Adam Smith Institute

With all the bankruptcies in the airline industry over the last few years, companies blame high fuel prices, the war in Iraq, the industrialization of China and India, and several other factors for their difficulties. But Southwest Airlines, based in Dallas, Texas, took a different approach that is paying dividends as oil prices rise. In 2000, the company realized fuel prices could rise dramatically and hedged their gas price.

As Moira Herbst wrote,

For 2008, 70% of its fuel needs are hedged at $51 a barrel. That means that while competitors have to contend with spot prices hovering around $120 a barrel, Southwest can buy oil at less than half that... For 2009, the company is covered about 55% at $51 a barrel; for 2010, 30% at $53 per barrel; and for 2011 and 2012, at more than 15% at $64 and $63 per barrel, respectively.

Although continuing this strategy will prove more expensive as fuel prices continue to go up, Southwest has continued to make profits while other airlines have failed. Former CEO of American discount airline JetBlue David Neeleman hoped to follow a similar strategy, but the company rejected his Idea.

As airlines continue to fail and the number of bankruptcies continues to rise, it is not difficult to imagine the Federal Government following the same path it did in the 1980s with Chrysler and recently with Bear Stearns. But Southwest proves that innovative thinking and sound strategy can carry a company through the most difficult times. Government intervention allow less wise companies to unfairly take away Southwest's business, once again rewarding incompetence and penalizing intelligence.
 

In all the discussion of the American sub-prime mortgage market, few people have pointed out that the US government actually compels banks to make loans to poor people in poor neighbourhoods – regardless of whether those loans are prudent and are likely to be repaid.

It started with the Community Reinvestment Act of 1977, which aimed to support community groups, but in 1995 the Act was extended and beefed up, giving regulators far more powers to punish banks who refused to lend to people in poor urban neighbourhoods – so-called ‘redlining’ – because they considered the risks too high in those particular areas.

Congress's idea, obviously, was to extend to poorer people the same rights and enjoyment of home ownership that the middle-class majority possessed. But in fact it precipitated the banks into giving loans to some rather shaky people. Quite simply, they feared retribution by the regulators if they did not.

As a result, sub-prime loans mushroomed in the late 1990s. Not too bad for as long as the US economy was booming. But booms inevitably burn out and then the banks started to realize the magnitude of their dodgy contracts. And now, the whole world is being sucked into this crisis, and ordinary, prudent bank customers find themselves and their money frighteningly exposed. That's the cost of American political correctness. Thanks, guys.

George Osborne's non-dom tax policy is now in tatters. It wasn't a bad policy, all in all, to make non-domiciled investors stump up a bit of cash to pay for the public services that they enjoy by dint of living here. The proposed burden was modest, and the policy had been tested out on the business community before it was announced. I don't think I would have proposed it (on the ground that the UK needs every investor it can get, and there are plenty of places round the planet who are willing to tear up the tax forms and welcome them in). But nobody really objected too much.

Indeed, it went down pretty well with the general public. Whereupon (unfortunately) Chancellor Alastair Darling thought that he too could stick these rich foreign investors for some cash to help fill his budget deficit – and, in haste to steal Osborne's halo and without any consultation, promptly overdid it.

So now we've had a stream of non-domiciled investors mumbling and grumbling that they might – or will – soon be leaving the country for more agreeable and lower-taxed places, like Bermuda or Switzerland, where policy is less fickle and arbitrary, and where you can plan your business for the longer term. The latest, according to reports, is Brevan Howard, a $22bn investment fund currently based in London's Pall Mall. But that's just the latest of dozens.

So at a stroke, Darling has killed off the UK's hard-won status as a buzzing international investment centre where non-dom enrepreneurs are welcome and left in peace to get on with making money for themselves and, indeed, all those Brits they work with and invest in.

To will back that status, Osborne – when Chancellor – will have to do far more than just promise a somewhat lower rate of tax. Investors' confidence in UK policy has, unfortunately, been shot away by the government's arbitrary, opportunistic attack on them. Osborne will have to say that he'll restore the status quo ante – and sign in blood that it won't change again during his term of office – before the big fund managers will think about returning.

... Dr Eamonn Butler writes about the problems in the financial sector and the government's £50bn bailout. Click here to read the article.

98. "It is more rational to plan for the satisfaction of our future wants and needs than to expect blind chance to do it."
 
This is true, but often the statement is used to claim superiority for a centrally planned society and for government intervention in the economy. Neither of which it is correct. We all plan individually for the satisfaction of our wants, and imperfect though we are, we tend to do it more accurately than government does, and in less costly ways. We are not leaving it to blind chance if we fail to plan collectively, we are planning individually. We know more about our circumstances than any government can, we know more about our needs and preferences, and we have a bigger stake in the outcome than any bureaucrat can ever have. We plan for ourselves, they do not.

