Summary: Target 2 imbalances narrow but remain wide
"Little else is requisite to carry a state to the highest degree of opulence from the lowest barbarism, but peace, easy taxes, and a tolerable administration of justice" - Adam Smith
Summary: Target 2 imbalances narrow but remain wide
Will Hutton tells us, in last Thursday's Guardian, that widespread consensus on the UK's staying out of the EU is wrong-headed—joining would have kept our exchange rate low, which in turn would have meant no financial boom and an economy based (more) around producing manufactures. To add to this, our entry would have meant a more activist European Central Bank, which would have been willing to intervene when necessary. There is more wrong with his article than I could possibly tackle in one post, so I will focus on the key elements I've summarised above. None of what I say implies it necessarily would have been bad to have been in the Euro over the past ten years—such an alternative history is almost impossible to conclusively support—just that the arguments Hutton uses are extremely weak.
Pretty much all of his argument is bizarre, utopian and uneconomic. Devaluations work not because they make a country's products cheaper to foreigners, adding to net exports and driving GDP growth. Devaluations work because they boost inflation, which gets around nominal wage stickiness, allowing markets (particularly labour markets) to clear and giving relative prices the space to adjust. They make no difference to the price of a country's goods to foreigners, and in practice often boost imports as much as or more than exports, due to improved conditions. This is even true if we devalue by decree, as Hutton's desired artificially low €-£ exchange rate would be—it's just that the inflation could take slightly longer to come as firms and households bid up prices.
What's more, this is a Good Thing. We don't want to spend energy, time, labour and capital hours, as well as space, producing valuable things only to sell them in exchange for artificially few foreign goods. If countries are happy to send us desirable stuff in exchange for less of our stuff then that's great, and in any case it sows the seeds of its own balance, as consistent deficits (ceteris paribus) will drive down the exchange rate. This may eventually force the UK to run surpluses, but this would not be a Good Thing. Running surpluses means lower social welfare because we are consuming less leisure or goods or services than we would otherwise be able to enjoy. And we may never even have to run one if we keep creating loads of property or financial wealth to pay for our imports.
But let's imagine that Hutton could have subverted economic rules as basic as gravity and magically have kept the exchange rate at his desired low rate without any of the obvious expected balancing effects from wages and prices. And let's imagine that we want to send more goods abroad to get less in return. Would this have supported the manufacturing industries he wants? It's difficult to see how. If the City was providing the best financial services options for the world at £1 = €1.25 then it's not obvious that a cheaper pound, and cheaper financial services, would make them less attractive. The UK's economy contains a relatively large contribution from financial services because the UK is relatively good at financial services—as well as hi-tech manufacturing, advertising, and many service sector areas. These are the UK's comparative and in some cases absolute advantages.
And would the UK be better under the ECB (albeit with some British influence) rather than its own Bank of England? It's hard to see why Hutton thinks this. The BoE let inflation rise to hit 5.2% on the CPI measure, and has consistently allowed inflation to stay above target—the ECB has inflation below its 2% target, despite the obscene jobs crises in Spain, Greece and other crisis-hit countries. It is basically refusing to do any monetary stimulus. There is essentially no debate in Europe over whether the ECB should actually meet its inflation target, or indeed consider other economic variables, or go yet more radical and drop inflation targeting altogether. Would the UK's input really outweigh the massive consensus there, especially when the UK is divided on the issue itself? Again, I am sceptical. Strangely, Hutton seems to think that pointing to the UK's own situation and reminding us we're not living in "a land of milk and honey" is sufficient to gloss over the fact that most of the Eurozone is doing so much worse!
This laughable logical leap is nothing compared to his claim that both sides of the political divide are "united only in their belief, against all the evidence including Britain's export performance, that floating exchange rates are a universal panacea." As might be expected, he doesn't give the tiniest shred of evidence that the consensus view holds that floating exchange rates are not only the best exchange rate policy, but a panacea for all types of economic ills. But really, that's not the point. Even if everyone did—ridiculously—think that floating exchange rates were actually a panacea for economic problems, that wouldn't go any way to implying that they weren't better than fixed exchange rates.
