Gary Becker was right, part one: Crime

Gary Becker famously applied economic thinking to whole areas of activity that lie beyond the realm of narrow economic transactions.  One such area is crime.  The prevailing thinking of the day was that criminal activity derived from mental aberration or from social repression, and might be tackled by measures to improve mental health or to upgrade social conditions.

In his paper “Crime and Punishment – An Economic Approach” (1968) and in subsequent publications, Becker advanced the alternative view that criminals were basically rent-seeking, trying to secure more of the resources that others produced instead of contributing to economic growth themselves.  He posited that criminals are rational, performing a kind of cost-benefit analysis in which they set the gains they stand to make from a crime against the likelihood of being caught and facing a penalty.

Society can alter that cost-benefit equation in two ways, by increasing the likelihood of detection, or by increasing the penalties faced upon conviction.  Increased police presence is by far the costlier of the two options, while jacking up the penalties can be relatively less costly to do.

Becker’s insights have altered the way in which authorities tackle crime.  Zero tolerance, for example, proposes that pursuit of minor offences (“broken windows”) can create a climate in which potential criminals feel they are more likely to be caught.  The use of CCTV to identify criminals by recording them in the act is similarly intended to raise the stakes of crime by making its detection seem more likely.  On the other side of the equation the use of longer prison sentences also increases the costs that the potential criminal has to set against the benefits.

It was entirely typical of Becker, and part of his great contribution, that he took economics out from the economy itself and into the activities and relationships in society at large.  Crime was one such area.

Mervyn King on Thomas Piketty

In the Sunday Telegraph former Bank of England Governor, Mervyn King, reviews Thomas Piketty’s book, “Capital in the Twenty-First Century,” and carefully shows where and why it is wrong.

He points out that technology and globalization “have raised the demand for special talent and lowered it for unskilled labour.”  The Wimbledon prize money is 33 times what it was (in real terms) forty years ago, whereas manufacturing wages have merely doubled over the same period.

Returns go to the winners of the tournament, whether in tennis, finance, law, computing, advertising or other occupations. The “winner takes all” mentality has invaded many walks of life, although the identity of the winner changes over time.

King takes on Piketty’s central claim that the rate of return on capital (r) exceeds the rate of economic growth (g), and his assumption that this will lead to ever greater concentration of wealth.  King questions the idea that “the owners of capital reinvest all their profits and the spendthrift workers consume all their wages.”  Where, he asks, are the families that have pensions and own houses?  And what about the sovereign wealth funds that are important forms of collective ownership?

A key issue King identifies in Piketty is his failure to take into account risk in investment. “Adjusting for risk,” he says, “average rates of return have historically been much closer to growth rates.”  Indeed, King notes that the current risk-adjusted rate of interest is below the growth rate.  Where Piketty claims that the period 1910-1970 was exceptional because of major shocks, King suggests that the risk premium “which constitutes a large part of the rate of return on capital,” reflects the possibility that major shocks could happen again.

King tells us that the share owned by the top one percent has fluctuated up and down, but is lower today than it was 200 years ago, and “a similar story can be told for Britain and Sweden. In Europe, the concentration of wealth among the elite remains far below what it was in the 19th century.”

Although Piketty concentrates on capitalism’s alleged failings, King says one should not ignore the achievements of a market economy in creating growth and reducing poverty.  Quite so.  No-one has found a better way to raise living standards for billions of people.  The wealth of a market economy has funded education, healthcare, sanitation, the arts and scientific research as well as raising material prosperity.  Piketty’s attack on it is but the latest in a series emanating from the Left, and King has done us all a service by undermining it.

Gary Becker, 1930–2014

Gary Becker, made a Nobel Laureate in Economics in 1992, has died aged 83.  He was one of the great economic minds of the second half of the 20th Century, and was described by his mentor and friend, Milton Friedman, as “the best student he ever had.”  At the Adam Smith Institute we knew him through the Mont Pelerin Society, whose meetings he attended.

He was a leading liberal thinker (using the word in its European sense), whose original contribution was to introduce economic thinking into other areas of human behaviour such as the family, marriage, discrimination, crime and addiction.  In a key insight he showed, for example, that the entry of women into the workplace had raised the value of their time and thereby reduced their demand for children.  He incorporated into economic thinking ideas that had hitherto been thought to belong to sociology and other areas of behavioural study.

