In a recent posting I queried the relative merits of macroeconomic management by Central Banks. I suggested that inflation targets were confounded by targets contractually outside the box like asset prices: And asked if Banks which target, say, stable prices achieve that objective better than those who do not.

As Bill Thomson, formerly VP of Asian Development Bank and now an adviser to Franklin Templeton International, said in a personal response:

“Of course, these discussions avoid the wider discussion of what inflation is and how it should be measured. The measures have changed dramatically over time and vary widely from country to country. The US CPI is especially vulnerable to the charge of being a politically charged figure. Since the CPI has major budgetary implications, in that many expensive government programs (including social security) are indexed to it, the government has a vested interest in holding inflation adjustments down”

Some market observers believe that the CPI may understate the true level of the US by as much as 5 percentage points.

More generally what is the point of this elaborate game in which a Central Bank with some independence is charged with meeting a target which keeps being changed by a Government preoccupied with short term politics? In Britain the Treasury is in constant conflict with the ONS on issues of measurement. Allowances may be made for increasing quality of items in the CPI (such as computers) of little interest those who use them as typewriters.

Anatole Kaletsky highlighted this in the Times:

the Federal Reserve Board strips energy prices out of its calculations of core inflation. Thus there is no risk that US monetary policy might be damagingly tightened by over-zealous central bankers in a panic response to soaring oil prices.

and

Although the European Central Bank suggested last week that it did not see an inflationary threat from temporary shortages of oil, it continues to include energy prices in its main indicators of inflation, leaving its monetary policy hostage to shocks such as Hurricane Katrina.

Is EU macroeconomic policy in a mess or what? Probably, but perhaps no more than the EU is already in.

Although some commentators suggest that hurricane Katrina will have a bigger economic impact than 9/11, there are many reasons why it need not. Anatole Kaletsky (Times) sees the US economy as robust enough to withstand the shock without much difficulty, and thinks the main threat will be to the eurozone economies.

the US, a powerful economy with annual output worth over $11 trillion (£6 trillion), growing at 3 to 4 per cent, locked through free trade and deregulated financial markets into a global economy that produces at a $50 trillion annual rate, will hardly miss a beat from the $50 billion losses estimated along the Gulf Coast.

There will be a slowdown caused by the drop in production and consumption in the area, but this will soon be regained by faster growth. There will be a surge in spending on construction and on flood defences, and the US deficit might rise a little. Lost oil production will be offset to some degree by the release of international reserves, and since energy prices are not part of the US core inflation index, they need not change monetary policy.

Why does Kaletsky see danger for Europe? Some of it lies with the central bank. Energy is included in their inflation measure, so higher oil prices will make interest rate cuts less likely. And Kaletsky sees the eurozone as finely balanced between a fall back into recession and a fragile recovery. The impact of higher oil prices and a fall in consumer confidence might tip the balance downwards.

A eurozone recovery depends to some extent on their embrace of more economic flexibility and freer labour markets, prompted by the election of Merkel in Germany, and, later, of Sarkozy in France. Kaletsky suggests that the hurricane and its disorderly aftermath might even influence those elections. What the eurozone seems unable to grasp is that the necessary reforms are most likely to occur in a growing economy with active monetary management, as was true of 1980s Britain. When individual members of the zone lack monetary autonomy, they lack one of the ingredients of successful reform. Katrina, from which the US should recover with scarcely a flicker, could undermine the fragile recovery which some see in the eurozone countries.

Christopher Fildes has a very funny column in the Telegraph, devoted to the discipline of hedonomics, or the dismal science with its own happy ending, as he calls it. When shares have gone up you can report that they are rising. When they have gone down you can report that they are cheap to buy. All news is good news is the basis of hedonomics, as practiced by our Chancellor, among many others.

This is the newly identified branch of economics which exists to show that every story has a happy ending. As so often happens, practice has been running far ahead of theory. Chancellors work on it, deal-makers live by it, tycoons try their luck with it. In the stock market, hedonomics finds its natural home.

Deal-makers profit from deals, so they talk up their advantages. Tycoons radiate optimism about what they can do for a company (in exchange for a small percentage of it). Buy! Deal! Trade! The news is always good.

Do not imagine that hedonomics is a mere phenomenon of the financial markets. Chancellors of the Exchequer have long relied on it to keep them out of trouble. It has let them describe runaway public spending as the social wage, or runaway inflation as a blip, or the frozen wastes of recession as the green shoots of recovery.

Hedonomics explains why our revised inflation index takes out housing (the biggest cost) and council tax (about to leap through the roof). Inflation as measured is better news than it feels like, and the same for the quality of our public services. As so often, the writer puts pungency into his humour.

____
[footnote:
Christopher Fildes tells us he has been writing his Telegraph columns for 21 years, and that it is time to stop. We will miss them. He combined keen economic insight with real flair. Best of all, he was no respecter of powerful positions, and often treated the holders of them with skepticism and, when they deserved it, with scorn. Yet he leavened his humour with courtesy. Nobody did it better.]

Two letters in the FT [29.August] summarize a dilemma for the art of Central Banking

John Leslie favours Keynesian intervention in a period of longer-term declining inflation with some risks of deflation, but with high inflation in the 1970s a New Classical approach did better.

"… it depends on the long-term price trend and the presence or absence of major inflationary and deflationary risks."

Leslie thinks downward pressure on consumer prices should still allow the Keynesian approach one last shout for the next few years. My guess is this will test it to destruction.

In more alarming contrast K.R. Duncan says that in the US since 1998, it has taken $4.72 of debt growth to generate $1 of nominal GDP growth (long-term average of about $1.50 to $1). Since Mr Greenspan took office, the personal savings rate has declined from about 7.5 per cent to about 0 per cent and the money supply (here M0) has increased 334 per cent. Duncan says valid Central Bank policy must demonstrate the US economy can deliver superior growth on a foundation other than debt and dis-saving

Curiously it is not always clear what central bank policy on interest rates really is targeting. Even if contracted to target inflation CB is bound to keep one eye, perhaps appropriately enough for a one-club golfer, on asset prices, especially housing. Because motives are always fungible it is not clear how considerations outside the box affect close-argued decisions on interest rate.

Meanwhile some evidence in the EU suggests that Central Banks which fix on a single target, say inflation range, do not meet that target better than those fixed on another.

The figures have shown falls in UK house prices, which might threaten people's sense of affluence and their readiness to borrow and spend. However, as we have said before, a change in pension rules presages a tidal wave of new money into housing, money which, in the absence of new supply, can only raise prices.

The rule is for self-invested personal pensions (SIPPS). From April 6th next year, people will be able to include residential housing, including principal or second homes, plus buy-to-let housing, into their SIPP, where they had previously been limited to commercial property. Christine Seib runs the story in the Times, citing a survey by Hargreaves Lansdown.

Hargreaves Lansdown found that 37 per cent of its existing Sipps clients planned to buy a residential property with their pensions. If this percentage is extrapolated from the 140,000 people who own a Sipp, there would be more than 50,000 people willing to take advantage of the new rules.

The average Sipp property purchase is expected to be worth £195,000, which means that savers are likely to spend £10 billion on new properties, £8.5 billion of which would be spent in Britain — equivalent to about 5 per cent of the value of the UK property market.

This is a wall of money, and it may well be a considerable underestimate. If the wheels were coming off the Chancellor's economy (as the falling growth rate suggests), this could keep them turning a little longer by sustaining consumer demand. If there were to be an eventual collapse in the housing market, though, it could hit the value of people's pensions as well as their property assets. By then, of course, the Chancellor might have moved house himself, and it would be someone else's problem.

My sourcebooks disagree, but it was in July 1740, I think on this day, that Adam Smith matriculated into Balliol College, Oxford. He had won a place there as Snell Exhibitioner. His journey from Scotland, on horseback, had started in June.