Will Hutton's argument is completely invalid, though perhaps he gets some points for making such an outlandish and unpopular case. If it would have been good for the UK to enter the Euro 10 years ago, then it is not because it would have allowed us to permanently rig all markets to send off more of our stuff for cheaper than it is worth. And it seems completely implausible that the UK could have influenced the ECB enough to see it ditch its destructive hard money policies during the crisis, instead it seems more likely the UK would be just another country suffering under its negligence.
One of the arguments put forward by hte Robin Hood, or financial transactions, tax people is that high frequency trading is the work of the very Devil and it needs to be curbed by that tax. HFT is that algorithmic trading that takes place in nanoseconds as computers and algobots play with each other.
And I will admit that there's not a huge deal of use to the activity. It provides liquidity, this is true, it makes the players a profit, this is also true. Those against it state that it doesn't serve any public purpose: which is of course entirely the wrong question to be asking. We're all allowed to do whatever it is that we wish as long as that doesn't create some public disservice: that's what those old standbys freedom and liberty mean. The test of whether you're allowed to do something is not that you need permission: it's whether there's any good reason why you should not.
But logic aside there's not really anything much to worry about as Craig Pirrong points out:
HFT has been a bugbear for several years now. The monster that would eat the equity markets, and then move onto derivatives for dessert. But HFT has apparently fallen on (relatively hard times). HFT volumes are down. HFT market shares are down. And most interestingly, HFT profits are down, by about 50 percent on a per share basis, more on a gross basis because volumes are down.
Pirrong points out that Schumpeter told us all about this. But it's there in Smith too. When a new method of making excess profits is found (excess being above the normal rate in this instance) then the opther capitalists will observe that excess profit being made. They will then direct their own capital into this new method: the competition from their doing so wearing away at the ability to make the excess profit. given that markets often overshoot there'll often be a period of less than normal profits in the field but over time we'll end up in a reasonably stable equilibrium where this new field, such an exciting opportunity only a few years ago, is now returning normal profits just like the rest of the economy. And everyone goes off to hunt for the next excess profits opportunity.
Which leads us to two observations: the first being that markets here are doing their thing about providing information. In this instance that capital should flow into this field with the excess profits. Then when there aren't such excess profits no more should enter this field.
The second is that markets have, clearly and obviously, moved much faster than the regulators or the taxmen. We don't need to tax the activity as it's already contracting having exploited that excess profits possibility. As so often, even if it really is a problem, a market left alone to get on with things has sorted out said problem.
An interesting new paper looks at the effects of tax cuts on the UK economy. The finding won't surprise you and me but it's interesting to wave at others:
This paper estimates the effects of tax changes on the U.K. economy. Identification is achieved by isolating the ‘exogenous’ tax policy shocks in the post-war U.K. economy using a narrative strategy as in Romer and Romer (2010). The resulting tax changes are shown to be unforecastable on the basis of past macroeconomic data. I find that a 1 per cent cut in taxes stimulates GDP by 0.6 per cent on impact and by 2.5 per cent over three years. These findings are remarkably similar to the corresponding estimates for the United States.
This is another piece of evidence to illuminate our basic problem over the size of government and the taxation necessary to pay for it.
We know very well that some government spending is just great: both in what it achieves for us and also in the economic growth it produces. I'd certainly argue that a decent court and legal system is worth the money spent on it.
However, we also know very well that all and every taxation has deadweight effects: there's some economic activity that simply doesn't happen as a result of the imposition of the tax. Thus, if we want to maximise GDP we should be spending money only up to the level where the growth produced is greater than the growth not happening as a result of the taxation.
