The starting point in the immigration debate

At the Telegraph, Conservative MP Gavin Barwell says what for many Conservatives is the unsayable: that immigration is great for the economy:

Last week, the Organisation for Economic Co-operation & Development published a report which showed that immigration makes a positive contribution to the public finances of many countries, including the UK. Yes, you read that right: migrants in the UK pay more in tax than they consume in public services (that’s not true of every migrant of course, but collectively they make a net contribution). Without them, we would have to make further cuts to public services or pay higher taxes or both. . . .

We have to find a way to earn a living in an increasingly competitive world. Allowing the best and the brightest from around the world to come and study and work here can help us do that. So yes let’s make sure we have control of our borders, yes let’s tackle abuse, yes let’s talk about how many people and who we should allow to move here – but don’t let’s delude ourselves that immigration is always bad news.

And that's the point. The one point I disagree with Barwell on is when he says that "nobody is claiming immigration significantly increases" GDP per capita. Well, I am. Letting immigrants locate in rich countries deepens the potential division of labour: hiring a Tanzanian accountant to look after my firm's finances instead of doing them myself frees me up to focus on whatever I'm best at.

That minor quibble aside, I'm delighted that Mr Barwell has decided to be brave about immigration policy. While there are legitimate debates to be had about access to public services and social cohesion, the starting-point in any discussion about restricting immigration should be that restrictions make us poorer.

Austrian Business Cycles and Neutral Money

The proponents of Austrian Business Cycle Theory (ABCT) are often very critical of the diagnosis offered by monetarism: that sharp and substantial contractions in the money supply are the cause of major recessions. Rather, according to ABCT, a recession is a painful medicine curing the disease monetary policy already caused, as Professor Jesús Huerta de Soto, Spain’s leading Austrian economist, explains:

"[Money] is always injected into the economy in a sequential manner and at various specific points…..only certain people will be the first to receive the new monetary units and have the chance to purchase new goods and services at prices not yet affected by monetary growth….which can only lead to changes in society’s entire structure of relative prices." (Money, Bank Credit, and Economic Cycles, p. 533)

The argument here is that money isn’t neutral, that is, changes in it’s quantity affects peoples’ behaviour as price changes aren’t uniform. If money were perfectly neutral; doubling the quantity of money would cause all prices and wages to instantly double and people would go about their lives exactly as they would otherwise. When money isn’t neutral the failure of prices to adjust ubiquitously sends the wrong signals to entrepreneurs, creating mal-investment (capital allocated according to misleading price signals) and a following period of correction/recession. That’s ABCT in a nutshell.

So far, so good. However, Austrians like Soto seem to contradict themselves in their criticism of the aforementioned monetarist diagnosis:

"Attributing crises to a monetary contraction is like attributing measles to the fever and rash which accompany it." (Money, Bank Credit, and Economic Cycles, p. 527)

According to this criticism, monetarists have confused cause and effect; monetary contractions don’t cause recessions, recessions cause monetary contractions. It’s as if Soto is claiming that any sharp contraction in the money supply, even if we accept the premise that it was caused by the recession, had no further effect on the economy - that any sharp monetary contraction is neutral.

If ABCT aims to explain recessions whilst denying monetarism it must state, then, that money isn’t neutral and also neutral. Even more problematic is the apparent claim that money is far from neutral on the way up when growing at a fairly steady rate, but neutral on the way down when declining rapidly. Anyone worried about money supply growth prior to the crisis should also be worried about the fact it tanked in 2008. Soto joins Mises, Rothbard, Schlichter, and perhaps Hayek on the list of popular Austrians who are especially critical of monetarism.

On the other hand, some economists who identify as Austrians, such as Professor Steve Horwitz of St Lawrence University, have accepted some broad form of monetarism. Horwitz goes so far as to suggest that ABCT doesn’t explain every recession, and is only a theory of unsustainable boom. This clearly departs from the classical ABCT which did seek to explain all recessions and is very specific in it’s explanation thereof. And though I mostly agree with Horwitz’s interpretation, it can’t be labelled ABCT, because a theory of unsustainable boom is only a theory for half the cycle. So it leaves the question: can we create a version of ABCT which is consistent in its treatment of money throughout the cycle?