There were just a handful of Scots students in Balliol at the time, and their time there was not altogether happy. Their strange dialect and manners caused them to be treated almost as foreigners.

And Smith would discover that Balliol was certainly no haven of free thought. When his (Jacobite) masters found him reading David Hume's Treatise on Human Nature, a gift to him from the author, they censured him and confiscated the ungodly book.

But at Oxford, Smith would learn something about incentives, which would form a major foundation of his subsequent views on economics. Teaching staff were salaried, whether or not their classes attracted students. At Oxford, he noted, "the greater part of the public professors have, for these many years, given up altogether even the pretence of teaching."

"The discipline of colleges and universities," he went on, "is in general contrived, not for the benefit of the students, but for the interest, or more properly speaking, for the ease of the masters."

No doubt things have changed.

Because of my own background I am often asked by would-be entrepreneurs seeking escape from life within huge corporate structures: 'How do I build a small firm for myself?' The answer seems obvious: buy a very large one and just wait.

- Paul Ormerod, author of 'Butterfly Economics' and 'Why Most Things Fail.'

The book Freakonomics by Levitt and Dubner is absorbing, and unlike any other economics book. There is no theme, but a series of insights into what the numbers tell us on the small scale.

Some are straightforward, such as the observation that if you own a backyard pool and a gun, a child is 100 times more likely to be killed by the pool than by the gun. Some are cleverly done, such as the mathematical proof that some public school teachers are cheating to give their students and their schools better grades on tests. The clue, says Levitt, is to enter the mind of a cheat. How would you do it? You would probably erase some wrong answers and fill in a series of correct ones, or fill in answers left blank. Levitt designed an algorithm to spot the cheats by the pattern their fraud left.

Some are disturbing. Why did US crime drop so sharply in the 1990s? Levitt looks at the suggested explanations, including changing demographics, more prison terms, innovative police methods, and tighter gun control. He compares time with time and state with state, remorselessly showing the degree, if any, each influence might have had. Then comes the killer punch. He suggests it was Roe v. Wade and the legalization of abortion which prevented many potential criminals from being born. Children of poor, single, young parents stand a high chance statistically of becoming criminals, and this is the very group which made big use of abortion. He compares the crime figures state by state over time to see if the high abortion states had the biggest crime drop two decades later. They did.

The authors look at human honesty through sale of bagels to business workers through the honour system (you take the bagel and leave the money). Who cheats and when? The answer is that dishonesty is more rife in big corporations, and more prevalent in the higher executive levels than with the lower workers. (Maybe that's how they got to the top? suggests Levitt mischievously). Although people have every opportunity to steal bagels undetected, the vast majority do not. They are guided by Adam Smith's impartial observer, say Levitt and Dubner, for 87 percent of the time.

These snatches convey something of the flavour of the book. It is very empirical, using precious information and data not previously available, as well as looking afresh at those which were. It is easily one of the most readable economics books ever written, as well as one of the most fascinating.

A soap bubble looks like a bubble at the time, but you can only be sure of a financial bubble once it has popped. Allister Heath (The Business) thinks US housing is in a bubble, and suggests that China and hedge funds might also be. If that isn't enough, we have nanotechnology coming along.

Housing first. In Manias, Panics, and Crashes: A History of Financial Crises, Charles Kindleberger describes a bubble as "a series of price increases that are so large as to make an asset loose all relationship to fundamentals before ultimately suffering a price implosion."

Allister Heath points out that US housing has risen 50 percent in five years, with a quarter of that in the last year alone. Moreover, he tells us, housing supply in the US, unlike Britain, is outpacing demand. It is not the only potential bubble in town.

In an important report out this weekend, Bear Stearns is warning that China, hedge funds and nanotechnology are three other areas which are already or may soon succumb to bubbleonomics and where a meltdown is likely to occur.

There have been bubbles before, like the South Sea Company and Dutch tulips, and the world recovered. Yes, but it took time and only after much chaos and ruin. This time, says Heath, it could be worse.

There have been plenty of bubbles over the past five centuries, but with the exception of the equity boom of the 1920s, none that could wreak as much devastation as the current three - if they pop. Bubblenomics has always been a mad science; but the huge sums involved today are truly frightening.

Of course, people make money when a bubble is inflating. It's just that a lot more of them lose a lot more when it pops. If you're the nervous type, get out of US housing investment, Chinese stock and hedge funds. And look the other way when nanotech becomes flavour of the month.

Stephen Davies defends the much maligned business corporation in the Freeman, published by the Foundation for Economic Education. He describes it as "the key institution of the modern world" for the way it transformed economic growth.

Historically, much growth was 'extensive,' using more land or more people to gain more production. It is 'intensive' growth, which uses resources and labour more efficiently, which leads to a real increase in output per capita, and hence to a rise in living standards. For much of history, its main source was the specialization brought about by trade. Called 'Smithean' growth after Adam himself, it kept to about 1 percent per annum compounded.

That compound rate went to 2 percent a year and more from about the middle of the 19th century. "Technological innovation became systematic and rapid," Davies tells us. They spread more widely, too. The key was the lowering of transaction costs, "the costs of finding the other party to a transaction, making and enforcing the contract, and so forth."

Enter the business corporation, which co-ordinates the work and exchange of a number of people. This was the great institutional innovation which enabled growth to accelerate. It is why we are rich today, and why so many poor people across the world are growing richer. There may be much to dislike and to criticize about large corporations, Davies tells us, but this criticism often lacks historical perspective. The corporation has improved the conditions of life for millions.

Differences in economic performance are widening between Europe, Asia and the United States, says the Organization for Economic Cooperation and Development (OECD). Brian Childs (International Herald Tribune) reports that Jean-Philippe Cotis, OECD chief economist, has recommended the European Central Bank should cut rates from 2 to 1.5%.

The recommendation came as the OECD cut its growth forecast for the economy of the 12-member euro region to 1.2 percent for this year, down from a forecast of 1.9 percent in December. The OECD said that it expected growth of no more than 2 percent in 2006.

This compares with US growth forecast at 3.3% and China's at 9%. Their estimate for the UK was revised down to 2.4% (the Chancellor's figure is 3.5%). Gary Duncan (Times) quotes Capital Economics predicting that when taxes increase to meet the shortfall, UK growth will be hit even more.

Capital’s analysis warns that "payback time" has arrived after the Government's spending drive and heavy borrowing. "It looks very likely that taxes will rise in the next year or two," it says, arguing that the resulting period of tighter fiscal policy could knock a full percentage point off the economy's annual pace of growth.

It doesn't have to be like this. If the Eurozone economies will start to free up their labour markets, lower the costs of setting up business, and cut taxes, their growth rates would probably head skywards. Similarly, if the UK Chancellor would stop spending other people's money on his public sector, the UK figures would shoot up. The trouble is that if you rob Peter to pay Paul, you'll get Paul's vote. And if he outnumbers Peter, you'll get elected. But it should surprise no-one if Peter decides to quit work or to emigrate. The world owes no-one a comfortable living for nothing, however big their majority.

From next April UK investors will be able to buy residential property as part of their self-invested personal pensions (SIPPs). Until then it has only been possible to do this for commercial property, but from April 2006, investors using SIPPs will be entitled to full tax relief on the purchase price. If they buy to let, as many are expected to, rental income from them will accumulate tax-free in the pension fund, and there will be no capital gains tax when the property is sold. These are substantial benefits added to home-buying.

In the FT [subscription] Rebecca Knight reports on a survey by Sippdeal Limited, which finds that 64% of SIPP holders said it was "definite or likely" that they would buy property using their pension. This consisted of 56% who would buy to let, 29% for a holiday home, and 15% for their principal residence.

