Where next for capitalism?

Writing for the BBC today, Madsen outlines his ideas about what capitalism should do to renew itself:

What capitalism should now do is to free itself from these rent-seeking perversions and spread its benefits as widely as possible.

It should act against anti-competitive practices to give people instead the power of free choices between competing goods and services. It should spread ownership of capital and investment as widely as possible through such things as personal pensions and individual savings accounts.

Read the whole thing.

The Bank should raise rates now

No, not the European elections – the really significant news is that the Bank of England's outgoing deputy governor, Charlie Bean, says he expects UK interest rates to rise pretty soon. He expects the official interest rate, which has been at its post-crisis 'emergency' rate of 0.5%, to rise in "baby steps" to around 3% between 2017 and 2019. That is below the rate of about 5% that prevailed before the financial crash, but then world conditions remain shaky, so this is where Bean expects things to settle for a while.

We have long known that all nine members of the Bank's interest-rate-setting Monetary Policy Committee concur that interest rate rises will need to be very gradual, but there seems to be a growing mood that the process needs to start sooner rather than later if this gradualist plan is to succeed. Many economists (including me in my new book The Economics of Success) have been saying for a while that the UK economy is racing ahead too fast – reminiscent of the unsustainable credit and house-price boom that got us into our financial fix in the first place.

Any rise in interest rates, even "baby steps", will cause problems for business and domestic borrowers. When rates are at 0.5%, even a baby step of 0.25% represents a big increase. Sure, real-world interest rates are already above this figure set by the Bank, but the point remains. There will be mortgage defaults, and some of those 40,000 zombie businesses identified by the Adam Smith Institute will fail.

That is not entirely a bad thing. Our present economic pain is the result of our cheap-credit binge of the late 1990s and early 200s. It is the hangover after the party, and sadly, a hair of the dog will not cure it, but make the inevitable reckoning worse. Boom-time assets, financial, physical and human, need to be reassigned to more productive uses. We cannot live in a fantasy economy forever.

The most pain, as usual, will be felt by taxpayers. The government does get away with paying very low rates for its borrowing – partly because in these turbulent times it is regarded as about the least-unsafe place to put your savings. Even if rates go up in baby steps, the impact on the government's interest bill will be large. There will be more business-killing calls to "make the rich pay more".

It all goes to show: F A Hayek was right: the best policy is not to get into boom-bust cycles in the first place.

UKTI Fails Small Exporters

The primary purpose of UK Trade and Investment (UKTI) is to help small exporters. Large companies, whether exporters or those concerned with inward or outward investment, can mostly look after themselves, calling on Whitehall when they need to.  Small and medium enterprises (SMEs) have neither the strings to pull nor the resources to divert to tangling with bureaucracy.

Following the crash, banks rebuilt their capital by reducing credit, especially to those most in need of it.  Exporting SMEs were seen to be high risk and had their credit withdrawn across the board.  Rebuilding the banks’ capital at the expense of the economy was the right medicine at the wrong time.

You might think that UKTI would have leapt to the defence of small exporters and taken their part in securing credit or, at the very least, preventing banks from taking punitive action without warning.  You would be wrong.

Many SME directors only discovered that their credit cards had been cancelled when they were checking out of overseas hotels at the end of their export missions. Some were trapped in foreign countries until alternative payments could be made. Each of these episodes cost the SME hundreds of pounds as it made alternative arrangements.  One director, in the USA, landed up in gaol.  And of course the embarrassment did nothing for the SMEs’ export market credibility, never mind the inconvenience and loss of working time.

Apparently word buzzed around the SME community quickly and they began using travellers’ cheques again.  This may be old (2011) news to some but it has not been widely published.  It was brought to my attention by a group of Cambridge based SMEs which had read my recent ASI report (“Is government helping exports?” 16 May 2014) on UKTI.

Apparently my critique was not the half of it.  They are mostly technology companies and, I was told, UKTI does not even get to first base when it comes to technology.  Time for a serious review of UKTI?

On Mike Milken being history's greatest feminist

This will cause much spluttering amoung the bien pensants of our age but it is at least arguable that Mike Milken, the corporate raider, was actually history's greatest feminist. The case is ably made by Noah Smith:

Unless, of course, it can’t. Becker theorized that regulation and other government protections can shield discriminatory companies against attack. That would protect the jobs of the people who worked at those old-line companies, but would perpetuate workplace unfairness in the process.  In other words, Becker thought that competition kills discrimination. Open up the floodgates of dog-eat-dog capitalism, and women and minorities will win greater equality in the workplace.