The free society produces an overall order out of all of these millions of inputs. It directs towards the satisfaction of our wants the activities of distant people we will never meet, and has us helping to meet the needs of strangers.

This spontaneous society is better at meeting our needs than any alternative which can be dreamed up by a single human mind, or by a small elite. The larger society contains information from all of us, and produces an ordered outcome not sought deliberately by any of us, but more rational than blind chance could produce, and certainly more rational than anything government could ever achieve.

It meets our needs efficiently and continually directs resources to those who produce the most from them. It enables millions of us to pursue different goals at the same time. Any attempt to plan what society as a whole shall do, or what it shall produce, forfeits that versatility, that spontaneity and that problem-solving ability. It substitutes the priorities of the few for the needs and aspirations of the many.
 

A report in The Times on how rural land values are soaring:

Farmers have seen their land values soar by 30 per cent in a year. With markets in turbulence and surging global food prices making agriculture profitable, land is now seen as a safe haven for cash and pension funds.

City institutions, led by Blackrock, UBS and Schroders, are setting up funds to invest in land and agribusiness. Other hedge funds are exploring the market. They are in competition with British farmers and businessmen from Ireland, Denmark and the Netherlands, where land is even more expensive.

Well, yes, but there's something else going on as well, it's not just the usual interaction of supply and demand. There's subsidy as well.

The Common Agricultural Policy (spawn of the very devil that it is) has recently undergone some changes. Instead of subsidy being based upon production, it is now linked simply to the acreage (actually hectarage but forgive this traditionalist his little pleasures) of land held. It's not quite in one leap though: over a period of years it moves from the historical amount based on past production to the flat per acre payment. That change is having its obvious effect: previously you had to actually farm the land, get something out of it. Now you just have to own the land to get the cheque.

That obvious effect being of course that the price of land will rise, as David Ricardo woud have pointed out. The subsidy is now simply an additional rent to the property, one which will simply feed through into increased capital values. It's a little difficult to work out exactly what the subsidy actually is (come on, this is the EU we're talking about) but £100 an acre or so looks like a reasonable estimate. Taking a 5% interest rate (or return upon capital, your choice) we would thus expect the subsidy to increase the value of land by some £2,000 per acre (ignoring the effect that the earlier subsidy system had on such land).

£3,500 Price of an average acre of farmland a year ago
£5,000 Price that an acre is close to fetching today

Ah. So, that's what the CAP does, increases the wealth of those already owning land and making future farmers require more capital to enter the business. Not, perhaps, the desired outcome. Which brings me to my perpetual and oft asked question about the European Union itself.

Can we leave yet?

95. "The economy offers too much choice. It wastes resources and confuses people."

Some commentators say that there are too many varieties of items such as lipstick, colours of toilet paper, and types of milk on offer. They suggest that this leaves shoppers not knowing which to choose, and that it represents a waste of resources.

But these resources are not wasted if people want them. To some people they may seem wasteful, but not to the consumers. Some people prefer full fat milk. Others choose semi-skimmed or 2 pecent fat. Still more opt for goat's or sheep's milk, and some for soy milk. People have their reasons for making these choices. In many cases they express a taste preference by their purchase. Others might consider health or nutritional factors. The supermarket shelves offering their variety of milk might confuse some, but they are simply responding to customer preferences. The same is true with other products

Markets respond to demand. They supply the goods people want in the forms and varieties that are sought. Those who are good at this have resources directed their way. Those who are bad at it find themselves struggling. Henry Ford famously offered his Model-T in "any colour you like, so long as it's black."  He lost market share to rivals who offered the different colours buyers wanted.

In a planned economy one could commit the production of shoes to purple sandals of size ten. In the absence of any other footwear, people would buy them and one could point to the lack of waste in not producing different styles, colours and sizes. But the consumers would not have gained the products that satisfied their preferences.

Those who call product differentiation wasteful are those who would have the economy produce the priorities they thought appropriate and sufficient, rather than the ones which emerged from free choices by the population. Choice is the hallmark of free societies.

Despite the obvious monetary-induced stresses that have emerged since mid-2007, few economics commentators have questioned the role that monetary policy has played in causing this situation. In fact, monetary policy has everything to do with where we are today. The low levels of interest rates that were maintained on both sides of the Atlantic between 2002 and 2004 are the main reason why there was a surge in debt-financed activity, undertaken by financial businesses, households and government.