Given that SIPP investors control assets worthy about £35bn, according to Martin Cadman, ex-chairman of the Sipp Provider Group, there could be a huge influx of money into the house market next spring. House prices, which have been flat, could begin to drive upward again. This, in turn, might well lead people to feel themselves richer, and free to borrow more against the increased equity in their homes. And that, in its turn, could boost the high street spending which has recently flagged.

It illustrates how easily manipulation of the housing market can bring about wider economic consequences, some intended, some not. Those alarmed by the degree to which UK economic performance depends on record levels of personal debt might have to steel themselves for still loftier heights. And those who predict that it must crash down at some stage will find themselves staring into an even deeper chasm.

Pension savings could increase substantially, albeit in possibly vulnerable property; though first-time buyers who have struggled to enter the property market could find the bottom rung yanked further beyond their reach. I suppose there must even now be people in the Treasury wondering to what degree, and for how long, this generated boom will conceal the bad news coming elsewhere in the economy.

A number of rose-tinted NGOs oppose water privatization for ideological reasons, but a paper for the Journal of Political Economy suggests that it does actually save lives in developing countries, says Paul Staines on the Globalisation Institute Blog.

Sebastian Galiani of the Universidad de San Andres and Paul Gertler of the University of California and the National Bureau of Economic Research looked at what happened in Argentina after their extensive privatization programme in the 1990s. They found that child mortality fell 8% in the areas that privatized their water services - the effect being largest (26%) in the poorest areas. Privatization was associated with significant reductions in deaths from infectious and parasitic diseases.

Hate to say "told you so" but...

Britain's Conservatives are complaining that public spending ruthlessly favours areas loyal to Chancellor Gordon Brown's own party.

The Public Expenditure Statistical Analyses, published by the Treasury, shows that this year's public spending in (Labour-dominated) Scotland, for example, will be £1,368 per head more than in (Conservative-dominated) England. Scotland will get £7,635 per head, England just £6,267. And within England it is the same: the (overwhelmingly Labour) North-East will get £7,223 per head, a whopping £1,739 more than the (overwhelmingly Conservative) South-East with just £5484.

Some think the disparity even more unjust because Scottish MPs in the UK Parliament can vote on England's health, education, and other policies, but English MPs have no say over Scotland's devolved systems. Already, the government has relied on the votes of Scottish MPs to get get through its policies for England - like foundation hospitals. That is likely to be more and more common now that the government has a more slender majority.

Among the critics are Lord Barnett - who, back in 1978, invented the formula that diverted more public money to Scotland. "It was never meant to last this long," he said. "It has become increasingly unfair."

But while Mr Brown's voters may thank him for the extra cash, others ask: does it do any good? This year, some £1,653 will be spent per head on health in Scotland, against just £1,350 in England. But, say critics, health outcomes in Scotland are actually worse.

The UK economic news has been fairly good for over a decade. The cycle seems to have been smoothed, and growth has followed on growth. The supply side reforms of the Thatcher years gave us a flexible labour market, and the change from manufacturing to services enabled us to benefit from changes in the terms of trade. Some of the former volatility has been exported to new manufacturers, whose low-cost goods have increased our spending power. We have grown blasé about good news, reading about expansions, flotations and acquisitions.

There were disquieting features, such as the low profitability of UK businesses, and the flat equity market, plus the high proportion of employment now dependent on new public sector hiring. Some worried that the apparent prosperity depended on debt-financed spending and an inflated house market. Government policy seemed to be unwise, too, with huge levels of borrowing and spending, new tax burdens on individuals and business, and regulations which hit the flexible labour market and business profitability.

Just recently there has been a spate of bad news. Businesses have closed, jobs lost, manufacturing down. High street sales have plunged, the housing market is flat, and bankruptcies are at record levels. Tables have shown Britain plunging down the league table of competitiveness. Economists are predicting slowdown, rising unemployment, and higher taxes. Businesses are preparing for retrenchment as the global economy cools. Good business news tends to lag, with results often published after the fact. But bad news is a lead indicator; and people cut back when they see losses coming, which can be a year before the accounts are published.

These early warnings, added together, suggest we might be heading into an economic rough patch. The casual acceptance of increased prosperity could be shaken by lower growth, falling spending power, and rising unemployment. At present the bad news is coming one pebble at a time, but some analysts feel the ground tremble as though something bigger is on its way.

If it does happen, it would be a good time for politicians not to be in office, and a good time for the Chancellor to move on from the Treasury. Apres lui, le deluge.

You might think the UK government report Public Expenditure Statistical Analysis sounds pretty boring, but ex-CBI economist Douglas McWilliams has uncovered a few interesting items in a report for his Centre for Economic and Business Research [subscription only, unfortunately].

McWilliams shows that public expenditure has reached 52% of GDP in Scotland, which sounds high enough - but it is now a staggering 59% of GDP in Wales and the North East.

He also shows that the growth of public expenditure as a percentage of GDP has grown faster in Britain (at 4.2%) than in any of the 27 OECD countries - 17 of whom actually reduced their spending figure over that period.

Although the Treasury glibly calls this 'investment,' it is, in fact, spending. At some stage someone has to pay for all of this. No prizes for guessing who that will be.

The UK’s standing in international league tables is going down, says Allister Heath in The Business newspaper (Business Brief).

Heritage index of economic freedom
1998 UK rank 3rd – 2005 UK rank 9th

World Economic Forum measures
1998 UK rank 4th - 2004/5 UK rank 11th

International Institute for Management Development
1998 UK rank 12th - 2004 UK rank 22nd

Economic Intelligence Unit business environment ranking
1997 UK rank 2nd - 2005-09 UK rank 8th

AT Kearney/Foreign Policy magazine globalization index
2002 UK rank 10th - 2004 UK rank 12th

Individual indices might be open to question on methodology, but there does seem to be a consistent pattern. The UK’s competitive position has been eroded by less flexible labour markets, increased government regulation, and tax increases. Unless this trend is reversed, the UK could end up with the low growth and high unemployment rates which characterize countries like France and Germany. This is not where we want to be.

The 'black' or undocumented economy is attracting attention. Both our own Office of National Statistics (ONS) and its EU counterpart, Eurostat, have been trying to quantify it. Part of the black economy is criminal in the normal sense of drugs and fraud, but most of it is simply economic activity which is unrecorded to escape tax and regulation. In general, the higher the burdens which those two impose, the greater the temptation to evade them.

Although at first glance the black economy looks like money lost to government finances, much undocumented activity would probably not be worth doing at all if it had to be taxed.

Carl Mortished’s European Briefing in the Times quotes the Italian think tank Eurispes which estimates underground business activity in Italy to be about 27% of the economy. This is roughly in line with the IMF's estimate that about a third of Italian workers are off the books. Estimates for Greece are higher still, as are those for some of the ex-Soviet countries. Excise duties in Britain on alcohol and tobacco are high enough for a flourishing underground trade to flourish. It is quite something in Britain to inspect discarded cigarette packs to see the various languages in which the health warnings appear. America’s black economy is reckoned to be about 9% of GDP, with its small size usually attributed to the lower taxes there.

Of two possible ways to reduce the black economy, one is to intensify snooping, searches and policing, employing additional officers to crack down on fraud. Particular attention is devoted to nannying, cleaning, plumbing and building, since evasion seems to be widespread in such areas.

Another way is to lower the tax and regulatory burden so that it becomes far less necessary or worthwhile to evade it. The ASI follows Adam Smith himself in following the second course. Under his advice hundreds of taxes and duties were abolished or drastically reduced, and the romantic Cornish smugglers became an endangered species.

