Ignore the doomsayers: The recovery is real

Some commentators claim that the UK’s current economic recovery is illusory. They say that the recovery is based on an artificial boom fuelled by loose money and will eventually come crashing down to earth.

I think it is very likely that this view is wrong, for at least two reasons. One, the UK does not have loose money that would fuel a credit boom. Two, the best tool we have for telling if the recovery is ‘real’ or not is the market. And the market is telling us that it sees things as looking good.

The idea that we have loose money is extremely common. It is based on the assumption that a Bank of England base rate of 0.5%, historically very low, must mean that money is loose. This is what Milton Friedman referred to as the ‘interest rate fallacy’. It is a fallacy because it fails to ask the key question: ‘compared to what?’

That ‘what’ is, or ought to be, the ‘neutral rate of interest’ – the interest rate where, in David Beckworth’s words, “monetary policy is neither too simulative nor too contractionary and is pushing the economy toward its full potential.” The tightness of money is determined by the central bank rate relative to the neutral rate. If the neutral rate of interest is lower than the base rate, then money is tight.

Is the neutral rate of interest in the UK currently above or below 0.5%? It’s hard to say. Milton Friedman pointed out that usually low rates were a sign of tight, not easy money. This is because low rates almost always coincide with very low inflation, nominal GDP growth and money growth—which Friedman pointed out were much better ways of assessing the stance of policy.

It’s possible to infer from things like NGDP growth (well-below trend until recently) that money has been unusually tight. NGDP growth seems to be returning to the trend rate, if not the trend level, that it was before the crisis. People calling ‘easy money’ may disagree, but if they are simply pointing to low interest rates without trying to compare them to the neutral rate, they’re not proving anything at all.

But even if it’s not down to easy money, maybe the recovery really does sit upon a throne of lies that will inevitably collapse. How could we tell?

Since the world is very, very complex, it is unlikely that one individual expert or panel of experts will be able to possess all the information they would need to make reliable predictions about the future.

Where possible, we should prefer the ‘wisdom of crowds’. And we have something that can do so very effectively: the market. And the market seems pretty optimistic: the FTSE 100 is growing strongly; firms are taking on new staff; gilt yields are extremely low.

Second-guessing the market is particularly unusual for people on the right of the political spectrum. As Josh Barro put it recently, “A conservative is somebody who thinks every market is efficient — except the Treasury bond market.” (A point worth remembering next time you read about the UK’s “looming debt crisis”.)

Of course markets can get things wrong. There is a high degree of uncertainty involved in all predictions like this. But, given a choice between the aggregated judgement of millions of market participants, all bringing their local knowledge to bear, and the judgment of a few experts, I’ll go with the market.

In summary, there’s no reason to think that either we have excessively loose money or that the recovery is illusory. Note that mine is an entirely negative argument – I am not claiming that money is too tight, or just right, nor am I claiming that markets are correct. I’m saying that, given the information we have available to us, we should resist the urge to doomsay. In short: don’t worry, be happy.

Why Labour’s rent controls will do more harm than good

Now that we have more detail, Labour’s new ‘rent control’ policy is not quite as bad as I’d initially feared. Instead of the old school price ceilings that destroyed parts of New York City, Labour are proposing ‘second-generation rent controls’, which limit the ability of landlords to renegotiate rents during tenancies, and ‘make three-year tenancies the norm’.

The real-world effects of this are likely to be that expected rent increases over the three-year lease will be priced in to the starting rent, so it’s unlikely to actually make anyone better off unless there’s an unexpected increase in rents. If rents fall below expectations, this would hurt tenants.

Since landlords are bound within tenancy agreements, rises in rents are likely to be sharper than they currently are for new tenants. This means that housing mobility is likely to be reduced – tenants locked in to a relatively low rent will find it more costly than they otherwise would to move. This is very important: it looks as if lowered housing mobility causes higher unemployment, because people are less able to move to find new jobs.

Rent controls of any kind are likely to decrease the supply and quality of available housing. ‘Second-generation’ controls are less tight and so less harmful than classical rent controls, but as Hopi Sen has pointed out, the German experience does not seem encouraging. There, rents have risen far more quickly over the past decade than they have in Britain, as new construction has slowed.

There is also evidence to suggest that second-generation rent controls have a similarly negative impact on housing quality as classical rent controls. A 1985 study by the Richmond Fed found that controlled housing units were 7.1% lower in quality in 1974, and 13.5% lower in 1977, pointing to a cumulative negative effect. If classical rent controls are only worse than bombing, second-generation controls may be close to petty vandalism.

