On Russell Brand's misunderstanding of profit

The former Mr. Katy Perry took to Newsnight this week to display to all of us his ignorance of economics.

And after a few textbook political dodging of the question, Brand, 38, finally laid down his revolutionary manifesto which would create: 'a socialist egalitarian system based on the massive redistribution of wealth, heavy taxation of corporations and massive responsibilities for energy companies exploiting the environment.'

Hmm. I wonder whether we can manage it without starving 8 million Ukrainians this time. The fallacy at the heart of his prejudices though is this:

'David Cameron says profit isn't a dirty word, well I say profit is a filthy word,' the comedian passionately declared. 'I think the very concept of profit should be very much reduced because wherever there is profit there is also deficit. This system currently doesn't address these ideas.'

Ah, no. Entirely misunderstanding what is going on here.

Profit is simply the proof that value is being created. Leave aside for a moment who is getting that profit and consider what it actually is. We have the costs of our doing something: whatever those costs might be in labour, wages (no, not the same thing), raw materials, other inputs and for purists, the opportunity costs of doing something else with all of these things. We also have the income from having done this thing, whatever it is. All profit is is the acknowledgement that the income is higher than hte costs of having done it. Thus value has been created.

And we like people creating value: it's really rather the point of having an economy at all, creating value. For if no value was being created then there wouldn't be any value for us human beings to consume.

Indeed, we can go further. The opposite of profits is losses: they being an acknowledgement that  value is being destroyed. What is being produced from our process is less valuable than the things we are using to do the production. There is therefore less wealth to share around: people are all poorer therefore.

Losses are the destruction of economic wealth, profits the creation of that wealth.

Now, we can indeed mumble to ourselves over who gets these profits. We can even note that the consumer surplus (which is the profit accruing to consumers from that production with profit normally being defined as the value created flowing to the producers) is usually vastly higher than those "profits".  But even as we shout about the distribution of profits we must all recall the most important point here. Which is that we very much desire that profits be made. For they are, by definition, the proof that economic value is being created, that the value of output is higher than the value of inputs.

And that really is what we want in an economy, an increase in value creation.

The govt is finally catching up with the ASI

A second day for the ASI to celebrate. It may have taken HMG four years to catch up with our policy on a bad bank, but it took just six months for our arguments on green taxes to win through. In April’s blog, “An end to Zombie politics”, we called for the government to “suspend surcharges on energy bills [and] subsidies to energy suppliers or technologies”. Yesterday Cameron told the House of Commons that he is doing just that. There has been a certain amount of backing and filling since, with today’s Times suggesting that the Government may pick up costs no longer funded from energy bills. This sort of robbing Peter to pay Paul misses the point. The most recent IPCC report altogether rejects the alarmism formerly propelling green policy. In addition, reviews of the climate change literature point to the benign effect for the next fifty years of such warming as may occur. To use the slogan of climate change campaigners, “the science is settled”, that is settled against the expensive green policies which the government seems set to abandon.

And while in self-congratulatory mood, let’s note that our call for an acceleration of shale exploration was endorsed overnight by the National Trust, also reinforced by the agony of the Grangemouth complex, unable to compete with cheap American feedstock.

Whatever next? Let’s set up our scorecard on the policies we were calling for earlier in the year.

Is economics a science?

There should be no Nobel Prize in Economic Science, says economist Liam Halligan, because economics is not a science. It was, of course, only added (by the Swedish central bank) some 75 years after Alfred Nobel's death; but recipients get the same grand medal and scroll, get to shake hands with the King, and give a lecture.

Halligan cites this year's award to Eugene Fama and Lars Hansen of Chicago University, and Robert Shiller of Yale, jointly honoured for "laying the foundations for the current understanding of asset prices". Understanding? As Halligan says, "You may be forgiven for thinking that no one truly understands asset prices. The global stock market turmoil of recent years is surely testament to that."

The sad thing is that economists are so keen that their subject should be thought of as a science that they have infused it with many of the tools and approaches of the physical sciences – making it look more like applied mathematics than the study of (decidedly non-mathematical) human beings that it really is. I often say that, through their intense application of mathematics, the mainstream economists of today pride themselves on a more and more precise understanding of things that the rest of us know are complete tosh.

