An alternative ‘Agenda for Hope’

Owen Jones has written a nine-point ‘Agenda for Hope’ that he argues would create a fairer society. Well, maybe. I’m not convinced by many of them. Then again, it would be quite surprising if I was.

But it got me thinking about what my nine-point agenda would be — not quite my ‘perfect world’ policies, but some fairly bold steps that I could just about imagine happening in the next couple of decades. Unlike Owen’s policies, few of these are likely to win much public support. On the other hand, most of the political elite would think these are just as wacky as Owen’s too.

Nine policies to make people richer and freer (and hopefully happier):

1) The removal of political barriers to who can work and reside in the UK. Removing all barriers to trade would increase global GDP by between 0.3% and 4.1%. Completely removing barriers to migration, though, could increase global GDP by between 67% and 147.3%. Those GDP benefits would mostly accrue to the poorest people in the world. We can’t remove these barriers everywhere but we can show the rest of the world how it’s done. Any step towards this would be good – I suggest we start by dropping the net migration cap and allowing any accredited educational institution to award an unlimited number of student visas.

2) A strict rule for the Bank of England to target nominal GDP instead of inflation, replacing the discretion of the Monetary Policy Committee. Even more harmful than the primary bust in recessions is what Hayek called the ‘secondary deflation’ that comes about as people, fearing a drop in their future nominal earnings, hold on to more of their money. That reduces the total level of nominal spending in the economy which, since prices and wages are sticky in the short run, leads to unemployment and a fall in economic output. NGDP targeting prevents those ‘secondary deflations’ and would make economic busts much less common and harmful. In the long run, we should scrap the central bank altogether and replace it with competition in currencies (see point 9, below).

3) Significant planning reform that abolished the Town and Country Planning Act (which includes the legislation ‘protecting’ the Green Belt from most development) and decentralised planning decisions to individuals through tradable development rights (TDRs). This would give locals an incentive to allow new developments because they would be compensated by the developers directly, allowing for a reasonably efficient price system to emerge and making new development much, much easier. The extra economic activity from the new home building alone would probably add a couple of points to GDP growth.

4) Legalisation of most recreational drugs and the medicalisation of the most harmful ones. I think Transform’s outline is pretty good: let cannabis be sold like alcohol and tobacco to adults by licensed commercial retailers; MDMA, cocaine and amphetamines sold by pharmacies in limited quantities; and extremely dangerous drugs like heroin sold with prescriptions for use in supervised consumption areas. The sooner this happens, the sooner producers will be answerable to the law and deaths from ‘bad batches’ of drugs like ecstasy will be a thing of the past. Better yet, this would bring an end to drug wars like Mexico’s, which has killed around 100,000 people in the past ten years.

5) Reform of the welfare system along the lines of a Negative Income Tax or Basic Income Guarantee. As it is, the welfare system disincentivises work and creates dependency without doing much for the working poor. A Negative Income Tax would only look at people’s incomes (not whether they were in work or not in work), reducing perverse incentives and topping up the wages of the poorest earners. This would strengthen the bargaining position of low-skilled workers and would remove much of the risks to workers associated with employment deregulation. Of course, the first thing we should do is raise the personal allowance and National Insurance threshold to the minimum wage rate to give poor workers a de facto ‘Living Wage’.

6) A Singaporean-style healthcare system to replace the NHS. In Singapore, people have both a health savings account and optional catastrophic health insurance. They pay a portion of their earnings into the savings account (poor people receive money from the state for this), which pays for day-to-day trips to the doctor, prescriptions, and so on. The government co-pays for many expenses but the personal cost disincentivises frivolous visits to the doctor. For very expensive treatments, optional catastrophic health insurance kicks in. This is far from being a pure free market system but it is miles better (cheaper and with better health outcomes) than the NHS. (By the way, if you really like the NHS we could still call this an ‘NHS’ and still get the superior system.)

7) A school voucher system and significant reform of the state education and free schools sectors. This would include the abolition of catchement areas and proximity-based admission, simplification of the free schools application process, and expansion of the free schools programme to allow profit making firms to operate free schools. These reforms, outlined in more detail in two ASI reports, would increase the number of places available to children and increase competition among schools to drive up standards.