One interesting aspect of this announcement is that it may affect supply now, as would-be investors in new housing are discouraged by the prospect of stricter controls on their investment. If the measures are actually brought in – crossing the rent control Rubicon – an expectation of tighter controls may reduce supply even more.

It’s not clear what mechanism Labour is proposing to make three-year tenancies ‘the norm’, but it’s hard to imagine any effective measure that would not end up hurting tenants who want shorter leases. This probably means young people.

As we say virtually every day, the best way to reduce the cost of housing is to build more. Labour’s proposals seem counter-productive, but they’re nothing compared to the harm caused by the planning system.

We recently learned that more of Surrey is covered by golf courses than by houses. Rolling the green belt out even a bit – by, say, a mile outside London – would create space for hundreds of thousands of new homes, relieving pressure on existing housing stock, reducing rents and – a nice bonus – creating lots of jobs and adding a few percentage points on to GDP growth. We can dream.

Three steps forward

In today’s City AM I outline a fairly simple growth agenda that would, I think, deliver very strong growth without requiring tax cuts (which are very important, but seem to be politically dead in the water right now). My three items are reform of planning, immigration and money (the ‘PIMs’, as I call them), by rolling back the green belt outside London, allowing high-skilled immigration, and targeting NGDP instead of inflation:

Whisper it, but things finally seem to be looking up. Investment is rising, unemployment is falling, and the deficit seems to be coming under control. But it could be a lot better. Real wages will not recover to their pre-crisis peak until 2020. And expected growth of 2.7 per cent this year is well below what we might expect in a real recovery.

The question is, how can we get the strong growth we all want? Tax cuts are nice, but hard to sell as long as the deficit remains large. And calls for business deregulation are often too vague to be useful. But there are clear areas for reform in planning, immigration, and money, and none would threaten the deficit. Reform these areas – the PIMs, we might call them – and real, booming, sustainable growth will come.

Read the whole thing.

Politics makes us ‘stupid’ because the world is complex

Ezra Klein has launched his new site, Vox.com, with an essay on ‘how politics makes us stupid’.

The piece is provocative, and Klein uses some interesting examples. Most striking is the study that shows that people’s maths skills get worse when the problem they’re dealing with has a political element and goes against their political instincts. (Klein seems to have slightly misunderstood the study he’s written about, but his basic point stands.)

The basic claim is that people engage in ‘motivated reasoning’ when they think about politics – in other words, they think in order to justify what they already believe, not in order to discover the truth. This, he suggests, is because the politically-engaged people get more loyalty to their ‘tribe’ than they lose by being wrong.

This ‘identity-protective cognition’, as he calls it, makes sense – a pundit who decides that the other side is right about some particular political issue (Klein uses global warming as an example) has a lot to lose in terms of status within the group they’re part of, and little to gain by being right.

Klein says that this has become worse as political parties have become more ideologically uniform and ideological ecosystems, like think tanks, blogs, media, more expansive. Not only is there the external cost of being wrong, but admitting to yourself that you’ve been wrong for a long time is quite difficult too, especially if you’re politically engaged and some of your sense of self is tied up with your beliefs. You could call this ‘rational ignorance’.

Even though that might seem plausible, I think he is assuming too much and is wrong about some of the phenomena he identifies. I’d like to suggest an alternative understanding of political ignorance that, I think, explains more and assumes less.

I think Klein’s fundamental error is to assume that the truth – or, at least, his mode of truth-seeking – is obvious. Basically, he starts off from the position that most people could reasonably see the light if they wanted to. If that’s right, then it could follow that incentive to disbelieve the truth. And “identity-protective cognition” is an interesting way of understanding that.

But suppose truth is not obvious – that we’re ignorant not because we want to be but because, in Keynes’s words, “we simply do not know!”. In contrast to the rational ignorance Klein is discussing, this kind of ignorance comes about because life is complex. The existence of this kind of ignorance is what allows people to disagree without either being willfully ‘dumb’.

To demonstrate his case, Klein uses examples of ideological dogmatism that are based on rejection of the hard sciences. Here he is assuming that a reasonable default position must be to believe in the usefulness of science, so anyone who deviates from that by disbelieving some scientific point must have an incentive to do so. But if they are simply unaware of the fact that science is usually a good way of learning things, them ignoring scientific consensus is simply a mistake.

Klein may see it as being obvious that science is great. But he has probably spent a lot more time thinking about it than most people – for many, rightly or wrongly, the jury is still out on science, as a great man once said. Error, not group loyalty, may be a simpler explanation for people’s refusal to accept what seems to be a well-established truth.