In the UK, inflation targeting has failed to create the conditions necessary for sustainable growth. Indeed, it has more than failed; it has actually been a significant cause of the credit boom. The problem with all static policy targets, whether they are for monetary variables, the currency or inflation, is that they work only so long as they remain consistent with longer-term equilibrium between supply and demand. Inevitably, however, they are framed by politicians and civil servants looking into the rear-view mirror.

Had it been in place earlier, inflation targeting inflation might have prevented some previous acts of economic vandalism. But it is hard to establish a rigid policy framework capable of accommodating future changes in the economic environment. Worse than that: the goal of monetary policy becomes solely to achieve the target; policy makers become blind to other evidence that suggests a change of course might be appropriate. The problem in the UK has been that the inflation target was not designed to accommodate a situation in which there was excess domestic demand at the same time as significant downwards pressure on inflation.

Because the policy framework established by Gordon Brown in 1997 was so narrow, the MPC was encouraged, if not mandated, to ignore obvious signs of overheating in the economy. The result was that the policy signal became stuck on Go.

The MPC should be given a broader remit. This may still have inflation at its heart, but it should also be made clear that policy must be formulated to ensure that the UK is on a sustainable growth path. Sometimes this may mean that inflation deviates from an explicit target – but on the basis that this is consistent with a wider balance being maintained in the economy.

Richard Jeffrey is Head of Securities at Ingenious and is a member of the ASI's regulatory action group.

94. "Business doesn't care about consumer safety, and cuts corners by economizing on safe conditions for its workers."

What private business wants most of all are satisfied customers who will not only come back, but tell their friends. A reputation for unsafe products is the last thing a business needs. A toy company with a reputation for products which injure children is not going to sell many toys. An airline with a bad crash record tends to be avoided by travellers, as does a railway company, state or private, which kills its passengers.

It is often a good thing to have industry-wide safety standards. They help impart general confidence and inform on how safety is best maintained. Best practice can become the norm. The industry itself should be consulted on this, however, because they know better than any outside inspector can. In many cases a voluntary code policed by the industry itself is satisfactory. In others, legislation incorporating their advice may be needed. But the notion that they don't care about product safety is profoundly wrong. And the notion that some bureaucrat sitting in Whitehall or Brussels with no knowledge of the industry is the best person to lay down rules for product safety is equally wrong.

It is also true that a contented, motivated workforce tends to be more productive and less prone to disruption. It is not in the interest of business to have casualties among its workers. Again, it is good to have the industry's input into safety standards, because they know the conditions. As the economy becomes more prosperous, and as technology advances, it becomes possible to achieve and insist upon ever higher safety standards.

State industries in the UK and abroad are not safer for customers or employees than are private businesses. If anything, it is the prosperous private industries which can afford better safety standards, just as it is the rich economies which can do so.
 

93. "Some businesses deliberately build obsolescence into their products to force people to buy more when they wear out."

Some might economize on longevity where there's a demand for a cheaper product. If people want durability, they pay for it. If you recognize that fashions change and technology advances, you might opt for a cheaper product with a shorter life span. The pace of innovation is accelerating, and most customers seem to want the latest product. It depends on what you're buying.

There are products, such as houses, which people expect to last. Builders do not deliberately build houses which will fall down after a few years to force people to buy new ones. Instead they recognize that the market there is for durability.

For mobile phones and iPods, on the other hand, most customers would not want a product to last for decades. They prefer not to pay the extra costs of achieving this quality, and settle for one which will last them until they are ready to move on to a more up-to-date version.

There's a sort of urban myth that companies spend millions designing products that will fall apart or otherwise cease to function just three days after their warranty expires. This would cost extra, be difficult to achieve, and would probably result in customers buying a rival's product next time because the first one turned out to be no good.

More commonly there's a trade-off between durability and price; you can pay more for a product that will last longer, but you might not want to. Attics and garages are full of junk that people don't use any more. Waist high fax machines and desk top calculators are museum pieces now. Businesses don't deliberately equip their products with termination dates or auto-destruct mechanisms. They want them to last about as long as people expect them to. And for some of today's products, this is not very long.

Dr Andrew Sentance clearly relishes the difficult jobs. By day, he's the Chief Economist of British Airways, which of course has been in the thick of it recently. And by night (well, the odd Wednesday at least), he's a member of the Bank of England's Monetary Policy Committee (MPC), in charge of setting interest rates. He came along yesterday to share his thoughts at a Power Lunch here at the Adam Smith Institute.

As usual, the lunch was off the record, though I can reveal that the economists around the table disagreed on pretty much everything, as of course you would expect. But they did seem to agree that the MPC is sailing through relatively uncharted waters. Global forces point as much to inflation as they do to downturn. The financial sector is in crisis but other parts of the economy still seem robust.

