: lend directly to firms, usually in the form of big, multi-year loans. The borrowers are often either companies that are too small to raise equity or debt on capital markets, or private-equity funds buying such firms.

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How microcredit can help poor countries after natural disasters

Small pots of liquidity

BOTH, in different ways, worry about liquidity. And global warming may, indeed, be bringing meteorologists and financiers together. On January 18th, VisionFund, a microlending charity, and Global Parametrics, a venture that crunches climate and seismic data, launched what they billed as the “world’s largest non-governmental climate-insurance programme”. The scheme will offer microfinance to about 4m people across six countries in Asia and Africa affected by climate-change-related calamities.

Natural disasters are becoming more frequent and severe. They disproportionately affect poor countries, where many eke livings from vulnerable agricultural land. Yet it is often in the aftermath of disaster that credit is hardest to obtain. As non-performing loans rise and the perception of risk increases, microfinance institutions (MFIs) rein in lending; they receive little support from donors and relief programmes, which tend to favour humanitarian aid….Continue reading

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Financial regulators too often think “this time is different”

FOR a phenomenon with such predictably bad outcomes, a financial boom is strangely seductive. Not a decade after the most serious financial crisis since the Depression, the world watches soaring markets with a mixture of serenity and glee. Natural impulses make finance a neck-snappingly volatile affair. Governments, though, deserve heaps of blame for policies that amplify both boom and bust. As regulators begin picking apart reforms only just enacted, it is worth asking why that is so.

Finance is hopelessly prone to wild cycles. When an economy is purring, profits go up, as do asset values. Rising asset prices flatter borrowers’ creditworthiness. When credit is easier to obtain, spending goes up and the boom intensifies. Eventually perceptions of risk shift, and tales of a “new normal” gain credence: new technologies mean profits can grow for ever, or financial innovation makes credit risk a thing of the past. But when the mood turns, the feedback loop reverses direction. As asset prices fall, banks grow stingier with their loans. Firms feel the pinch from falling sales, get behind on their debts and sack workers, who get behind on theirs. The desperate sell what they can, so asset prices tumble, worsening the crash. Mania turns to panic.

The pattern is an ancient one. In their book “This Time is Different”, Carmen Reinhart and Kenneth Rogoff,…Continue reading

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Morgan Stanley’s unexciting model takes the prize on Wall Street

MORGAN STANLEY emerged in 1935 out of a global financial disaster, as one of Wall Street’s leading firms. In a rare shred of consistency in America’s turbulent markets, history has repeated itself. But it was a close call. An ill-timed infatuation with debt ahead of the 2007-08 financial crisis threatened to add it to the industry’s towering funeral pyre, which consumed all its big competitors with the exception of Goldman Sachs.

Of the two, Morgan Stanley came out of the crisis the more tarnished, less for what it did than for what it was: less profitable; less connected, through its former employees, to political power; and less respected for having evaded disaster. But after the release of financial results from the fourth quarter of 2017, Morgan Stanley’s valuation has surpassed Goldman Sachs’s. This reflects not only the improvement in its profitability but also investors’ greater confidence in how it is managed.

Goldman, with some justice, finds the comparison unfair….Continue reading

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Monetary policy suffers a shortage of central bankers

IN THEIR quest to stabilise the job market, central banks are setting a bad example. Jerome Powell, whom senators this week confirmed as the next chairman of America’s Federal Reserve, will lead an institution with three existing vacancies on its seven-member board, and a fourth that will open up imminently. Not since July 2013 has its rate-setting committee boasted the full complement of 12 voting members.

This monetary undermanning is, however, much worse in Nigeria. Its monetary-policy committee was unable to meet as scheduled on January 22nd-23rd because it lacked the six members necessary for a quorum. Five recent nominees still await confirmation by the country’s Senate. The chamber is holding up all but a few executive appointments in retaliation for President Muhammadu Buhari’s failure to remove an official (the acting anti-corruption tsar) whom the Senate twice rejected. In the absence of a monetary-policy meeting (and the lengthy communiqué that eventually follows it), the central bank…Continue reading

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The French government experiments with venture capitalism

Don’t be coy, carp about the food

AS A boy, Antoine Hubert used to catch butterflies. These days, the agro-engineer has eyes only for meal worms. In a demonstration factory near Dole in eastern France, he shows how trayfuls of plump, half-grown worms are fed, left to grow in a darkened dormitory, and then—after two months—slaughtered and cleaned with a blast of steam. A machine divides the resulting mush into oil and protein powder.

Around 70% of a worm is protein, making it ideal for animal feed. Demand is soaring, notably at fish and shrimp farms. Mr Hubert predicts aquaculture businesses will need 70m tons of feed annually in ten years’ time, up from 40m now. The global market for animal feed, he reckons, is already worth €500bn ($610bn).

Ynsect, his firm, thus expects to grow once it opens a new factory this year. He dreams of annual output exceeding 1m tonnes, hinting at a hunger for scale often left unsatisfied in a French entrepreneur: local…Continue reading

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The World Bank’s “ease of doing business” report faces tricky questions

HOW many days does it take to correct a misleading newspaper interview? Four, in the case of Paul Romer, the World Bank’s chief economist. On January 12th a surprising article in the Wall Street Journal alleged that one of the bank’s signature reports—on the ease of doing business around the world—may have been tainted by the political motivations of bank staff. The story was based on an interview with Mr Romer, who pointed out that Chile’s ranking in the yearly report had dropped sharply during the presidency of Michelle Bachelet, a left-leaning politician who took office for the second time in 2014. Chile sank so heavily not because doing business had become harder, but because the bank had repeatedly changed its method of assessment.

That method mostly entails answering measurable questions, such as how many days does it take to start a business, register a property or file taxes. The answers determine a country’s score (known as its “distance to…Continue reading

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Why driverless cars may mean jams tomorrow

THE most distractingly unrealistic feature of most science fiction—by some margin—is how the great soaring cities of the future never seem to struggle with traffic. Whatever dystopias lie ahead, futurists seem confident we can sort out congestion. If hope that technology will fix traffic springs eternal, history suggests something different. Transport innovation, from railways to cars, reshaped cities and drove economic advance. But it also brought crowded commutes. Now, as tech firms and carmakers aim to roll out fleets of driverless cars, it is worth asking: might this time be different? Alas, artificial intelligence (AI) is unlikely to succeed where steel rails and internal-combustion engines failed.

More’s the pity. In America alone, traffic congestion brings economic losses estimated in the hundreds of billions of dollars each year. Such costs will rise unless existing transport systems receive badly needed investment. For example, fixing New York’s beleaguered, overcrowded subway will…Continue reading

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