In the old story the wind and the sun competed to remove a man’s cloak. The force of the wind proved inadequate; then the sun came out and the man took his cloak off. It should be required reading in the Treasury.

Post-war Germany had an economic miracle. So did Hong Kong, Japan and the Asian tiger economies. China, it could be argued, has experienced one since Deng Xiaoping took over after Chairman Mao. What are the ingredients that make a miracle possible? The Lex column [subscription] in the Financial Times reminds us of what Mancur Olson said.

In The Rise and Decline of Nations (1984) he showed how the operation of interest groups can impede economic progress. At a period of turmoil such as in revolution or war, these associations lose their ability to defend their members’ interests at the expense of society, or to inhibit competition and innovation. This makes the miracle possible.

The 'Thatcher Revolution' in Britain overturned the power of vested interests by pushing through elements of monetarism and privatization, but it took a remarkably strong-willed leader. Countries more used to coalition and consensus would find that harder, but it could be argued that globalization brings the upheaval which undermines the entrenched interest groups and makes rapid economic progress possible. It is arguably better than war or violent revolution. Some of the countries which rapidly emerged from decades of communist rule have proved fertile ground for economic transformation.

The turmoil is unsettling, to say the least, and threatens comfortable and traditional ways of life protected by rules which preserve and entrench the status quo and the prevailing economic distribution. There will always be votes in support of the established order. But the rewards of change can be great, too. The wealth acquired by economic transformation can be used to combat malnourishment, poverty, and disease, to raise standards of education and health, and to bring access to more of life’s opportunities.

For good or ill, the world seems to be going through such a period.

One of the good things about the gradual but remorseless break-up of the old Soviet Empire is that we can finally correct a lot of illegal and improper 'privatization.' It gave the word a bad name!

Not a line you would expect from the Adam Smith Institute. But the privatization that we pioneered in Britain in the 1980s involved taking basket-case state monopolies, making them competitive, and allowing the general public to acquire some meaningful ownership in them.

The 'privatization' in East European and Central Asian countries such as Ukraine and Kyrgyzstan, by contrast, involved giving the state monopolies to the friends and relations of their thuggish pro-Soviet rulers.

Sure, neither Ukraine's Leonid Kuchma nor Kyrgyzstan's Askar Akayev were as repugnantly unsavoury as some local dictators. But extolling socialism while your family chomp cigars bought out of straight theft rather tends to get people's backs up.

I talked to Ukraine's new liberal Finance Minister and Deputy Prime Minister at our recent investment seminar. They plan to take the worst cases of 'privatization' theft, re-nationalize them, and then privatize them properly involving the whole population. It's the right thing to do. Let's hope the new government of Kyrgyzstan come asking them for advice.

Danny Kruger is one of the Conservatives' more able parliamentary candidates. But he was forced to pull out of the fight in Tony Blair's Sedgfield constituency after being savaged by left-wing columnist Polly Toynbee for saying we need "creative destruction" in public services.

Nevertheless, it is Polly, and not Danny, who is the stupid one, according to brainbox journalist William Rees-Mogg in today's Times. Because, as he points out, the phrase "creative destruction" was popularized by the leftish Austrian economist Joseph Schumpeter. It describes only the cyclical process of renewal and growth in the modern economy.

His view was that the new is always built on the demolition of the old; railways replace stage coaches, automobiles replace the horse and buggy, electricity replaces gas lighting, and so on. This process he referred to as "creative destruction". It is essentially benign.

So Danny was just making the point that we need radical reform in health, education, welfare, and the rest. Without a bit of "creative destruction" nothing will change, and public services will continue to be stuck in their ways, costing too much and delivering too little, too badly.

Professor Tim Congdon, a former Chancellor's 'wise man' now at Lombard Street Research, makes an interesting point in LSR's current Monthly Economic Review.

Non-monetary economists have argued that the rise in base rates from 3.5% in autumn 2003 to 4.75% in August 2004 would lead to a marked weakening (or even a crash) in the housing market, and a subsequent sharp downturn in domestic demand growth.

The monetarists, led by Lombard Street Research (esp. in their Oct. 2004 Review), have argued that a 4.75% base rate was insufficient to cut credit and money growth to levels consistent with target inflation. Instead they have argued that the annual rate of money growth would stay close to double digits. They predicted that early 2005 would see "resilience or even buoyancy" in domestic demand.

True, mortgage approvals in the four months to Dec 2004 were down by almost 30% from the same period in 2003. But:

In late 2004 the annual growth of the stock of mortgage debt was no less than 15%. So - if new lending drops by a third - the annual growth rate falls to 10%. 10% is still too high.

Since mortgages represent over half the loan assets of the UK banking system, non-mortgage credit would have to be particularly weak to prevent overall balance sheet growth. In fact the annualized growth rate of M4 in the three months to January 2005 was 10.4%, and that of M4 lending was 13.4%. The money growth implies inflation way above target levels.

Looking at the real world, "it is clear that the housing market is not collapsing and that consumer spending is steady." Corporate investment and the construction sector are also strong. While it is too early to say, and there is some mixed data, so far the monetarists seem to be proving better predictors of events than their non-monetarist rivals.

A new report published by the Centre for Economic Policy Research finds that the American economy reacts faster and further than the eurozone economies. Even though the US downturns are a quarter bigger, the US gets the benefit of expansion and growth earlier, and its booms last 50% longer than the eurozone's. This is the up-side of flexibility. Even in the downturns, the US consumers can maintain their living standards better because they can borrow more. Furthermore, the shocks are usually brief, and have a beneficial side in speeding economic adaptation.

Graham Serjeant, financial editor of the Times, amusingly compares the two types of economy to different dishes:

If economies were rated as food, America's would be a soufflé and the eurozone's would be stodgy old-fashioned Christmas pudding. America’s flexible go-getting economy responds eagerly to cycles and shocks, rising and falling faster and farther in response to any change in the economic temperature. The eurozone, by contrast, has a tendency only to stay where it is. Its stolid mass is slower to expand or contract, varies less either way and takes up to ten years longer than the US to respond fully to external shocks such as the worldwide web or dear oil.

If there is a moral, it seems to be that those who opt for a quiet, smooth life do less well than those prepared to ride its peaks and troughs.

US Federal Reserve Chairman Alan Greenspan spoke about Adam Smith at his lecture yesterday at St Bryce Church in Kirkcaldy. In his speech he said that Smith's account of economic processes "does appear to adequately describe today's determinants of world commerce and the wealth of nations."

"More than two centuries of economic thought have added little to those insights," he added. Smith's ideas had become "the sole remaining effective paradigm for economic organization."

The shortlist of intellectuals who have materially advanced the betterment of civilization unquestionably includes Adam Smith.

And The Wealth of Nations itself was "one of the greatest achievements in human intellectual history," and had led to "changes that were to measurably enhance world standards of living."

UK Chancellor Gordon Brown described Dr Greenspan's speech as "the most optimistic (about this world at least) ever delivered from a Church of Scotland pulpit." Media coverage of it includes the Times, Telegraph and Herald.

Brian Micklethwait says asset stripping is good:

"When economic resources are tied up in activities with an insufficient economic future to justify their use in this way, it makes perfect sense for someone to unbundle them and release them into the wild, separately. That there are people who specialise in doing this, who are always on the look-out to ply their trade, injects huge vitality into the economy of the world. Asset strippers ensure that existing resource uses are always questioned, and that the future, when it does emerge unmistakably, is not smothered by the past."

Professor Steven Nickel is a member of the UK's Monetary Policy Committee which sets interest rates. In a January 13th paper to the Bank of England’s regional agents he asks "Why has inflation been so low since 1999?" The answer, he suggests, is down to falling import prices and tighter margins in the distribution sector. Other economists have pointed to the falling prices of manufactured goods from Asia.