Under all the equations and algorithms, Fama's 'rational markets' idea is quite simple: markets quickly price in all new information. And since information itself can change quickly, the short-term movement of markets can be hard to predict.

That is plainly true: people in markets would soon find themselves losing money if they did not take account of the facts. However, there is more to human life (and therefore to markets) than mere facts – as both Hayek and Keynes knew. Halligan sums up this point with a phrase that should be engraved onto the computer screen of every supposed economist:

"...it obviously makes sense that share prices reflect all available information.... But they also clearly reflect rumours, supposition, herd-instinct, prejudice, hubris, pessimism and a myriad of other immeasurable qualitative factors, including occasional madness...." That's humanity for you. Good luck trying to model that.

The rediscovery of classical economics

It is appropriate that David Simpson should preface his new book The Rediscovery of Classical Economics with the famous 'road less traveled by' poem by Robert Frost. For his purpose is to put forward an alternative to the equilibrium economics that has dominated the subject for nearly a century. His alternative is classical economics, in the tradition of Adam Smith, Marshall and the Austrians. In their view, economic growth is the thing to study; they see markets as a dynamic process rather than as static; and they focus very much on human nature rather than seeing economics as a series of detached, static, mechanical models.

The reliance on equilibrium economics leads to some systematically bad policy mistakes. The mainstream economists tend to assume knowledge, such as the lowest-cost mix for production, that the classical economists point out must be, sometimes painfully, discovered. Knowledge, and how dispersed pieces of partial information are used and co-ordinated by market players, is critical, but the mainstream economists and their policymaker counterparts again assume that they can do better themselves, from the centre – a fatal conceit. And the mainstream economists again assume that people are rational in their economic behaviour – which, says Simpson, does not reflect the reality of the world that we are trying to understand.

The book shows how classical approaches provide a much better understanding of how market economies work than does equilibrium theory. All economics is about human behaviour – something often forgotten by the mathematical modellers – so Simpson starts with looking at human being, the limited information they have and their hopes and expectations, and adaptive nature. Adaptation of course means constant change, and the book looks at how markets adapt to change in an incremental, voluntary and self-organising way, another useful lesson for policymakers.

Simpson sees the process of policy formulation as another evolutionary, adaptive process, though of course the motivating factors are different. And they are much more complicated than the simple business objective of turning a profit, which is why government policy is so often confused and contradictory. Simpson concludes by extracting some key principles from the Austrian economics including some insights on the severe limitations of mathematical analysis in economics.

Readers who have that uncomfortable feeling that economic policymakers and the economists who advise them have a less than complete understanding of what they are doing will find out, from this book, why they are right to think like that. I hope both economics and policymakers read the book, as it will make them far more aware of their own limitations when it comes to managing the economy – which is not a sort of machine you can easily tinker with, but a complex, dynamic network of economic processes that is quite good at organising itself.

Sunday working: a reasonable compromise?

I never heard back from the BBC. They called me to ask if I might go on the radio to talk on Sunday trading. But there was a twist: Celestina Mba, a devout Christian, lost her job at Merton Council because she refused to work on a Sunday. So she is arguing before the Appeal Court that employers have a legal duty to "reasonably accommodate" such religious views. If successful, people of other faiths could win the same rights. And not just councils but all employers could find themselves obliged to make special provision for devout workers.

So what did the BBC want me to say? "We thought you would be on the side of business," they asserted confidently. That is, employers could set whatever working conditions they wanted.

Well, I am on the side of business, a much-oppressed minority these days. And I do want this case thrown out – but not for the reasons the BBC imputes to me as a "business supporter". My view is that working conditions are a matter for negotiation between employers and employees. If they cannot reach agreement, then it's no deal: the employer has to look elsewhere for staff and the employee has to look elsewhere for a job. If the labour market is properly competitive, there are lots of other employers and employees out there.

This argument is consonant with my libertarian prejudices. Yet the world is not as tidy as this. Employers and employees are not necessarily equal when it comes to negotiations. The loss of an employee is of minor consequence to a large employer; but the loss of a job can be devastating for a worker, particularly in times like these when other jobs may be hard to find. In this, as in other parts of life, the common law has always sought to ascertain and uphold what is "reasonable": we have discovered that if we all act "reasonably", we have fewer disputes and less violence.