Still, after some years of over-easy credit, particularly in the United States, and government profligacy, particularly in the United Kingdom, I reckon it would be daft not to expect some 'adjustment' as economists call it. The interesting question is whether the MPC can manage things so that everyone gets back to normal without going into a blind panic because the value of their home is falling while their mortgage costs are going up. At least the banks are using the MPC's interest rate cuts to strengthen themselves a bit, so while that's no short-term succour to borrowers (or Gordon Brown) in the long run it at least makes further banking panics less likely.

Trouble is, the government share of the economy has been growing fast, while it's the rest of us who have to take the strain of all the past policy mistakes and the current policy prescriptions. Mind you, Andrew and friends wouldn't want life to be easy, would they?

The ASI's latest report – Privatization - Reviving the Momentum – calls on the government to embark on a new wave of privatizations, which could net the exchequer in excess of £20bn. Given the worsening state of the economy and the increasing tightness of the public finances, the report notes that such an inflow of funds would be very welcome.

In addition to the revenues generated for the government, a new wave of privatizations would also deliver significant operational benefits, the report says. Previous privatizations have delivered a wide range of improvements, including increased investment, lower prices, greater choice and better service for customers – as well as underpinning billions of pounds worth of economic activity.

The leading privatization candidates identified by the report include the Royal Mail, Channel 4, BBC Worldwide, Scottish Water, Northern Ireland Water, Glas Cymru, the National Air Traffic Control System, as well as government stakes in British Energy and the Nuclear industry.

According to the report's author, investment analyst Nigel Hawkins:

"Privatization in the UK remains unfinished business. The task for Government, of whatever colour, should be to complete it and to reap the many benefits - including proceeds of some £20 billion."

Click here to download the full publication.

UPDATE: reported here in the Daily Telegraph.

89. "Regional aid is necessary to bring jobs to depressed areas."

This notion assumes that the present distribution of population and industry is the optimum, and that we should stop it changing. It further assumes that government can move factories and jobs about like pieces on a chessboard. Neither assumption is valid.

The patterns of population and economic activity are constantly changing. Some new product or process can create a localized boom, and changes in fashion and habits can diminish once thriving industries. Towns once famous for hats, gloves and cigarettes have seen those industries shrink, along with the jobs they sustained.

A similar outlook early into our industrial revolution might have sent regional aid to keep people on farms. Our economic development involved a change from an agricultural economy to one featuring various types of industry. People moved and the economy prospered.

Our economy has changed recently from one dominated by manufacturing into one with a much larger service sector. Governments have tried to move jobs to where people are, rather than helping people to move to where the jobs are. There are barriers to mobility of both jobs and people, barriers which include housing shortages and an insistence on uniform national wage rates.

Regional aid makes some areas more attractive by selectively lowering costs. Grants for new equipment, lower rates, tax holidays and the like, all try to tempt firms to where they would otherwise not have gone. They attract marginal firms, unviable without their help, and easily moved. When the subsidies end, we still find uneconomic firms in depressed areas, while those easily moved go off to where production costs are lower.

We should let depressed areas trade on their lower costs, including wages, and if there are economic changes, we should concentrate on mitigating their social costs, rather than trying to prevent them.

82. "Competition is wasteful."

Some people claim that competition uses more resources, producing many variants of products where only one is needed. It doesn't work that way because people have different tastes and values and prefer different products.

Producers rarely make products identical to those of their rivals, but will seek to emphasize a unique advantage possessed by their own. This allows customers to exercise their preferences for things like sweeter beverages, softer shoes or more stylish clothes. They can choose a car that is cooler, faster, or more practical, depending on their values. People express themselves partly through such choices.

If there were no competition, and people couldn't choose between alternative products, some committee somewhere would have to decide which standard product would have a monopoly. It would be a duller world, for such a body would have to approve products to satisfy everyone, and could not possibly keep up with changes in fashion and taste, or with innovation.

Even in cases where competing products are very similar, competition forces producers to keep quality high and prices keen. If their customers can desert them for other producers, they have to pay continual attention to refinements and improvements, or risk losing their market share.

Competition uses resources more efficiently, not less. It continually steers resources towards those who are good at satisfying their customers' needs, and away from those unable to provide them with goods of the quality and price that they seek. Those good at it usually prosper and expand; those who can't satisfy demand lose out.

Without competition the consumer has little power. Producers can deliver indifferent quality and prices bloated by inefficiency, and still survive because consumers have no-one else to turn to. Competition forces producers to attend to consumer needs and to improve both quality and value.