Professor Tim Congden of Lombard Street Research is not satisfied with this. He points out that the same factors affected Japan and Turkey, as they did all economies open to international trade. Yet inflation rates diverged dramatically. In Japan prices have declined since 1999 at an average annual rate of 0.2%. In Turkey they have increased by an average annual rate of 35%. Why didn’t these common influences lead to similar changes in inflation? Professor Congon suggests why:

The answer is to be sought in the differences in money supply growth over the last five years. In Turkey money has grown by about 35% a year, in the UK by 7% a year, and in Japan by 2% a year. (For the sake of clarity "money" here refers to a broad money measure).

Professor Congdon is right. They all experienced those supply-side changes, but their different experiences of inflation corresponded with the different money supply growth. It is difficult to conceive these days of a satisfactory account of inflation which does not feature changes in the money supply.

The Social Affairs Unit has a fascinating article on 'anti-economics' by Dr William Coleman:

The anti-economist is he who sees economics as a bane. Economics is harmful; it is "pernicious". No germ of good can be found within. No value can be salvaged from it. It contains no rudiment of insight; it is "dead", "bankrupt", "collapsed". The world would be better off without it. Therefore, its teachings should be discredited, its honours abolished, its representatives barred from public institutions, its institutional identity effaced, its centres of propagation encumbered or eliminated.

Read the full article here.

Anatole Kaletsky challenges conventional wisdom in Tuesday Times. He asks why the USA and the UK have fairly good growth and low unemployment, whereas the French and German economies have not.

Many assume the answer is: "over-regulation, inflexible labour markets, high taxes, absence of start-ups, inadequate R & D." Yet despite these factors, many European companies, as opposed to countries, have done rather well, with share prices holding up as well as their US and UK counterparts. Moreover, says Kaletsky,

America is hardly the free-market paradise that is so often suggested. Some forms of regulation are far costlier and oppressive than Europe's. The uncertainties and costs of litigation hugely increase the risks of doing business in the US. European regulations have never bankrupted entire industries in the way that US litigation has bankrupted companies involved in asbestos and toxic waste. US labour regulations may make it easier to fire workers but trade unions are more stubborn in their defence of work rules and financially ruinous contract provisions than their counterparts in Germany or France.

Yet since the mid-1990s the European economy has seen weak growth in per capita GDP, plus high jobless levels. Britain has largely followed the US since that divergence began. What macroeconomic event at that time, asks Kaletsky, occurred in the Continental economies, but not in the US and UK?

The answer is obvious — the Maastricht Treaty, creating the single currency, was negotiated in 1991 and began to be rigorously implemented from 1993 onwards. From that point onwards, European countries lost their ability to manage macroeconomic demand or use their exchange rate to increase growth and employment.

He still thinks Europe needs reform: "More economic freedom, lower taxes, less generous unemployment benefits, and lighter labour regulation." But, more controversially, he thinks none of these will work until Europe seems more demand growth.

Europe must stimulate demand with an Anglo-Saxon-style monetary policy, explicitly designed to achieve full employment as well as low inflation .… Demand management and supply-side reform must both be applied at the same time. That is the one clear and unambiguous lesson from the Anglo-Saxon economic model's recent successes. But will the Europeans ever understand?

It would be ironic if the Euro, designed to cement the EU as top economic power, has doomed it instead to below par performance.

The UK government's been telling us that we've never had it so good, but the Britain section of The Economist this week takes issues with their headline claims.

'Britain has had the longest period of sustained economic growth for 200 years' - On quarterly GDP estimates maybe, but annual figures show unbroken growth between 1949 and 1973, much longer. In any event, the present growth spurt started in 1992, under the Conservatives.

'Unemployment is at its lowest for 29 years' - True on the very restrictive official figures, says the Economist, but what about the 'economically inactive' folk who are not counted?

'Inflation is lower than at any time since the 1960s' - It has been lower, true, but now it is 3.4%, the highest since mid-1998, so that looks bad.

'Mortgage rates are ower than they have been for 40 years' - Yes, but that is because inflation is less: real borrowing rates haven't changed much.

Perhaps it's no wonder that people don't trust politicians any more. Or their economists, for that matter.

Published by The Wall Street Journal and The Heritage Foundation, the 2005 Index of Economic Freedom measures 161 countries against a list of 50 independent variables divided into 10 broad factors of economic freedom.

Long a symbol of economic prosperity and might, America for the first time ever no longer ranks among the top 10 “free” nations of the world.

Hong Kong and Singapore top the list, and the UK comes a respectable 7th, just ahead of Denmark (8th) and Iceland (9th). The USA is 13th, fractionally ahead of Sweden. As Johan Norberg puts it:

Sweden and USA gets almost the same economic freedom score (1.85 vs 1.89). This is partly because Sweden is a bit better than its rumour. But most of all this is because America’s economic freedom is being constrained on President Bush´s guard: Out-of-control government spending, massive farm subsidies, expansion of Medicare, a heavier regulatory burden and new anti-dumping tariffs.

[hat tip: Johan Norberg]

Europe was a good place to invest last year. What? Europe of the low growth, the high unemployment, the enterprise-deterring social costs, and the regulatory stranglehold? Well, no. The place to go was the new Europe further to the East.

A fund tracking the Frankfurt Index would have yielded 4%. In Paris it would have been 7%. The action, reports Carl Mortished in the Times, was in the countries which joined the EU last year.

Prague’s PX-50 index rose 59 per cent last year and Budapest’s Bux price index was close behind with a 57 per cent gain. Warsaw’s delightfully named WIG index was more measured, increasing by a quarter but enough to deliver a thumbs-up to the Polish strategy of courting foreign investment with low company taxes.

There is undoubtedly, Mortished tells us, a one-time adjustment to EU membership built in. Future growth has been anticipated after entry into EU markets. All the same, as German unemployment increased again in December and France yesterday revealed a third quarter of nil growth, it is nice to see that some parts of Europe are booming. By investing there firms gain access to lower costs, a skilled labour force, and few of the things which thwart enterprise in the old Europe. This is good for all of us. Pity about the 'continental social model,' though.

An FT survey of 21 leading economists (reported by Becky Barrow in the Daily Telegraph) thinks that the biggest threat to the stability of the economy is a sharp fall in house prices.

Asked about the biggest threat to the economy, a rapid fall in house prices was the "hands-down winner" after 75 per cent of the economists, who rarely agree on anything, voted the same way. Mr Oswald [of Warwick University] said: "The biggest risk in my view is that there will be a large fall in nominal house prices and that will start a downward spiral in confidence. I view this as likely."

Sushil Wadhwani, a former member of the Bank of England's monetary policy committee, said a housing market correction "could be deeper and longer-lasting than the current Bank of England forecast."

The reason everyone is looking at house prices is because when they rise, people feel richer and are more inclined to borrow against their equity; and that helps to sustain consumer spending. It has to be said, though, that the market in housing is compromised by the difficulties in adding extra supply to meet a rising demand. Planning (zoning) regulation makes it difficult to build houses where people want them. And changes in bank interest rates affect the cost of mortgages quite sharply.

It should also be noted that there are fashions as to which indicator to follow. 30 years ago it was the monthly balance of payments which sent economists into a tizzy. 20 years ago they waited anxiously for the unemployment statistics. More recently still it has been the exchange rate.

Goodhart's Law springs at once to mind. Formulated initially as a joke, it encapsulated an important truth. Once a factor is made a target for policy action, it will lose its effectiveness in conveying real information because the target will be pursued rather than any underlying economic reality. Fans of Heisenberg will spot the analogy.