And what was it that opened up those flood gates of dog eat dog capitalism? The invention of junk bond financing in the late 70s and early 80s in the US. And this is also exactly the time when the gender pay gap (and also the minorities one) started to shrink in that country. True, this is correlation, not a proof of causation. But when you've got a theory that predicts that if A then B, and A happens and then B does, you can start to have at least a little confidence in causation.

Further, when examining the same theory, you see that not A happening leads to not B happening then your confidence in the theory can rise again. As in Japan where the very concept of a hostile takeover is impossible to imagine, let alone a successful one, we see one of the largest gender employment gaps in the world.

All of which leads to a certain puzzlement. We have the likes of Beatrix Campbell insisting that this market orientated neoliberalism is the neopatriarchy, something that is designed to continue to keep the wimmin down. But it's precisely that market dogmatism that has led to womens' advances so far. For as Gary Becker pointed out, in a free market discrimination costs the discriminator and thus they do less of it.

Or, as we might put it, we should and do support free market liberalism precisely because it sets everyone free, women and minorities included.

Recycling seems to have become a continental religion more than anything else

Apparently we're simply not recycling enough these days:

Every home in the country will have to cope with compulsory rubbish recycling schemes by next year, according to papers released by ministers yesterday. Instructions prepared for councils have revealed a move to bring in separate collections of paper, metal, plastic and glass in order to meet recycling targets set by Brussels. This will mean that many homes will need more bins and any local councils which have clung to traditional weekly bin rounds – there are thought to be around 100 in England and Wales – will have to establish compulsory recycling systems.

We can and should divide recycling into three different and distinct tyeps. There's the recycling that makes a profit at standard market prices. We've been reycling gold on these grounds for many millennia now, old cars are melted down to make new ones and so on. That there's a profit to made in doing this shows that value is added by doing it: the addition of more value meaning that we're all getting richer. This is fine, in fact it's just great.

Then there's recycling that costs vastly more than is gained from having done it. You can recycle just about anything if you expend enough energy on it but no one would advise trying to turn used concrete back into Portland cement. Better by far to bake some more cement and put the rubble into the hole we've just dug.

There's also the class of things where the pure market numbers don't provide a profit but we'd like to recycle for other reasons. When there's an externality perhaps. Cleaning up a radioative waste site might not be profitable for the metals extracted from it but it could still be something we want to do anyway.

The danger is that we get confused about those possible other reasons. And then end up deciding that we should pursue that second, highl;y detrimental, type of recycling. And that's where the "recycle everything" movement is today. It's become an almost religious observation, one that's continent wide, that recycling stuff is a good thing to do in and of itself. But there's no actual reason to do this. There's no shortage of holes in the ground to put landfill into, only a shortage of licenced holes. There's no general shortage of resources for us to make new stuff from. But we are told that we must recycle ever more material, well, just because we must recycle ever more material.

We should take a step back from this sort of emotional observance and recycle only that which makes a profit. But trying to be rational about even secular religions never does get us very far, does it?

This craze for organic stuff is terribly dangerous you know

As we all know the internet was originally built so that we could propitiate Bastet by sending cat pictures to each other. So thus a picture of a cat.

But there is another reason for this image, which is to show quite how dangerous this obsession with organic materials is. For someone deciding to use organic kitty litter, instead of the required inorganic, might just lead to the closure of one of the world's radioactive waste depositaries. At a possible cost of $7.5 billion. To say nothing of the costs of climate change if we all stop using nuclear power as a result of being unable to get rid of the waste. Which is, when we look at it, quite a high cost of someone trying to go organic.

The background is that when you've got certain solutions containing radioactive particles you want to make sure that they're not going to dry out. For if they do they might go bang: and bangs with radioactive material are something that we'd rather enjoy avoiding. One of the things that can stop thing bangness is the use of kitty litter:

Nitrate salt solutions can ignite when they dry out – which is why it’s tricky working with nitrate solutions in the lab and why you need to make sure they don’t dry out, something many a chemistry student has found out the hard way. So you need to stabilize nitrate solutions before they dry out, or prevent them from completely drying out. Traditional cat litter is made from various inorganic geologic silicate minerals like diatomaceous earth, zeolites or bentonites, materials that are excellent in absorbing and stabilizing chemical species like nitrates, ammonia, and urea. This is the very reason we use minerals for cat litter. Unfortunately, someone working with this waste, before it was to be shipped to WIPP, used a new “green” cat litter, made with materials like wheat or corn. These organic litters do not have the silicate properties needed to chemically stabilize nitrate the correct way.