As it happens, of course, maximisation of GDP is not our goal. Maximising the utility of the population is meaning that all those things like leisure which detract from GDP are just fine. Indeed, those things like leisure are very much part of the point of the whole game: we want everyone to be as happy as it is possible to be without bursting from the joy of it all rather than everyone to be as rich in material goods as possible. That happiness to be determined by the lights of the individual concerned of course.
But even if we restrict ourselves to talking only of that small part of political economy which is indeed about GDP growth this paper does provide us with an interesting metric.
There is some part of the government's spending that is, nominally at least, about increasing GDP. The sort of stuff that Vince Cable's department does for example, all those various investment funds, the Green Investment Bank and so on. What this paper gives us is an interesting metric to use in measuring their performance. Say, just imagine, that all of this aid to business costs £15 billion a year. I use this number just to make the maths easy for that's 1% of GDP near enough. We now know that raising this much in tax costs us 0.6% of GDP in the short term and 2.5% in the medium term. We'd therefore very much like not to be raising this amount in tax: unless, that is, the spending of it produces a greater than 2.5% rise in GDP.
OK, hands up everyone who thinks that government "support" for business and development increases GDP by 2.5%?
Quite, time to close it all down and get the growth without bothering to do the taxing and spending, isn't it?
In a very readable article in the New York Times Paul Krugman expresses sympathy for the Luddites, suggesting that the benefits of future technological developments may not accrue very equally across society. This being the case, he suggests that policies such as a universal basic income may be one way of compensating the unlucky who have spent lots of resources on, say, a university education which has now devalued, something they couldn't possibly have predicted. Since I share Krugman's basic luck egalitarian intuitions, I am very sympathetic to his case.
The beef I have is with a response written by Gavin Mueller in Jacobin magazine. Up until now almost everything I've seen from Jacobin has been well researched, even handed and thoughtful, if coming from a very different set of basic premises to those I hold, but this is an exception. He makes much stronger claims than Krugman, calling technology "a weapon used against us" and arguing that a long-term goal of "abundance and leisure for all" (one I share!) may require "smashing the relations of production" in the short-term. Perhaps the line which most annoys me is "the belief that technology doesn't destroy jobs, but merely creates new and better ones, is, like so much else about bourgeois economics, a baseless assumption."
Does Mueller really believe that claim? Unemployment is 7.8%. Employment is touching 30m, its highest level ever. Since the 1750s there has been a tide of vastly transformative technological improvement and yet somehow a much larger population is employed. At the same time, this larger workforce is working much fewer hours and enjoys much greater abundance. Surely these widely available facts are enough to suggest that the assumption technology creates—as well as destroys—jobs is more than just a "baseless assumption"?
By no means is it certain that the trends of the past, which have seen mobile phones, more hygienic toilets and tasty soft drinks spread to even the poorest areas of the world, will continue. But certainly some evidence (e.g. the graph above) seems to suggest that technologies are spreading throughout society—and benefiting the general populace, not just the wealthy—faster than ever before. This is great, and implies that we can hope for greater abundance and leisure without smashing new technologies. If it turns out that not all benefit, then what we need is something like Krugman's universal basic income, not drastic societal upheaval.
Over at the New Statesman, Adam Smith Institute Fellow Preston Byrne argues that the state needs to extricate itself from legal aid, in order to allow pricing to operate more rationally and create a competitive market:
Remuneration structures for legal aid mean that service providers have traditionally had no incentives to “compete on price,” competing instead on “the basis of reputation.” This arrangement, pointed out the final report of the Labour-commissioned Carter Review in 2006, penalises “the efficient practitioner who manages to dispose of a case efficiently in circumstances where this is the right course of action” as he or she would “receive less in case fees than the inefficient practitioner who does not succeed in addressing case issues efficiently.” (page 26)
The inefficient practitioner, in certain circumstances, is thus rewarded. This is not to say that reputation should not be a factor in selecting a lawyer – far from it. Even with classes of goods that are more homogenous in function, such as toasters, an individual product can command a higher price if it is of better quality. In the private sector, a client's selection balances a lawyer's reputation against his or her fee, with the client benefiting from price competition between equally talented providers. No such competition, however, exists, nor can it exist, within the current legal aid structure.