So, will a house price crash threaten economic stability? Probably not because the market can be tweaked and massaged by interest rate changes. Should economic policy turn upon the monthly changes in the house prices? No more than it should on any other measure. A juggler keeps the balls in the air by only touching each of them briefly. If you hold onto one of them, the rest fall down.

UK Chancellor Gordon Brown believes the coming year offers a "once-in-a-generation" chance to eradicate global poverty. He stressed more debt relief plus "a very substantial increase in resources… akin to the Marshall Plan of the 1940s".

The goal is immensely worthwhile, but it is important to keep the following ideas in mind.
____

• There are no 'causes of poverty.' It happens naturally when you do nothing. It is wealth that has causes.

• Poor countries are not poor because others are rich, but because they are not rich themselves.

• Rich countries have created nearly all the wealth they enjoy, and poorer countries could do likewise.

• Humanitarian aid is a worthwhile way of helping to tackle such things as conquest of disease and access to clean water. By contrast development aid to invest in industry is less successful and less worthwhile, especially as it is usually directed by governments.

• The gap between rich and poor countries is less important than the attainment by poor ones of enough wealth to lift them from deprivation and give them access to sufficient food, water, healthcare and education.

• The wealth-generating process is robust enough to withstand many things done wrong in a country. It cannot, however, survive genocide, civil war and socialism.

• Corruption is endemic in many poorer countries because without a vigorous economy, political and bureaucratic careers are among the few avenues open to advancement.

• Trade barriers do more harm by rich countries than all of the good they try to do. We could help counties lift themselves from poverty by buying their goods.

• Foreign investment can greatly accelerate economic growth and development.
____

The idea that we could make poverty history is a noble and inspiring one. Let us be clear-headed about it, though. Cancel their debts (which were run up by a previous generation of predatory despots) and open our markets to their goods. Help them fight AIDS/HIV and Malaria. Help everyone gain access to clean water. Help them tackle corruption and predatory government. Buy their stuff.

US citizens trying to holiday abroad can be forgiven for thinking the big economic story of 2004 was the falling dollar, which does not get you very far these days. Those involved in production and transport, including car drivers, might go for oil prices. It hit a high of $55.67 a barrel, raising doubts about world economic recovery.

The third candidate for big news story (and the winner) was China. Powering ahead with growth rates close to 10%, it has sucked in world energy and raw materials, and churned out finished goods. Fears of overheating have abated somewhat as the Chinese have struggled to control their runaway tiger.

China helped to push world growth to about 5%, a 30 year high. The UK’s 3% was quite respectable, especially compared to some of its sluggish eurozone partners. The US outturn might be 3.5%, also quite creditable. It is an awesome thing to watch wealth being created on such a scale. Hundreds of millions of people are being lifted clear of poverty, malnutrition, and maybe disease, which look set to become African rather than world problems.

The prediction: more of the same. Expect more growth, more wealth creation. And expect next Christmas to be marked by more pious sermons from church leaders, unable to see wealth being created on an unprecedented scale. Once again they will denounce rich countries for not 'sharing more of their resources' with poorer ones.

Theodore Parker described democracy as 'a government of all the people, by all the people, for all the people'. Winston Churchill was perhaps more realistic when he called it 'the worst system of government except for all the rest'. Whichever definition is preferred (and they are not necessarily contradictory), most of us who have experienced democracy would not want to exchange it for any other system of government. But what kind of economic regime is best suited to real democracy? That question is too often ignored by economists.

Democracy assumes that ordinary people are wise enough to elect a government. If so, surely they are more than capable of deciding how best to spend their own money. And yet in the western European democracies people regularly vote for governments that take between 40 and 50 per cent of their incomes in taxation. In so doing they are saying that fallible politicians know better than they do themselves how to provide the health, education and other services that they need. The Adam Smith Institute has calculated that for the UK Tax Freedom Day falls on 30 May.

Even those on very low incomes are taxed to the hilt. For example workers on the minimum wage of £4.85 an hour start paying income tax after 19 hours work a week. By the time they have worked 27 hours, they are paying 33p in every extra pound in income tax and national insurance. Gordon Brown, with the agreement of the electorate, taxes the poor into greater poverty! How did we arrive at this crazy system?

In short, because we expect the government to do far too much for us. And as that attitude developed during the twentieth century our democracy gradually changed into what Ralph Harris has rightly called a 'demockery'. To reverse this trend will require radical, new thinking on the part of people and politicians and a very large reduction in taxation and government expenditure. If the government were to stick to its basic roles of defence, maintaining law and order and providing a temporary safety net for those who had fallen on hard times, taxation could be reduced to between 10 and 15 per cent of GDP and Tax Freedom Day would be in February. Many taxes could be abolished and others slashed. The UK would become the world's most dynamic economy as well as the truest democracy.

Many people uneducated in economics argue that wealth, like energy, cannot be created or destroyed, but merely transformed from one form to another. The Gross Domestic Product of the world must remain at an exact level, and as people get richer, there must be others getting equally poorer in order that the level of wealth in the economy stays the same.

Economic Growth is the increase in the total wealth and therefore standard of living of an economy. It is measured in monetary terms by the percentage change in Gross Domestic Product, adjusted for inflation.

What economic growth therefore means is that either the average person within the economy is wealthier, or the population has increased. It is usually some combination of the two.

In the UK, the population growth is much lower than the economic growth, and therefore it can be assumed that the average and total wealth of the country has increased. The same can be said for the rest of the world as a whole. The GDP per capita and total GDP of the entire world rises every year. It is difficult to argue when faced with statistics showing an increase in world wealth that growing countries are simply getting richer at the expense of others.

A fascinating insight into why communism and socialism fails appears on the website of the Foundation for Economic Education, which is based in the USA. It is an essay written by Henry Hazlitt in 1952. This is an extract:

Most of us have forgotten that when the Pilgrim Fathers landed on the shores of Massachusetts they established a communist system. Out of their common product and storehouse they set up a system of rationing, though it came to "but a quarter of a pound of bread a day to each person." Even when harvest came, "it arose to but a little." A vicious circle seemed to set in. The people complained that they were too weak from want of food to tend the crops as they should. Deeply religious though they were, they took to stealing from each other. "So as it well appeared," writes Governor Bradford, "that famine must still ensue the next year also, if not some way prevented."

So the colonists, he continues, "began to think how they might raise as much corn as they could, and obtain a better crop than they had done, that they might not still thus languish in misery. At length [in 1623] after much debate of things, the Gov. (with the advice of the chiefest among them) gave way that they should set corn every man for his own particular, and in that regard trust to themselves...

"And so assigned to every family a parcel of land... This had very good success; for it made all hands very industrious, so as much more corn was planted than otherwise would have been by any means the Gov. or any other could use, and saved him a great deal of trouble, and gave far better content.

"The women now went willingly into the field, and took their little ones with them to set corn, which before would allege weakness, and inability; whom to have compelled would have been thought great tyranny and oppression."

In other words, the Pilgrim Fathers were communists until they found out that it did not work. They reacted promptly to give a system that had failed. It is a pity that British society has not reacted as quickly to the failure of our communist-style healthcare and education.

James Batholomew is author of The Welfare State We're In.

Few market analysts make unequivocal predictions, preferring to hedge their forecasts along with their investments. An exception this week is Clem Chambers, CEO of ADVFN. Writing in The Business, he says we have entered a long-term bull market.

The reason is simple. We are experiencing huge global progress. I am using progress in the Victorian sense, progress being the improvement of humanity’s lot. This progress will make the world a rich place.

He sees this as an historic, long-term event.

This bull market is likely to run until a new bubble appears which could be 10 years, perhaps even 20. By the time it is over, share prices, index levels and participants will present an almost unrecognizable landscape.