One of the barrels of waste, that had already been put into the depositary, has gone bang as a result of this new and unapproved ingredient. That's not too bad: the correct use of robots means that it is potentially feasible to clean up the mess. The problem is, well, how many other damn fool hippes have we had filling up all of the other barrels?

There's undoubtedly a time and a place for desiring things to be organic: that Welsh hill lamb or that grass fed beef are certainly worth chasing across the plate. But there are also times when the obsession becomes rather dangerous. This would appear to be one of them.

Isn't this nice? Crimea will adopt English law

This is an interesting little snippet of news. Crimea is going to adopt English law:

Lawmakers in Moscow are working on a draft bill that will offer tax and other incentives to stimulate exports, according to Savelyev, the minister for Crimea. Businesses there will operate under English commercial law rather than Russian legislation to attract foreign investment, he said.

Obviously they're not adopting English electoral law, nor that on referenda and the like. But it's an interesting observation they've made: that part of what generates a thriving and entreprenuerial economy is that English commercial law. I very much doubt that they'll get it right mind, but at least it's a start. For the cornerstone of that English law is that as long as there's no law against it then you can do as you wish. This isn't something that accords well with the pysche of those who have ruled Russia in the past it has to be said.

Back when the Soviet Union was newly dead Anatoly Sobchak, the Mayor of St Petersburg (and Putin's mentor) decided that you no longer needed any permits from City Hall to start up in business. Just send us a letter telling us what you're doing so that we can set up the tax system for you. The next day the office was thronged with those seeking the permit that they'd need not to have any permits. The idea of really needing no permits seemed not to be believable.

Two further things: having English commercial law will be all very well but you do also need to have English courts and the English enforcement of those laws. And the second is that wouldn't it be so lovely if our own rulers recalled the basis of our legal system which is they get to tell us what we may not do but then they have to stay silent on what we may.

Liberalism day is 16th June

Monday 16 June has been chosen as Liberalism Day. The idea is to recapture the world 'liberal' from the American left – who, with their extravagant plans for government spending and taxation are far from Liberal in the true sense. As Milton Friedman put it in his 1955 article, Liberalism, Old Style:

"Liberalism, as it developed in the seventeenth and eighteenth centuries and flowered in the nineteenth, puts major emphasis on the freedom of individuals to control their own destinies.... Liberals favoured free competition at home and free trade among nations. They regarded the organisation of economic activity through free private enterprise operating in a competitive market as a direct expression of economic freedom and as important also in facilitating the preservation of political liberty."

That is all a far cry from American 'liberalism'. as the term has been used since the 1930s. That is not about free competition and individuals controlling their own lives, but about the New Deal era of public works, Lyndon Johnson's Great Society and direct market interventions like the Community Reinvestment Act (which kicked off the whole sub-prime mortgage debacle) and Barack Obama's recent, forlorn, efforts to completely reconstruct the healthcare sector, not on market principles (which it sorely needed) but according to the political conception of himself and his party.

Liberalism is a perfectly good word, but it does not actually mean anything like all that. it is about time that we Liberals took back out own word, without having to quality it by the foreword 'Classical' or the afterwords 'in the European sense'. Check out the website, and tweet the hashtag #LiberalismDay on or around 16 June.

QE boosts equities by boosting fundamentals

Many people suggest that the recovery in equity prices since 2009-2010, seen around round the world but particularly in the American Nasdaq, S&P500 and DJIA, does not represent a general economic improvement. Instead, they believe that these numbers are simply being buoyed by new money pumped into the system. I don't think this argument holds, and I will attempt to explain why. First let's consider why we think people hold equities. Essentially, people hold equities because they expect a given real return for a given risk profile. In our simplest model, people hold portfolios of assets based on their risk tolerance, their subjective judgements over probabilities, and their preferences. Adding in banks, insurers, pension funds and so on makes the overall picture more realistic, but doesn't change our theory much. People pick financial intermediaries that hold the assets according to our preferences—the intermediaries add value through scale, or through providing a payments system and settling accounts.

Why might electronic money printing (which we call "quantitative easing" or QE) affect equity prices?

Well, firstly, we might not expect an effect from quantitative easing under one circumstance. QE increases the amount of narrow money we have—that is the number of notes, coins and bank reserves in the system. Generally we think broad money—which includes bank accounts people can debit or write checks on, and is much, much larger—is what interacts directly with the real economy. The ratio of broad money to narrow money is called the money multiplier, and usually a rise in narrow money leads to an even bigger rise in broad money—but this multiplier is not stable. It's at least possible (although not historically typical) that a rise in narrow money could be completely counteracted by a fall in the money multiplier.