Putting bankers in jail cannot prevent mistakes

The Parliamentary Commission on Banking Standards has published its report on how to make bankers act less irresponsibly. Among other things, it recommends making bankers criminally liable for reckless professional conduct. “Too many bankers”, it says, “especially at the most senior levels, have operated in an environment with insufficient personal responsibility”.

The assumption here is that bankers acted recklessly because they were insulated from the negative consequences of their actions. I don’t know if that’s true. During the 2008 crisis, plenty of executives at failing financial institutions made the same mistakes that their firms made. AIG’s former CEO kept much of his net worth in AIG stock, most of which he lost. The CEO of Lehman Bros lost $1bn. Citigroup’s Sanford Weill lost $500m. Between them, Bear Stearns’ executives lost billions.

There are many other examples like these. If bankers had known that they were acting recklessly in business, they would not have done the same thing with their personal holdings. That so many executives' personal losses were so great suggests that they did not realise what they were doing. Their bad business moves were errors, not calculatedly reckless decisions.

Indeed, Jeffrey Friedman has shown that the real error was on the part of regulators. Financial regulations such as the Basel capital accords that were designed to make banks act more prudentially in fact did the opposite, incentivizing banks to load up on government-backed mortgage debt and, particularly in Europe, government bonds. And, unlike mistakes made by individual firms, these mistakes were compounded across the entire global financial system.

Making the punishment for failure harsher will only improve behaviour if the people affected already know that they’re doing wrong. If they’re simply mistaken – as I would imagine you’d have to be to lose billions of dollars of your own net worth – regulations like this will not have the effect we want them to.

But what about the ones who really did know what they’re doing? We used to have a mechanism for punishing reckless business practices — it was called bankruptcy. In banking, at least, this seems to have been abandoned in favour of unlimited bailouts. If we had let bad banks go bankrupt, as Iceland did, we might not be in such a bad situation today.

Throwing a few scapegoats in jail to satisfy an anti-banker mob ignores that the crisis was largely about regulators' and bankers' error. It is no replacement for letting bad firms go bust and punishing them the old-fashioned way.

What kinds of inequality should we be worried about?

Most political theorists are egalitarians of some sort. While I personally find Derek Parfit's argument in "Equality and Priority"—that egalitarianism sometimes says making others worse off without making anyone better off is good in one way, or even required—extremely convincing, and hence call myself a "prioritarian", I have trouble dealing with the arguments in Michael Huemer's "Against Equality and Priority". Nevertheless, I am very sympathetic to the basic claims of luck egalitarianism, i.e. that those advantages in life that are down to pure luck are undeserved. Combined with the fact that others are in desperate need, there is a strong case for redistribution before other complicating factors are brought in. But even egalitarians should (and often do) favour wealth or income inequality in the three following cases.

1. When inequalities come about as a result of different levels of effort. Some people are born with vast natural talents (e.g. Wilt Chamberlain) while others are not, or their talents are not in such high demand by the market. Some are born to dedicated, loving parents while others are raised in far less supportive environments. No one could claim they bear most of the responsibility for their genes or upbringing. But even if we could even out the differences in income or wealth due to different upbringings and talents, we'd want to leave in the differences from different levels of work. This is because leisure can be seen as a form of income, as it adds to utility. To give those who take more leisure the same money income as those who take less would be subverting equality, rather than enforcing it.

2. When inequalities derive from differences in job satisfaction or riskiness. People who do more dangerous jobs are paid more. This is exactly what economists would expect; extra money compensates the worker for the extra risk of injury or death. But it's also what we should want. A more satisfying, less risky job (like teaching or creating art) should pay lower by justice, and this is one of the really good and egalitarian elements of the market economy. This ties in with the previous point as one extremely undesirable element of certain high-paying jobs is the extreme hours they demand. If typically people's willingness to do extra hours begins to decline at an accelerating rate, we would expect high hours occupations—in a just, egalitarian system—to be paid disproportionately well.