If the truth is difficult to determine, people who have an interest in politics need some way of sorting the truth from the information they can access. Since there is a huge amount of conflicting data and theory in nearly every area of policy (whether garbage or not), people need some way of sorting the wheat from the chaff.

That’s where an ideology comes in. An ideology, I suggest, is a type of ‘web of belief’ that allows people to use what they already believe to be true to sort relevant and true new information from irrelevant and untrue information. As Jeffrey Friedman puts it, ideology “provides pegs on which to hang the political facts of which non-ideologues tend to be so shockingly ignorant”.

This fits with the fact that ideologues are usually a lot more informed than non-ideologues, an important fact that, so far as I can tell, Klein ignores.

Klein’s view is that political ideology ‘makes us stupid’, but ‘closed-minded’ is probably a more accurate term. The vast majority of the public is shockingly ignorant of basic political facts, with the informational ‘elite’ also happening to be the more closed-minded. The alternative to closed-mindedness may simply be to be extremely uninformed.

This matters because the things Klein blames for politics making us stupid – ‘gerrymandering, big money, and congressional dysfunction’ – are mostly irrelevant if the view I’ve outlined here is correct. In a complex world where the truth is hard to discover, even the purest politics would make us stupid.

This implies a much more fundamental problem with the democratic process than Klein suggests. The trade-off between ignorance and dogmatism may be unavoidable in politics, making a well-functioning deliberative democracy virtually impossible to achieve. This may imply that less cognitively-demanding ways of making decisions, like markets, may be even more valuable than we realise.

The progressive approach to immigration looks a lot like the conservative one

In a way, it’s refreshing that Yvette Cooper’s speech on immigration today has identified ‘free market liberals’ as the main advocates of freer immigration policies. There aren’t many of us, though, so we usually have to rely on immigration liberals on the left to win the argument over there for decent reforms to take place. Unfortunately, it looks as if they’re losing too.

Cooper’s main claims are that immigration reduces native wages and job opportunities, puts public services under pressure, and low-skilled immigrants are exploited by British firms.

The first two of these claims are basically wrong and the third is a little dubious, as I’ll try to show, but even if they were true they would only justify restricting low-skilled immigration. There is basically no decent economic argument against skilled immigration, and I’m doubtful whether even the most wild-eyed worrier about the cultural ‘Islamicization’ of Britain has Pakistani doctors in mind. But, without any explanation, Cooper says that Labour will keep the cap on skilled immigration (despite her admission that “top businesses are worried they can’t get the high skills they need”). Oh well.

On low-skilled immigration, the main focus of the speech, Cooper suggests that liberals support immigration “as cheap labour to keep wages and inflation low”. Ignoring that this is a straw man worthy of the Wizard of Oz, it’s also untrue. According to the impact assessment published by the Home Office last month, low-skilled immigration has, at most, a minor impact on native wages, which in a flexible labour market like Britain’s is temporary anyway. And on the ludicrous idea that anyone supports immigration to keep inflation low, see Lars Christensen – under inflation targeting, a positive supply shock like immigration will lead to more inflation.

The public services point is old and well-worn, and it hardly needs repeating here that immigrants pay more in tax than they cost in services – a phenomenon which over the next few decades will mean the difference between a national debt of over 180% of GDP (in a zero net migration scenario) and just over 50% (in a >260k/year net migration scenario). Presumably nobody really thinks that more high-skilled immigration would have a negative fiscal effect, but I suppose it’s possible that liberalizing low-skilled immigration a lot could change this. In that case, charge immigrants a fee to reside in the UK or restrict access to public services. There is no problem with immigration to which strict immigration controls are the best solution.

The final point is the one that Cooper focuses on the most, maybe so that the dreary conservative orthodoxy of her policies is less obvious. Undoubtedly, some genuine exploitation does take place – Cooper gives the example of agencies advertising in Poland for jobs that turn out not to exist, virtually forcing the victims into grim jobs that they did not sign up for. It may be that the law needs to be strengthened to punish people who defraud immigrants in this way. But there will be negative consequences too – by raising the risk for legitimate employers of employing immigrants, this kind of law will make it harder for immigrants to get legitimate work. The danger is that, as in the case of the Modern Slavery Bill, laws designed to prevent truly terrible crimes will end up curbing whatever legitimate work the government decides it wants to stop as well.

To be fair, there are two positives in Cooper’s speech: taking students out of the net migration figures would be good for the education sector, and taking refugees out is humane. But the fact is that Labour has accepted the “logic” of the net migration cap, is making no reforms to high-skilled immigration, and is basing low-skilled immigration policy on anecdotes instead of evidence. Liberals beware: the ‘progressive’ approach to immigration is starting to look an awful lot like the conservative one.