8) Intellectual property reform. As both Alex Tabarrok and Matt Ridley have pointed out, our IP (patent and copyright) law is too restrictive and seems to be stifling new innovation. Firms use patents as barriers to entry, suing new rivals whose products are too similar to their own. In industries where development costs are high but imitation costs are low, like pharmaceuticals, patents may be necessary to incentivise innovation, but in industries like software development where development can be cheaper than imitation, patents can be a terrible drag on progress. Tabarrok recommends that we try to tailor patent length in accordance with these differences; as a sceptic about our ability to know, well, anything, I’d prefer to leave it to private contracts and common law courts to discover.

9) Last but not least, the removal of the thicket of financial regulation and the promise of bailouts for insolvent banks. Known as ‘free banking’, this system of laissez-faire finance has an extremely strong record of stability – though bank panics still occurred in free banking systems, they were much less severe and rarely systemic. Only once the government started to intervene in the financial system to provide complete stability did things really begin to go wrong: deposit insurance, branch-banking restrictions, and other prudent-seeming regulations led to extremely bad unforeseen consequences. The financial crisis of 2008 probably owes more to asset requirements like the Basel accords, which heavily incentivised banks to hold ‘safe’ mortgage debt over ‘risky’ business debt, than anything else. Incidentally, the idea that having a large number of local banks is somehow better than having a few large banks is totally wrong: during the Great Depression, 9,000 of America’s small, local banks failed; at the same time not one of Canada’s large banks failed. The small banks were more vulnerable because, unlike the big banks, they were undiversified.

Now, if only there was a think tank to try and make these dreams a reality.

What’s the true free market monetary policy?

Let’s imagine we are in a world where central banks are given key roles in the macroeconomy, and have been for decades or even centuries in almost every country. In this imaginary world, studies into the relative efficacy of free banking regimes have been undeservedly overlooked, and the orthodoxy among major economists, even ones otherwise sympathetic to free markets is that they are a bad idea. Major policymakers, let’s imagine, are completely unaware of the free banking alternative, and most even use the term to mean something completely different. Proposals to enact free banking have not been mentioned in law making chambers for decades or centuries, if at all. It has not been in any party’s policy platform for a similar period of time, in this imaginary world.

What’s interesting about this imaginary world is that it is in fact our world. Economists like George Selgin, Larry White, Kevin Dowd (among many others) have done very convincing research about the benefits of free banking. And free banking may one day become a real prospect, perhaps in a new state or a charter city. But free banking has lost the battle for the time being, and abolishing the central bank and government intervention in money is as unlikely as abolishing the welfare state. Now one might say that if free banking is a desirable policy, it is worth continuing to wage the intellectual war for the benefit of future generations, who could benefit from the scholarship. Work done now could end up influencing and improving future monetary policy.

I do not discount the possibility this is true. At the same time, free banking is a meta-policy, not a policy—a way of choosing what monetary regime to enact, rather than a specific monetary regime. After all, it is at least possible that free banks could together target consumer prices, the GDP deflator, the money base, the money supply measured by M2, nominal income/NGDP. And for each of these different measures there are an infinite number of theoretical growth paths, and a large number of realistically plausible growth paths they could aim for. Now, free bankers say that the market will make a good decision, and I can buy that. But let’s say we’re constrained to choose a policy without the aid of the market mechanism: can we say there are better or worse central plans?

The answer is: of course we can! Old-school monetarism, targeting money supply aggregates, was a failure even according to Milton Friedman, whereas CPI targeting, for all its flaws, delivered 66 quarters of unbroken growth and a period so decent they named it the Great Moderation. The interwar gold standard brought us the stagnation of the 1920s (in the UK) and coming off us brought us our relatively pleasant experience of the Great Depression. Literally the order in which countries came off the gold standard is the order they got out of the Great Depression. And even though the classical gold standard worked pretty well, few of its benefits would obtain if we went back. Some central plans (the interwar gold standard, M2 targeting) don’t work, some work a bit (the classical gold standard, CPI) and arguably some work pretty well (NGDP targeting is one in this category, according to Friedman, Hayek and I). If we are stuck with central planning, then why not have a good central plan?