Of course, it could all be derailed by a major disaster, as he admits; but, barring that,

Everywhere, except perhaps Africa, countries are catching up, in the way Europe caught up with Britain in the 19th century. Anyone seeing Russians and Chinese shopping in London are experiencing the first drops of a monsoon of wealth that will be unleashed by billions of people. This process will run for decades and we will all benefit from it. Of course the Malthusians will predict doom, but history suggests otherwise.

Could it happen like this? In the past the stock markets have tended to accompany the expansion of wealth, and wealth is expanding rapidly on a worldwide basis. If it does turn out like this, the changes it brings could dwarf the political events which occupy so much of our attention.

Watching the Chelsea vs Newcastle United football match last night, I wondered why it is that people persist in supporting teams other than Chelsea. After all, Chelsea is top of the league and has the best players.

It could be that people support other teams simply because they are depraved or stupid. Since Chelsea is objectively the best team, surely we experience market failure when someone chooses to support another team - such as Liverpool.

The problem with this argument is that we do not make choices according to some top-down ruling of what's best. We make them based on a range of criteria that is unique to each of us. To some people, supporting the local team is very important. It may be that some people supported Manchester United because they like David Beckham as a player, and now also support Real Madrid now that he has moved there.

This subjective theory of value applies not just to football teams, but to the marketplace more generally. When buying a tumble dryer, one that takes 7.5Kg of washing is on one level better than one that takes only 6Kg. But if you don't need to do much drying, it might well be a waste of money getting the bigger one. Indeed, a customer might not be bothered about size at all, but very concerned about how quiet the machine operates. The 'best' product is different for different consumers.

When I was in France in the summer there was a great fuss in the French newspapers about a threat by the German manufacturer Bosch to close down its French plant. Bosch warned that it would move operations to the Czech Republic unless the unions accepted an increase in the working week to 36 instead of 35 hours. The 35-hour week in France is a sort of totem for many: even Jacques Chirac called it a social right.

The Bosch affair reopened the whole debate about what the French were doing with a 35-hour week when unemployment was hovering around 10 per cent and jobs were being lost to developing countries where wage-rates were 80 per cent lower. In an angry editorial, The Figaro denounced the unrealism of the unions which it regarded as deep-seated. In a subsequent issue there was an article from Sorbonne History Professor, Jacques Marseilles. He denounced the 35-hour week as a law for an "imaginary" France. It sprang, he said, from the Left's Dickensian idea of the economy as an overwhelmingly manufacturing one in which masses of industrial serfs are exploited and oppressed by grasping capitalists. The reality, he said was that only 16 per cent of the economy was now industrial. Nearly all the rest was services in which it was essential that labour be adaptable not hidebound by draconian regulation. The popular cult of minimum effort, he said, could only impoverish the French people in an ever more competitive world.

A new book called Bubbles and How to Survive Them is making waves. Written by John Calverley, Chief Economist at American Express Bank, it has a launch next week at the IEA.

Its challenging and innovative thesis is that the dot.com bubble and the housing market bubble (if it is one) are not one-off affairs, but part of what is now a bubble economy. People move their funds from one bubble to the next, with the smart investors trying to get into a bubble early and leave before it bursts. Calverley suggests that:

By cutting interest rates so dramatically, there is a danger that central banks have shifted the bubble from stocks to residential property.

The property boom, whose surge has swept through Ireland, Spain, the Netherlands and Australia, as well as the UK, is by no means the only asset bubble. Calverley looks from the stock market fall of 2000-2001 to price spikes in bonds, gold, copper, oil and art works.

We used to have a business cycle, he tells us, but central bankers have become quite good at smoothing it, holding both inflation and unemployment in check. But volatility has not been eliminated, he suggests, just transferred to asset prices. Worried by a possible collapse of any particular asset price, the bankers increase money supply in support, or to create a new bubble elsewhere.

Are we, then, in a period of managed volatility? The bubble economy might be less damaging, although scarier, than the troughs of boom and bust. Or we might be on a divergent harmonic whose swings will become too large to control. This new territory is not for those who prefer a quiet life.

In basic economics textbooks, students will normally be presented with a model economy where there is perfect information. This is where all consumers know everything about all the products available. Yet in the real world, perfect information does not exist. Some argue that the government therefore needs to step in to provide that information.

However, markets are rather good at helping consumers making choices, even though perfect competition is impossibile. When I buy a DVD, I lack perfect information about the movie market. The only way I could get perfect information is to watch every movie ever created. Fortunately, markets are good at filtering information for us. Amazon helpfully suggests DVDs that I might be interested in based on previous purchases. I can look on Orkut, a website that helps you network with friends, and find out what people I like regard as good films. Reviews in newspapers and word of mouth also help. Advertising also helps me make choices, and not necessarily to choose the film. I saw the trailer to the new Ladykillers movie and decided I should give it a miss.

Perfect information is just too time-consuming to get. Fortunately, we make good choices every day without it.

Some have wondered why Britain seems so prosperous, and supposed it is all done on record debt and over-inflated house prices. "Wait for the crash," they say. Yet Anatole Kaletsky in today's Times thinks otherwise. (non-UK readers may find the link difficult to access, so I will summarize)

After a century of relative decline, suddenly Britain has turned around. In less than a generation, Britain has overtaken Italy, France and even Germany in terms of per capita income. Britain’s unexpected good fortune was due to the confluence of three separate events, says Kaletsky.

First came the Thatcher reforms which constrained union power and gave us a flexible market economy. Second came the change in monetary policy when we stopped trying to maintain parity with other currencies. The big events were Britain's crashing out of the Exchange Rate Mechanism, and the granting of independence to the Bank of England.

Third, says Kaletsky, have been changes at global level. Goods that Britain imports, such as mass manufactures, are become cheaper, whereas

The things that Britain has always had an advantage in selling to the world — financial services, scientific research, education, entertainment and so on — are rising in price. Because of this shift in relative prices, the British people have effectively enjoyed a large pay increase without having to work any harder.

The three factors identified by Kaletsky seem real enough. None by itself would have sufficed, but the three taken in unison have helped reverse a century of relative decline. Meanwhile our European friends do not share our success. They have not grasped the nettle of market reform, or given their currencies freedom of movement, nor gained from globalization to the same extent.

Of course nothing lasts, either in politics or economics. But for the present, says Kaletsky, Britain's prosperity is no illusion.

The Dallas-based National Center for Policy Analysis looks at the Economic Freedom of the World index, which measures economic freedom through 38 different components. The NCPA authors, James Gwartney & Robert Lawson, compare the performance of freer countries with the others. They conclude that for the free economies:

1. Growth is higher. Real GDP from 1993-2002 grew by 2.4% in the freer economies, but declined by 0.5% in the least free.

2. Investment and foreign direct investment per worker was 45 times greater in the free economies than the unfree.

3. Productivity of investment is 70% higher in the free economies.

4. For the poorest decile in the least free countries, per capita income was $823, against $6,877 for the poorest tenth in the free ones.

5. Income share of the poorest 10% is nearly 20% higher in the freest countries than in the least free.

6. Average life expectancy at birth is 76 years in the free countries, 54 years in the least free ones.

7. Infant mortality in 9 times lower in the freest fifth of countries than in the least free.

8. The freer countries do better in health, education, living standards and other measures.

9. The free ones have less corruption in business & government.

10. There is a correlation between economic freedom and political rights and civil liberties.

Some of these points might be somewhat chicken-and-egg, in that countries score low because they are poor, rather than because they are unfree. But that difference might not be accidental.

In classical chess players fought to occupy the centre. They advanced King’s or Queen’s pawns, knights and bishops. He who had gained the centre could attack from there. Hypermodern chess, pioneered by Nimzowitsch, Alekhine and Reti, sought not to occupy the centre at once, but to control it from afar. It was often characterized by fianchettoed bishops controlling the long diagonals across the centre from the knight's second square.