Is it "reasonable" that businesses should respect the rights of religious workers? Plainly. But what exactly is "reasonable" depends upon the specific circumstances. In the case of religious days, a large firm may be able to accommodate everyone's preferences; a small firm may not; and the common-law courts are fully aware of that and would not expect anything different. Sadly, there is a growing tendency for politicians to intervene at this stage, taking one court ruling and applying it as general policy for everyone and across everything – a single rule, law or regulation that takes no account of the particular circumstances of each case. Which means that in many cases, the law is not at all "reasonable" but is repressive.

Regulation isn't the way to ensure a diverse marketplace

As we all well know one analysis of the Great Crash is that it all happened because financial markets werte too concentrated. There were banks that were "too big to fail" and which we couldn't just let go bust therefore we had to bail them out. I certainly ascribe to part of that analysis, or to it in part perhaps. And a useful solution would therefore be to break up large banks so that none are in fact to big to fail. Seems a logical answer.

However, what is actually happening is that we're getting ever greater regulation of those financial markets. And that's a problem, for being able to deal with regulation is a fixed cost: and increasing those reduces the number of smaller players. As Craig Pirrong puts it:

The hedge fund article also points out something I’ve been hammering on for years now: perversely, since compliance costs have a huge fixed cost element, the regulatory onslaught creates scale economies that favor concentration and consolidation, and which can potentially reduce competition. You are seeing it in hedge funds. You are seeing it in banking. You are seeing it in FCMs. And I do mean perverse, because among the ostensible purposes of these regulations were mitigating the too big to fail problem, and promoting competition. The dramatic increase in regulatory overhead that favors the big over the small is completely at odds with these purposes.

I think we do all agree that sometimes there are things that must be done and also that some of these things that must be done can only be done by government. However, the list of things that can successfully be done by regulation is rather shorter than that list of things that must be done and which can only be done by government. For as here, sometimes the effect of the regulations is diametrically opposed to the solution of the problem we're trying to deal with. More paperwork will lead to an increased concentration in an indsutry.

If you don't pay for someone else's university course then you're violating their human rights apparently

A rather worrying document crosses my desk. This one, in which we are told the following:

The Task Force’s human rights analysis begins by making a link between human rights and extreme poverty. For instance, the UN Human Rights Council has recently adopted Guiding Principles on Extreme Poverty and Human Rights that describe how poverty is connected as a cause or consequence of violations of 14 different human rights and all the key human rights principles − ranging from the right to food, the right to health, the right to education and the right to social security, to the principle of transparency.

Considering the negative impact that tax abuses have on poverty and human rights, the state has a number of obligations to counter tax abuses. These flow from states’ obligation to use the maximum available resources to progressively realise human rights − including the obligation to confront tax abuses as part of an overall plan to strengthen financial and tax governance.

This is the International Bar Association talking here: and it's an interesting perversion of human rights that has led us to this pretty pass.

That perversion is of course the idea that positive rights are human rights. It's pretty simple with negative rights: freedoms of speech, or association and so on. These cost nothing to provide, you just don't do things that would stop people having such rights. Positive rights, those rights to food, education, health care, they do indeed cost money to provide. In the UK at present something like 30 t0 40% of everything the entire country produces in a year in fact. We must therefore violate someone's right to property to be able to provide those things to all. We thus have a conflict of rights and one or other of them has to give.

Now I'm not an advocate of our not having a state financed welfare, health care, education or social security system. Even the most minarchist state that I can imagine happening is going to have some role for government in those fields. Which inevitably leads to taxation of course. But I am arguing that we cannot include these positive rights in our definitions of human rights. For they directly conflict with others, with negative rights that we have already decided are indeed human rights.

Clearly and obviously the UN and the International Bar Association disagree with me on this point but I wave a very English two fingers in their general direction. We're going to have government come what may and that inevitably means taxation to pay for it. But it's taking matters much too far to claim that my paying Johnny No VAT cash for cleaning my windows is a violation of Jimmy's human rights as he doesn't get a plaster for his cut finger.