And just because I’m allowing the term “central planning” to describe NGDP targeting, we needn’t describe it as “government intervention in money”. I don’t think they are really the same thing. “Government intervention in money” brings to mind rapid inflation, wild swings in the macroeconomic environment; in short the exact circumstances that NGDP-targeting aims to avoid. Targeting aggregate demand keeps the overall macro environment stable—a truly neutral monetary policy—allowing firms and households to make long-term plans, and preventing recessions like the last one, caused as it almost certainly was by drastic monetary tightening. Indeed, as monetary policy determines the overall path of aggregate demand, we might easily call “sound money” policies aiming for zero inflation or a frozen base as dangerous government meddling—they allow the actually important measures like nominal income to fluctuate drastically.

Consider an analogy: school vouchers. Many libertarians may favour a system where parents can spend as little or as much as they want on schooling (considering distributional concerns separately), rather than having central planners decide on the voucher-set minimum. But we usually see a voucher system as an improvement on the status quo—parents may not be able to fully control how much is spent on their children’s education but at least they can pick their school. Popular and successful schools grow to accommodate demand, while unpopular and unsuccessful schools can be wound down more quickly. Libertarians may see this as a way from the ideal situation, but none would therefore denounce the policy. The analogy isn’t perfect, but I like to see NGDP targeting as similar to school vouchers, versus status quo schooling as the CPI target. Libertarians shouldn’t make the perfect the enemy of the good.

Inflation drivel

Labour’s economic team—led by Ed Balls—is either confused and economically ignorant, or deliberately misleading and opportunistic. After Tuesday’s inflation release, they hit out at the government for the continued above-target rate (2.7% over the year to September, the same as over the year to August), as part of their new “cost of living” strategy. Spokesperson Catherine McKinnell said:

This is yet more evidence of the cost-of-living crisis facing families across Britain after three years of this Government’s failing policies. Prices have now risen faster than wages in 39 out of 40 months under David Cameron and now we learn that we have the highest rate of inflation of any EU country.

At the same time, shadow chancellor Ed Balls has repeatedly attacked the Tories’ fiscal austerity policies, blaming them for the extremely lacklustre recovery from the recession and even suggesting they may have been self-defeating. But at the same time he has also blamed above-target inflation for squeezing living standards.

But which is it? If the Tories were wrong to cut spending, it’s because the recession was driven by nominal factors, and cutting spending will further cut aggregate demand, only worsening the pricing mismatch that is leaving resources unemployed and output below potential. But we also know from our basic AD/AS model, the same one that we use to generate the result that falling aggregate demand is bad for output and employment, that higher AD means higher inflation. So if Ed Balls really wants more government spending, any of the models he’s relying on would also tell him he’d have to have higher inflation as well. You can’t criticise austerity and inflation.

But it goes deeper than this. What Ed Balls is missing is that actually the UK’s overall economic policy wasn’t particularly austere at all. Certainly at points it could have standed to be a bit easier, especially in the crucial 2008-2009 crash. But basically Ed Balls completely ignores monetary policy, which, in the final analysis, determines demand. The monetary policy committee, which sets rates and quantitative easing (QE) can choose whatever it wants demand in the economy to be. They use a faulty indicator, the consumer prices index. But they interact with the economy by constricting or expanding demand based on their policy goals (inflation close to 2%, stable output and employment).

Imagine the government decided to cut spending by £100bn (an illustrative number). If this was going to bring inflation down to 0%, from 2%, then the Bank of England would be changing its monetary policy if it allowed inflation to fall there. The Bank, knowing this, will manipulate interest rates and asset buying policy (QE) to make sure their goals are met. This is true even though the Bank’s current framework leaves so much to be desired. In 2010 and 2011 the Bank allowed inflation to go all the way up to 5.2%, meaning that they more than counteracted the effect of austerity on overall aggregate demand.

What this means is that Ed Balls, were he to slow down the pace of fiscal contraction and nevertheless bring inflation down to 2% now, would worsen the nominal recession, and yet redistribute yet more resources to state control. He may not know this—despite his economic education—or he may be staking out a deliberately misleading and opportunistic set of policies, playing on the public’s ignorance of economics.

Demand Matters

Markets are about supply and demand. Scarcely a more banal thing could be said in economics, and yet some of the time it seems like free-market economists look only at supply. Glance over policy recommendations from a free-marketeer and you’ll often see only tools for freeing up supply—labour market deregulation, planning reform, a bonfire of the quangos, an end to unbalancing subsidies or tax breaks, liberalisation of trade barriers. These are all fantastic things, which we definitely need. And even through the visor of the AS/AD model, even in a slump, these can make things better both by cutting prices and by raising wealth. But either deliberately or unconsciously, these economists are completely avoiding the demand side.