3. When inequalities are necessary, due to the infirmities of current human nature, to produce a greater total pot to help the needy. A prominent element of John Rawls' A Theory of Justice, the book that kick-started the recent era of social justice theorising, was the difference principle, the idea that inequality in society should only be as much as is necessary to make the worst-off person as well off as possible. But driving inequality any narrower would harm the worst-off and would thus be unacceptable. Of course, as G.A. Cohen shows in "Incentives, Inequality and Community" and his book Rescuing Justice and Equality, this isn't a demand of justice—it's just a practical consideration when we have the welfare of the badly-off in mind. But in the real world pragmatic considerations are often appropriate, and it may well be that certain inequalities in a given society can be practically justified on these grounds.

The really interesting question is this: how much of the inequality in real-world capitalist societies is down to these three legitimate sources, and how much is down to undeserved luck?  The key difference between 'bleeding heart' libertarians and traditional left-wingers may come down to this crucial (empirical?) question.

Chart of the week: Target 2 imbalances

Summary: Target 2 imbalances narrow but remain wide

What the chart shows: The chart shows that Target 2 imbalances, while narrower than a year ago, remain wide – and have stopped narrowing

Why is the chart important: Target 2 balances are the net claims and liabilities of banks in the euro area on each other by country. If the monetary union runs smoothly and is believed to be permanent, imbalances will be minimal – as indeed they were until the financial crisis erupted in 2008. If, however, there are concerns about the stability of the banking system in one country or about that country’s continued membership of the single currency, imbalances will widen, with ‘safe havens’ building up claims. Target 2 imbalances peaked when German banks had claims of more than 750 billion euros in August 2012. Although lower, German claims were still close to 600 billion euros in May this year. Whatever politicians and central bankers may claim, markets, companies and households do not believe that the euro area multiple crises are over,The chart shows that Target 2 imbalances, while narrower than a year ago, remain wide – and have stopped narrowing

If only Britain had joined the Euro?

Will Hutton tells us, in last Thursday's Guardian, that widespread consensus on the UK's staying out of the EU is wrong-headed—joining would have kept our exchange rate low, which in turn would have meant no financial boom and an economy based (more) around producing manufactures. To add to this, our entry would have meant a more activist European Central Bank, which would have been willing to intervene when necessary. There is more wrong with his article than I could possibly tackle in one post, so I will focus on the key elements I've summarised above. None of what I say implies it necessarily would have been bad to have been in the Euro over the past ten years—such an alternative history is almost impossible to conclusively support—just that the arguments Hutton uses are extremely weak.

Pretty much all of his argument is bizarre, utopian and uneconomic. Devaluations work not because they make a country's products cheaper to foreigners, adding to net exports and driving GDP growth. Devaluations work because they boost inflation, which gets around nominal wage stickiness, allowing markets (particularly labour markets) to clear and giving relative prices the space to adjust. They make no difference to the price of a country's goods to foreigners, and in practice often boost imports as much as or more than exports, due to improved conditions. This is even true if we devalue by decree, as Hutton's desired artificially low €-£ exchange rate would be—it's just that the inflation could take slightly longer to come as firms and households bid up prices.

What's more, this is a Good Thing. We don't want to spend energy, time, labour and capital hours, as well as space, producing valuable things only to sell them in exchange for artificially few foreign goods. If countries are happy to send us desirable stuff in exchange for less of our stuff then that's great, and in any case it sows the seeds of its own balance, as consistent deficits (ceteris paribus) will drive down the exchange rate. This may eventually force the UK to run surpluses, but this would not be a Good Thing. Running surpluses means lower social welfare because we are consuming less leisure or goods or services than we would otherwise be able to enjoy. And we may never even have to run one if we keep creating loads of property or financial wealth to pay for our imports.

But let's imagine that Hutton could have subverted economic rules as basic as gravity and magically have kept the exchange rate at his desired low rate without any of the obvious expected balancing effects from wages and prices. And let's imagine that we want to send more goods abroad to get less in return. Would this have supported the manufacturing industries he wants? It's difficult to see how. If the City was providing the best financial services options for the world at £1 = €1.25 then it's not obvious that a cheaper pound, and cheaper financial services, would make them less attractive. The UK's economy contains a relatively large contribution from financial services because the UK is relatively good at financial services—as well as hi-tech manufacturing, advertising, and many service sector areas. These are the UK's comparative and in some cases absolute advantages.