His insight on crime was the observation that criminals are not necessarily mentally ill or socially oppressed, but capable of calculating quite rationally if the likely proceeds of a criminal act would outweigh any penalty, taking into account the probability of being caught.

He was a key figure in the Chicago School, and was Professor of Economics and Sociology at the University of Chicago.  He was regarded as an inspirational teacher and a valued colleague, and will be sadly missed.  He wrote:

My teachers taught me that economics was not a game played by clever academics, but a serious subject that helped us understand the real world we lived in.

In aiding that understanding Gary Becker played a major role.

The sale of Royal Mail was well handled

The National Audit Office, some of the media, and the Opposition (of course) are saying that the sale of Royal Mail was "too cautious" and lost "hundreds of millions of pounds" for the taxpayer.  This is nonsense, and its currency shows how little some people understand about privatization, or perhaps how much people have forgotten by not doing it.

It was the first major privatization in two decades, and the aim was not to raise the greatest possible sum for the government, but to turn a state-run corporation into a successful and flourishing private business.  This was always the aim of the privatizations of the 1980s and 1990s.  When the major state industries and utilities were brought to the stock market and put into private hands the aim was always to achieve a first-day premium so that investors would feel satisfied that it was a success, and feel confident about its future.

No-one knew what the "correct" price was for Royal Mail, any more than they did for BT, British Gas and the dozens of others.  Since they had not traded in the private sector, or had to attract private investment, no-one knew how they would be valued.  Government took expert advice knowing that it would be, at best, an estimate.  It covered itself by retaining a proportion of the shares so it could gain later from any increase in value.  In the case of Royal Mail it has retained 30% for later sale at a higher price.

The pricing was cautious, as it was in the earlier privatizations, because government wanted a successful launch into the private sector more than it wanted the highest possible price.  Privatization was always a political as well as an economic act.  Its major aim was to replace state ownership and direction of industry by commercial and (where possible) competitive private sector activity.  It did so because the private sector is exposed to improving disciplines absent from nationalized industries.

The threat at the time of a Royal Mail strike cast more uncertainty over the company's valuation, even though that threat was later withdrawn.  We now have a successful private company holding its own in a competitive market, a company that has become one of the UK's leaders, and one whose future prospects look good.  This was a successful sale, and those who carp about not gaining the maximum possible price simply do not understand what privatization is all about.  It isn't about selling off stuff for the top price; it's about building up companies that can thrive by providing goods and services in a dynamic competitive market.

Osborne’s Surprise

The most exciting part of George Osborne's fifth budget came as a total surprise.  This was the complete overhaul of the pensions system, and it achieved two of the Adam Smith Institute's long-term objectives: simplification combined with tax reduction. 

The previous rules, complicated and cumbersome, arose from the Treasury's lack of trust in people's ability to manage their own affairs competently.  The Treasury tried to micro-manage how pension pots should be drawn upon.  They limited the amount that could be taken in cash, and capped the amount that could be drawn in annual income to a small amount, with a punitive 55% tax on anything in excess. 

The Treasury's concerns were twofold.  They didn't want high earners to use pension pots to circumvent income tax, and they didn't want people drawing so much that they had insufficient left to support them and might become a burden on the state.  People were compelled at one stage to buy an annuity, despite the poor value these have represented.

Osborne's bold budget has introduced the revolutionary idea that people are better at judging their own interests than Treasury officials are.  At a stroke he has given them the choice of how much to draw and when to draw it, and abolished the 55% rate.  Anything they do withdraw will be taxed at their marginal rate.  Significantly, the Chancellor pointed out that those on his side of the House know that lower tax rates can sometimes bring increased revenue, and he expects it will happen in this case.

Saving for retirement has suddenly been made more attractive, and since much of this saving is in equities, it means more investment will be available to create and sustain jobs and to boost growth.  It also means that fewer people will choose to be dependent on the state in their old age.

The Chancellor has expressed his confidence that people will behave responsibly and with due regard for their own interest.  Bravo.  It is an admirable sentiment and one that should be adopted in other Departments.  The ASI will be encouraging them to do so in the months ahead.