The Labour government attempted to address these issues in 2008 by introducing graduated fee arrangements – termed differently, price controls. Lawyers found these problematic when they were introduced, (paragraph 11) and continue to find them problematic today (paragraph 389); much of available state-funded work is “plainly inadequately remunerated,” says the Bar Council, despite the fact that the cost of the system to taxpayers continues to rise.
If you’re frustrated by how vicious and pointless politics is, a brief Kindle single by Arnold Kling may offer some insight. “The Three Languages of Politics” (£1.34, US link) dissects one of the main problems with politics: that progressives, conservatives and libertarians are all speaking different languages that rarely overlap and cause us to misunderstand and vilify our opponents.
The three languages are based on three different ways of thinking about problems. Progressives, says Kling, see political problems as being conflicts between oppressors and the oppressed; conservatives as between barbarism and civilization; libertarians as between coercion and freedom. These ideologies cannot be boiled down to these three things, but the rhetoric used by their adherents often can be.
As a libertarian I often find discussions with non-libertarians frustrating because they don’t even seem to care about the stuff that matters to me. (I’m told the feeling is mutual.) On drugs, for instance, conservatives seem not to care at all about the fact that people are put into jail for what they do in the privacy of their own home, and progressives often only seem to object to the harm caused by anti-drug laws, not to the very fact that these invasive laws exist at all.
Of course this is frustrating and it is tempting to say that these people are coercive authoritarians – just as a progressive might say that I am a defender of oppressive businesses when I advocate for looser business regulation, or a conservative would say that I want to let British society unravel by letting more people immigrate to the UK. Maybe they have a point, maybe not. We’re speaking different languages without realising it.
The phenomenon of ‘motivated reasoning’ doesn’t help. The more informed a person is, the more closed-minded they are. If your web of belief about politics is well-developed, you will have stronger prior reasons to dismiss new information that contradicts what you already know. We are much quicker to question the methodology of a study whose conclusions we dislike than one we like.
And politics is usually about tribes, too. Even if you aren’t a member of a political party, you probably know people you consider to be on your side in politics, particularly if you are immersed in politics in your job or an extracurricular hobby. Much, even most, political discourse can be seen not as an effort to change the minds of your opponents (or your allies), but as a way of developing your status in your tribe.
All of these factors contribute to a poisonous political environment that rewards tribal point scoring above all else. Disagreement is never comes from honest error, but from malice or stupidity. Arnold Kling’s “The Three Languages of Politics” is a wise, insightful deconstruction of the hatefulness of political discourse. It is a classic. Everyone who talks about politics should read it.
George Selgin spoke the tuesday before last, 28th May, on the possibility some deflation—that coming from improvements in the supply side—is not harmful to the economy, but good. He made an extremely convincing case, pointing out that the so-called Long Depression of 1873-1896 was actually the site of a vast improvements in living standards and social welfare. And he pointed out that the problems attendant with deflation, that economists are fond of pointing out, only obtain when that deflation comes from a demand shock, not a change in supply.
Summary: US household debt relative to disposable income rose slightly in Q1
What the chart shows: The chart shows US households gross debt, relative to personal disposable income. This debt/income ratio edged up in Q1 2013 for the first time since Q1 2009.
Why is the chart important: The financial crisis that erupted in 2007 was very much an excess debt crisis. Historically, US households have shown themselves able to carry a debt burden that puts their interest and amortisation payments around 15% of disposable income. By 2007, interest and amortisation took 18% of disposable income and debt was close to 130% of income. The implication was that debt was 1/6 too high at normal interest rate levels. This means that debt had to come down from 130% to below 110% of income. But, unsurprisingly, households continued to deleverage. The Q1 2013 figure (if not revised away) shows that households now feel confident at taking up some debt again. This strengthens the case for a sustained US recovery. US household debt relative to disposable income rose slightly in Q1.