And would the UK be better under the ECB (albeit with some British influence) rather than its own Bank of England? It's hard to see why Hutton thinks this. The BoE let inflation rise to hit 5.2% on the CPI measure, and has consistently allowed inflation to stay above target—the ECB has inflation below its 2% target, despite the obscene jobs crises in Spain, Greece and other crisis-hit countries. It is basically refusing to do any monetary stimulus. There is essentially no debate in Europe over whether the ECB should actually meet its inflation target, or indeed consider other economic variables, or go yet more radical and drop inflation targeting altogether. Would the UK's input really outweigh the massive consensus there, especially when the UK is divided on the issue itself? Again, I am sceptical. Strangely, Hutton seems to think that pointing to the UK's own situation and reminding us we're not living in "a land of milk and honey" is sufficient to gloss over the fact that most of the Eurozone is doing so much worse!

This laughable logical leap is nothing compared to his claim that both sides of the political divide are "united only in their belief, against all the evidence including Britain's export performance, that floating exchange rates are a universal panacea." As might be expected, he doesn't give the tiniest shred of evidence that the consensus view holds that floating exchange rates are not only the best exchange rate policy, but a panacea for all types of economic ills. But really, that's not the point. Even if everyone did—ridiculously—think that floating exchange rates were actually a panacea for economic problems, that wouldn't go any way to implying that they weren't better than fixed exchange rates.

Will Hutton's argument is completely invalid, though perhaps he gets some points for making such an outlandish and unpopular case. If it would have been good for the UK to enter the Euro 10 years ago, then it is not because it would have allowed us to permanently rig all markets to send off more of our stuff for cheaper than it is worth. And it seems completely implausible that the UK could have influenced the ECB enough to see it ditch its destructive hard money policies during the crisis, instead it seems more likely the UK would be just another country suffering under its negligence.

That high frequency trading we need the financial transactions tax to save us from

One of the arguments put forward by hte Robin Hood, or financial transactions, tax people is that high frequency trading is the work of the very Devil and it needs to be curbed by that tax. HFT is that algorithmic trading that takes place in nanoseconds as computers and algobots play with each other.

And I will admit that there's not a huge deal of use to the activity. It provides liquidity, this is true, it makes the players a profit, this is also true. Those against it state that it doesn't serve any public purpose: which is of course entirely the wrong question to be asking. We're all allowed to do whatever it is that we wish as long as that doesn't create some public disservice: that's what those old standbys freedom and liberty mean. The test of whether you're allowed to do something is not that you need permission: it's whether there's any good reason why you should not.

But logic aside there's not really anything much to worry about as Craig Pirrong points out:

HFT has been a bugbear for several years now. The monster that would eat the equity markets, and then move onto derivatives for dessert. But HFT has apparently fallen on (relatively hard times). HFT volumes are down. HFT market shares are down. And most interestingly, HFT profits are down, by about 50 percent on a per share basis, more on a gross basis because volumes are down.

Pirrong points out that Schumpeter told us all about this. But it's there in Smith too. When a new method of making excess profits is found (excess being above the normal rate in this instance) then the opther capitalists will observe that excess profit being made. They will then direct their own capital into this new method: the competition from their doing so wearing away at the ability to make the excess profit. given that markets often overshoot there'll often be a period of less than normal profits in the field but over time we'll end up in a reasonably stable equilibrium where this new field, such an exciting opportunity only a few years ago, is now returning normal profits just like the rest of the economy. And everyone goes off to hunt for the next excess profits opportunity.

Which leads us to two observations: the first being that markets here are doing their thing about providing information. In this instance that capital should flow into this field with the excess profits. Then when there aren't such excess profits no more should enter this field.

The second is that markets have, clearly and obviously, moved much faster than the regulators or the taxmen. We don't need to tax the activity as it's already contracting having exploited that excess profits possibility. As so often, even if it really is a problem, a market left alone to get on with things has sorted out said problem.