Laws, power, tax and servitude

One of the least well known British classical liberals was Thomas Hodgskin, who flourished in the early nineteenth century. I have been reading about him in George H Smith's new book, The System of Liberty. Something of a precursor to the Public Choice School thinkers of the twentieth century, Hodgskin critiqued the political process and despaired of getting much liberal change out of it:

Rapidly...as the gentlemen at Westminster work, making three or four hundred laws per year, repeating their tasks session after session – actively as they multiply restraints, or add patch after patch, they invariably find that the call for their labours in continually renewed. The more they botch and mend, the more numerous are the holes. Knowing nothing of natural principles, they seem to fancy that society...derives its life and strength only from them. They regard it as a baby, whom they must dandle and foster into healthy existence; but while they are scheming how to breed and clothe their pretty fondling – lo! it has become a giant, whom they can only control as far as he consents to wear their fetters.

But of course the legislators have something with which to buy that consent – their ability to raise money through taxation and spend it on the noisiest complainers:

One of the first objects then of the law, subordinate to the great principle of preserving its unconstrained dominion over our minds and bodies, is to bestow a sufficient revenue on the government. Who can describe the disgusting servility with which all classes submit to be fleeced by the demands of the tax-gatherer, on all sorts of false pretences...? Who is not acquainted with all the restrictions placed on honest and praiseworthy enterprise...? What pen is equal to the task of accurately describing all the vexations, and the continual misery, heaped on all the industrious classes of the community, under the pretext that it is necessary to raise a revenue for the government?

Thomas Hodgskin, The Natural and Artificial Right of Property Contrasted (1832).

The "Papers, please" immigration bill

In today's City AM I highlight some of the worst parts of the government's Immigration Bill. The Bill forces private citizens like landlords, nurses, wedding registrars and others to become de facto state informants, reporting anyone they suspect of being an illegal immigrant to the authorities:

But “papers, please” could soon become government policy. Whatever your perspective on migration, the Immigration Bill currently being debated in Parliament would turn thousands of private citizens into state agents, forced to report anyone they suspect of being an illegal immigrant. Almost every provision in the Bill will deputise some group of British citizens in this way, and would subject others to invasions of privacy.

Private landlords will have to run immigration checks on tenants, and will be at risk of prosecution if they fail to comply properly. The crackdown on “sham marriages” will expose more Britons to investigation. Marriage registrars are already required to report “suspicious” marriages to the state, but this Bill will double the period during which couples are under threat of being reported. Any Briton hoping to marry a non-EU citizen is open to investigation, and there will inevitably be mistakes that remove protections from legitimate couples.

Though concerns about health tourism are legitimate, the actual cost is tiny:

This week, it was reported that the NHS spends £2bn on treatment for temporary migrants in the UK. But most of this is on those, like students and temporary workers, who are already paying tax here.

The cost of actual health tourism – people coming to the UK specifically to get health treatment – is estimated by the government to be £70m, or 0.06 per cent of the NHS’s annual budget. Enforcing tighter controls may seem attractive. But if the cost is greater than the amount of money it saves, it doesn’t make sense.

Read the whole thing. I'd be interested to hear people's views in the comments.

Why is everyone shouting that the nuclear deal is so expensive?

I have to admit that I'm not really getting all this screaming about how expensive the nuclear deal is. Just not getting it at all:

Seven years ago, I collected all the available cost estimates for nuclear power. The US Nuclear Energy Institute suggested a penny a kilowatt hour. The Royal Academy of Engineering confidently predicted 2.3p. The British government announced that in 2020 the price would be between 3 and 4p. The New Economics Foundation guessed that it could be anywhere between 3.4 and 8.3p; 8.3 pence was so far beyond what anyone else forecast that I treated it as scarcely credible. It falls a penny short of the price now agreed by the British government.

And there's any number of people out there shouting that at £92 per MWhr Ed Davey has agreed to pay twice the current price for the electricity that will be generated. Or, as George Monbiot points out above, that 9.2 p or so per kWhr.

Sure, this is indeed more expensive than the current costs of electricity but here's the bit that I'm not getting. These complaints, they're over something that is vastly cheaper than all of the other things that are being done with the full agreement of those currently complaining.

This strike price, it's the same as a feed in tariff in its effects. And here's the list of the feed in tarifs on other technologies. Solar at 14.9 p, Hydro at 21.65 p, wind at 21.65 p again. This nuclear scheme, the one that people are complaining so hard about, is under half the cost of wind power. So, either nuclear is amazingly cheap or it's grossly expensive and wind power is twice as bad either way around.

So, as I say, I don't really get it. How can people complain about the costs of this nuclear deal and then go on to support alternative technoligies which are twice as expensive?

Summary