The new Socialism echoes this approach. It no longer nationalizes industries into state ownership, but seeks to control them through new regulatory bodies which have great powers to circumscribe their activities. It does not need government itself to raise spending into a recession if it can manipulate its private citizens to do so by stimulating them to borrow and spend.

It can use bodies which it controls to stipulate in minute detail the activities of business. It can determine the hours, conditions and sometimes even the pay of its workers. It can stipulate not only the targets to be attained, but the technology used in the process. Like a hypermodern chess master it controls from afar, without actually occupying the central territory of business.

A problem is that capitalism depends on the enterprising mind and the innovative thinker, and on the freedom to try out the new. This is the source of new products and processes. This is how new ideas on efficiency and cost saving are incorporated. If government has the Socialist mindset that political brains should direct the economy, then it will stifle the very dynamism which makes capitalism so beneficial. It will do so whether the approach is one of direct central command, or of control from afar in the hypermodern style.

Last week's business stories told us how much work we have to do. Record profits were announced from several major companies including HSBC and Barclays and were promptly denounced. Company chairmen had to 'defend' the high profits, and the range of adjectives was deployed, usually starting with 'obscene.'

It seems the British are quite prepared to see Wayne Rooney make millions, and are happy to see Blue and Busted rake the stuff in. We pay to see Brad Pitt's movies and help him become rich. In these cases we can see their value. They entertain us.

For corporations and their high paid executives, we apparently do not see how we benefit from their activities. The fact that they bring us keen prices, good quality and steady improvement is not appreciated, so we seem to resent their success and their reward.

The false supposition is that the profits could and should have been distributed into higher wages and lower prices. Yet it is the successful firms, the profitable ones, which attract investment and expand, creating more jobs. The profitable ones are those good at meeting our tastes in quality and style. They can stay profitable by staying competitive.

It is profitable firms which pay the dividends that boost pension funds, and whose stock rises to augment the savings of those who bought them, or whose pension or insurance fund bought them. Our business leaders should be proudly trumpeting their profits, pointing out the good they do for the rest of us. Alas, given present attitudes it may be some years before we reach that stage.

In a piece in today's copy of The Business I point to a new policy. At one time governments used to increase their spending as the economy moved into the trough of a business cycle. While this seemed to be effective at first in smoothing the cycle, it built up difficulties and trouble and ceased to work.

Now governments have discovered that they can dragoon private citizens into upping their spending during the down part of the cycle. They make saving less worthwhile by burdening companies with taxes and regulations, depressing share prices. They make spending easier with lower interest rates and by measures which boost house prices and encourage people to borrow.

The privatized Keynesianism builds up indebtedness and inflated house prices, and cuts into investment and pension provision. Government hopes that the boom part of the cycle will come to the rescue, and that rising wealth and prosperity will solve these problems. For the full article click here.

Gene Healy has tried out a different US supermarket:

There's this pejorative phrase, "market worship." Well, having just visited Wegman's, the temple of the great god Market, sign me up for the cult. As Tyler Cowen put it, Wegman's "makes Whole Foods look like a 7-11." The first 15 minutes in the store, I couldn't buy anything, my circuits were so fried by the obscene abundance around me. I wanted to jump through bins of sausage and bruschetta cackling madly like Scrooge McDuck. I wanted to make myself a hidey-hole behind some cereal boxes, and stay burrowed away until the store closed, and then eat myself sick all night like a dog.

So competition in the food industry brings good results. Much of the world has too little food, but in capitalist economies we have to deal instead with obesity. It's odd that while we let food be open to competition, we try to limit competition in other essential things like health and education. Maybe we need a little less 'government worship'.

The DTI is apparently looking into whether holiday companies should be made to reduce their prices during school holidays. But the IEA's John Meadowcroft points out any attempt to cap prices would ignore the reality of what is happening:

The price of any scarce resource is principally determined by demand: holidays are more expensive outside school term time because demand is higher than at any other time of year.

If prices were artificially lowered at this time of year, it is likely that more people without school-age children would want to go on holiday at this time, leading to the possibility that many families with children would be unable to go on a package holiday at all. We can only wonder at what new intervention government ministers would then dream up to correct their original error.

Robbie Millen in today's Times draws attention to a new book The Wisdom of Crowds by James Surowiecki which makes a case for the intelligence of groups, and "why the many are smarter than the few."

Millen himself points out that:

When you go to a supermarket to buy orange juice, the likelihood is that it will be there. The orange grower, packager, wholesaler, grocer - a large number of people far away from each other - have made a series of decisions that allow you the consumer to buy a Del Monte drink.

The free-market economy works because millions of us make small calculations about what to make, sell, or buy, what price to sell at, what price to buy at. Nobody directs it, yet the magic of supply and demand makes us all wealthier; and certainly happier than the glum shoppers at the Gum stores of the old Soviet era."

Precisely so.

Does the cut-throat business of selling to the public focus too much on price, and not enough on quality and service?

Some lament the abolition of Retail Price Maintenance by Edward Heath. Retail Price Maintenance was the way manufacturers fixed prices in the high street. A manufacturer could stop you from undercutting your competitors. Thus, retailers could differentiate themselves only by service (in a broad sense), rather than by price.

Others lay the blame at the free-market more generally. It encourages us to buy plastic kitchen utensils, rather than traditional, harder-wearing ones. We often buy the cheapest items, not the items of quality.

I, for one, do not lament the death of Retail Price Maintenance. Given the choice, I would rather get the goods cheaply and arrange the advice myself. I prefer to read reviews from other customers on the internet, or from magazines and newspapers, rather than rely on the advice of a sales assistant who might be just encouraging me to buy what he has the most mark-up on. I suspect that today, the low or no-cost advice available when buying a product is considerably higher than at any point in the last hundred years.

As for the availability of cheap things, this is great if you are a student or you want something that you are not going to use often. Not everyone needs the best quality, and the market lets us select from a vast range of options to suit our needs.

Adam Smith was not infallible. He took the view that the labour it took to make or acquire something constituted its value.

"Labour, therefore, is the real measure of the exchangeable value of all commodities."

"What is bought with money or with goods is bought with labour."

"Labour alone, therefore, never varying in its own value, is alone the ultimate and real standard by which the value of all commodities can at all times and places be estimated and compared."

- all from Wealth of Nations Chapter 5 of Book 1 (1776)

Hume had expressed a similar view in his essay Of Commerce (1752), and Marx was famously to take the labour theory of value and build upon it the notion of profit as surplus value and exploitation.

Yet Smith had earlier expressed a demand and supply account of value. In his Lectures on Jurisprudence delivered in 1763, Smith said, "It is only on account of the plenty of water that it is so cheap as to be got for the lifting, and on account of the scarcity of diamonds... that they are so dear." He also noted that a rich merchant lost in the Arabian desert would value water very highly.

Mark Skousen points this out in The Making of Modern Economics, and asks if Smith was suffering from absent-mindedness when he later wrote The Wealth of Nations and opted for the labour theory. He quotes economist Roger Garrison suggesting that Smith's Presbyterian values led him to distinguish between 'useful' production of things like food, and 'unproductive' items such as diamonds.

It is more useful to think in terms of a demand theory of value. Something can take a great deal of labour to make, and yet be worthless if nobody wants it. A good worth a great deal at one time can fall in value if people cease to demand it because of changes in fashion or technology. Yet it might take just as much labour to make it. Fountain pens suddenly fell in value when ball point pens first appeared on the market. It was the demand which changed, not the labour it took to make them.

Successful entrepreneurs include those who correctly anticipate that demand will give more value to particular goods and services than the costs, including labour, of making them. Too bad about the labour theory, but Smith was right about almost everything else.