Is this because there are no doctrinaire libertarian things that can be done on the demand side? I’ve certainly heard many policies like quantitative easing called “socialism” by fellow travellers, but I’d like to think that my libertarian-leaning friends were more thoughtful than instinctively dismissing ideas they see as ideologically impure out of hand.

And further than that, there are things we can do to make the demand side more libertarian, at least if we don’t make the perfect the enemy of the good. School voucher systems are not decried for their “socialism” by libertarians despite the fact that under these systems schools are still paid for and run by the state. Monetary policies that are more free market (and more sensible) than our current one should be looked upon in the same way. It’s not the case that anything short of abolishing the central bank is “socialism”—unless we want to completely devalue the word. And even if an intermediate policy were a form of “socialism” or “central planning”, the realistic alternative is not a free market in money, but an abysmal central plan!

What are these intermediate policies that free-marketeers seem to be ignoring? Firstly there is nominal income targeting, which relies on markets both to stabilise demand and to allocate that demand among competing industries according to consumer preferences; and secondly counter-cyclical taxes, which rise automatically in good times and fall in bad times. Those are both thoroughly libertarian and entirely focused on demand.

In fact, the two most important libertarian economists of the 20th century—Friedrich A. Hayek and Milton Friedman—both endorsed demand-side policy, in the right circumstances. Friedman blamed the US Great Depression on the Federal Reserve, allowing a massive collapse in the money supply and aggregate demand. Hayek said that after the inevitable collapse of a misallocated capital structure there could also be “secondary deflations”, where aggregate demand collapses and there is a costly adjustment period. Both would support monetary policy to deal with this issue—stabilising demand, so as to avoid painful adjustments from big inflationary or deflationary shocks. If money is non-neutral in the boom, why would it be neutral in the downturn?

One response libertarians might make is that Say’s Law shows there is nothing we can do about demand. But Say’s Law clearly doesn’t hold in the short-run, and Austrian economists who rightly critique the assumptions economists often make about equilibria should be absolutely clear of this. In the short-run, a dip in aggregate demand—absent any response from the government, central bank, or hypothetical free banks working together—necessitates a period of deflation. But we know that (at least nominal) wages are sticky-downwards, meaning that calling for an adjustment to the new equilibrium means calling for years of the grave evil of unemployment foisted on millions. Say’s Law reasserts itself in the medium- to long-run, and by then the misery and destruction of potential wealth has all already happened.

What libertarians are missing is that the relentless focus on supply is leaving them almost completely out of the conversation, and thus leading to worse policy than necessary. If free marketeers were talking about the best things to do on the demand side, as well as on the supply side, then there would be less of the all-eggs-in-one-basket big project spending stimulus, and more diverse market-oriented ways of countering the demand shortfall.

Kick the ‘wise men’ out of the Bank of England

In today’s City AM, newly-minted ASI fellow Lars Christensen (aka The Market Monetarist) writes on the ‘Carney rule’. The Carney announcement is a tiny step in the right direction, he says, but as long as the ‘wise men’ of the Monetary Policy Committee are running monetary policy, policy will be erratic and unpredictable, preventing adequate planning by firms and adding to market panic in economic downturns. Instead, we should have a strict rules-based system of nominal GDP targeting:

A much better rule would have been to commit to stabilising the level of nominal GDP (NGDP), a measure of aggregate demand, keeping market expectations of NGDP growth on a 4 or 5 per cent growth path. This should be combined with an open-ended commitment to expanding the money base to hit this target. This would avoid the nitty-gritty of the Carney Rule and be clearer and easier to communicate to markets.

Monetary policy based on the discretion of “wise men” leads to market uncertainty and panicky jolts as investors react to tiny changes in central bankers’ pronouncements. Replacing the MPC with rules-based policy would bring discipline and predictability to the Bank of England far beyond what was outlined yesterday.

I would prefer to have no Bank of England at all, with money emerging from the market as outlined by Hayek in 1976. Having said that, perfect is not the enemy of good — replacing the discretion of ‘experts’ with predictable, market-led rules would be a huge step in the right direction. If Carney’s new rule fails, it may come on to the agenda sooner than we think.