Yes indeedy, tax cuts do grow the economy

An interesting new paper looks at the effects of tax cuts on the UK economy. The finding won't surprise you and me but it's interesting to wave at others:

This paper estimates the effects of tax changes on the U.K. economy. Identification is achieved by isolating the ‘exogenous’ tax policy shocks in the post-war U.K. economy using a narrative strategy as in Romer and Romer (2010). The resulting tax changes are shown to be unforecastable on the basis of past macroeconomic data. I find that a 1 per cent cut in taxes stimulates GDP by 0.6 per cent on impact and by 2.5 per cent over three years. These findings are remarkably similar to the corresponding estimates for the United States.

This is another piece of evidence to illuminate our basic problem over the size of government and the taxation necessary to pay for it.

We know very well that some government spending is just great: both in what it achieves for us and also in the economic growth it produces. I'd certainly argue that a decent court and legal system is worth the money spent on it.

However, we also know very well that all and every taxation has deadweight effects: there's some economic activity that simply doesn't happen as a result of the imposition of the tax. Thus, if we want to maximise GDP we should be spending money only up to the level where the growth produced is greater than the growth not happening as a result of the taxation.

As it happens, of course, maximisation of GDP is not our goal. Maximising the utility of the population is meaning that all those things like leisure which detract from GDP are just fine. Indeed, those things like leisure are very much part of the point of the whole game: we want everyone to be as happy as it is possible to be without bursting from the joy of it all rather than everyone to be as rich in material goods as possible. That happiness to be determined by the lights of the individual concerned of course.

But even if we restrict ourselves to talking only of that small part of political economy which is indeed about GDP growth this paper does provide us with an interesting metric.

There is some part of the government's spending that is, nominally at least, about increasing GDP. The sort of stuff that Vince Cable's department does for example, all those various investment funds, the Green Investment Bank and so on. What this paper gives us is an interesting metric to use in measuring their performance. Say, just imagine, that all of this aid to business costs £15 billion a year. I use this number just to make the maths easy for that's 1% of GDP near enough. We now know that raising this much in tax costs us 0.6% of GDP in the short term and 2.5% in the medium term. We'd therefore very much like not to be raising this amount in tax: unless, that is, the spending of it produces a greater than 2.5% rise in GDP.

OK, hands up everyone who thinks that government "support" for business and development increases GDP by 2.5%?

Quite, time to close it all down and get the growth without bothering to do the taxing and spending, isn't it?

Do technological advances destroy jobs without creating new ones?

In a very readable article in the New York Times Paul Krugman expresses sympathy for the Luddites, suggesting that the benefits of future technological developments may not accrue very equally across society. This being the case, he suggests that policies such as a universal basic income may be one way of compensating the unlucky who have spent lots of resources on, say, a university education which has now devalued, something they couldn't possibly have predicted. Since I share Krugman's basic luck egalitarian intuitions, I am very sympathetic to his case.

The beef I have is with a response written by Gavin Mueller in Jacobin magazine. Up until now almost everything I've seen from Jacobin has been well researched, even handed and thoughtful, if coming from a very different set of basic premises to those I hold, but this is an exception. He makes much stronger claims than Krugman, calling technology "a weapon used against us" and arguing that a long-term goal of "abundance and leisure for all" (one I share!) may require "smashing the relations of production" in the short-term. Perhaps the line which most annoys me is "the belief that technology doesn't destroy jobs, but merely creates new and better ones, is, like so much else about bourgeois economics, a baseless assumption."

Does Mueller really believe that claim? Unemployment is 7.8%. Employment is touching 30m, its highest level ever. Since the 1750s there has been a tide of vastly transformative technological improvement and yet somehow a much larger population is employed. At the same time, this larger workforce is working much fewer hours and enjoys much greater abundance. Surely these widely available facts are enough to suggest that the assumption technology creates—as well as destroys—jobs is more than just a "baseless assumption"?

By no means is it certain that the trends of the past, which have seen mobile phones, more hygienic toilets and tasty soft drinks spread to even the poorest areas of the world, will continue. But certainly some evidence (e.g. the graph above) seems to suggest that technologies are spreading throughout society—and benefiting the general populace, not just the wealthy—faster than ever before. This is great, and implies that we can hope for greater abundance and leisure without smashing new technologies. If it turns out that not all benefit, then what we need is something like Krugman's universal basic income, not drastic societal upheaval.

The top three myths about immigration