But assuming this doesn't happen, there are three reasons why QE might boost equity prices. First would be because it increases inflation and the future price level. If prices rise, cash is worth less, so relative to a given nominal amount of cash, all things being equal a given equity is worth more. In other terms, the firms' nominal expected returns would rise.

The second reason is that in a depressed economy monetary easing like QE may boost real growth, which we would expect to raise any given company's expected real returns. It might also reduce the risk of very bad economic outcomes. Since equities are riskier than bonds, gilts and cash they pay a risk premium to those who hold them—a higher return (lower price) to compensate for this. If risky outcomes in general become less likely, these risk premia might narrow, making equities more desirable and expensive.

The third reason QE might raise stock prices is because it increases overall social wealth, and thus may lead to greater risk-tolerance overall, if people are willing to bear more risk as they get wealthier, and thus shift towards riskier assets like equities.

In each of these three, the jump in equity prices comes from fundamental factors. One could certainly drive up stocks by creating lots of inflation, but we can easily check if that's what's happening by looking at inflation. Any real/relative growth in equities would refute that explanation. In contrast, real growth, reduced risk and shifted preferences due to extra wealth are all legitimate reasons for higher equity prices.

Accounts of why QE buoys stocks without improving fundamentals (and hence part of the argument that stock indices are not good proxies for economic health) tend to rely on a narrative that QE "flows into equities". But as explained, people try to hold their wealth in the portfolio that fits closest to their preferences. If QE money did "flow into equities" then people would now be holding more of their wealth in stocks than they wanted to—they would rapidly rebalance their portfolio. Typically people needn't even do this themselves, because their pension fund will do so for them. QE has to improve the fundamental factors in order to boost equities.

The Negative Income Tax and Basic Income are pretty much the same thing

I’ve been talking about the Negative Income Tax lately, and equating it with the idea of a Basic Income. I think most of the policies’ respective advocates would deny that they’re the same policy. In this post I’m going to outline why that’s incorrect and I’m happy to say that they’re basically the same thing. For the uninitiated, a Negative Income Tax is a form of welfare that replaces most existing welfare schemes with a single payment that supplements the income of the unemployed and low-paid. The payment is withdrawn as your earnings increase, ideally at a gradual enough rate that increasing your earnings (and hence reducing leisure time) is always worthwhile.

An example: a £5,000 basic payment at a 50% marginal withdrawal rate (this means that for every additional pound earned, the worker will receive 50p less in NIT payments). Someone with an income of zero would receive an NIT payment of £5,000, or just under £100/week. If they took a job that paid £5,000/year, they would receive a top-up of £2,500/year; that paid £7,500, a top-up of £1,250/year. Once they reached £10,000/year, they would receive nothing in NIT.

This idea was supported by Milton Friedman, among others, and has a reasonably strong pedigree on the right. Even libertarians who object to income redistribution in principle usually concede that a Negative Income Tax is the least bad form of welfare, because it is administratively simple and perverts incentives less than most welfare schemes. It is particularly appealing to many liberals and libertarians because it is unpaternalistic.

A Basic Income, on the other hand, is usually conceived as a flat payment to everybody irrespective of circumstance. This leads to a very big problem: assuming it replaces most forms of welfare as an NIT does, a basic income high enough for unemployed workers to subsist on would simply not be affordable to pay to everyone. A policy that ideally would be designed to help the poor ends up being a very expensive subsidy to people who do not need extra money.

Advocates of the Basic Income recognize this, and their solution is typically to use the tax system to ‘claw back’ the payment from relatively high earners. So everyone gets the money, but it is withdrawn according to earnings.

In practice, that’s more or less the same as a Negative Income Tax – the only difference is whether the withdrawal takes place at the ‘front’ of the payment (as with the NIT), or the ‘end’ (as with the Basic Income). Strange as it may seem, the policies advocated by Milton Friedman and the Green Party are the same in all but the technical detail.

But even if there is a surprising amount of agreement in terms of the kind of welfare we’d like to see, the detail may be more difficult to agree on. How much should a ‘basic income’ be? When should it begin to be withdrawn, and at what rate?

Questions like this are, I think, likely to be where what breaks up this (unholy?) alliance. But maybe not. Traditional policies like the minimum wage probably do more harm than good, and, rightfully, the question of how to improve the lives of the low paid does not seem to be going away. It will take compromise, but in the Negative Income Tax / Basic Income, we may have an answer.