The Pin Factory Blog

I don't like to say 'told you so', but the current economic crisis says it louder than those mere words. Back in 2007-08, the politicians were rushing to blame the recklessness of the banks for the financial meltdown. We at ASI argued that the real culprit was actually the recklessness of the politicians. The UK and US governments, in particular, had been throwing a wild party, living beyond their means for decades, spending like mad, creating pointless public sector jobs, then printing money and keeping down interest rates in order to pay for it. But you can't keep partying forever.

And the politicians' answer to the inevitable hangover that followed? A hair of the dog. Quantitative easing that flooded us with fake electronic money which the politicians hoped we would think was real. Interest rates cut so low that they could go no further. Spending that just carried on – with a rising debt 'ceiling' in the US, and public spending cuts in the UK that are only just big enough to be real.

Continental Europe, meanwhile, superciliously grinned that it had escaped the contagion of those reckless Anglo-Saxon bankers. But again, the banks' high-risk behaviour were just what you'd expect when a government-fuelled party was in full swing – not the cause of it. And the Euro area was high on its own party substances. It had welcomed in dodgy economies like Italy, and even Greece, which had faked its financial ID to gain entry, and just turned a blind eye as their economic behaviour got more and more outrageous.

By now it's plain that you have to blame the politicians for all this, not the bankers. It is the politicians that the bankers are now punishing, because they fear that governments have let the financial rave get out of control and have no idea how to get themselves sober again. If the authorities do not reach for the strong coffee and drink it down to the bitter grounds of real deficit and debt reduction, the police and ambulances are going to be arriving, lights flashing and sirens blaring, rather earlier than they think.

I'm afraid that this all makes me rather angry. There are innumerable fools out there screaming that speculation, the banksters, the Vampire Squid, futures markets, are starving the poor by making food too expensive.

The true blame lies elsewhere:

A new report by the Committee on World Food Security found that using grains like corn and wheat to create bioethanol, often blended with gasoline to create transport fuel, has added 0.5 percentage points to the growth in world cereal demand, pushing it to 1.8% a year from 1.3%.

In vegetable oils, which are used to make biodiesel and dominate Europe’s market, growth has been even more pronounced. While their use for food slowed down between the 1990s and 2000s, from 4.4% to 3.3% a year, industrial use soared, so that in the decade to 2010 it grew from 11% to 24% of world use.

It really is the entirely stupid, damn fool, biofuels movement which is causing the food price rises. That US and EU politicians have insisted that all fuel used must be made of a certain percentage of plant derived material. It really is the entirely stupid, damn fool, laws, passed by our entirely stupid, damn fool, Lords and Masters which is killing the poor as we put food into cars not people.

The speculators, the commodity traders, the futures, options, the deep and liquid markets do their best to mitigate the effects of this damn foolery but the reason the poor are dying for lack of food is the actions of our own politicians.

That the proposed solution is for those politicians to be given more power over the food system moves me from rather to incandescently angry.

Could we all, please, just agree that biofuels are a damnably stupid idea that kill people and so just stop making or using them?

Please?

High rates of income tax don't work. They don't raise more money for the Treasury, nor do they soak the rich and help the poor. Britain's 50% tax rate – which actually means 52% by the time you add the National Insurance tax – is a case in point. It should go. Indeed, if the UK is to recover economically, it must go.

Over the last century, America's tax rates have gone up and down. Presidents Coolidge, Kennedy, Reagan and Bush all made large cuts to the rate. And after each, the wealthiest Americans ended up paying more tax, and paying a larger share of the total. Evidence from Canada, France, India, Hong Kong and Russia is perfectly consistent with this. The same has been true in the UK. When the top tax rate here was 60%, the richest five percent paid just over a quarter of the total tax take. After Nigel Lawson cut it to 40%, they were paying nearly a third of it. And revenues rose so strongly that Lawson did not have to borrow – indeed, he actually paid off some of the national debt.

When you take half – or more – of people's income in taxation, you really do cross a threshold. They regard it as unjust and unfair. So they down tools, move themselves or their business and their money abroad, cheat on their taxes, or pay expensive accountants to find ways to avoid the tax. That does the economy no good at all, and it generates absolutely no money to fund other government projects. Indeed, it loses the Treasury money.

We will know in February. By then, everyone's tax returns for the last year will be in, and we will be able to see what the effect of the 50% tax has been. I am certain the evidence will show lower returns and a smaller share being paid by the rich. Only three of the 86 largest economies in the world have tax rates higher than ours. Can we really be surprised if people think the UK is a rotten place to do business? And is it not obvious what we have to do about it?

There's an interesting paper here on blood donations. As we know, many countries have both paid blood donors and unpaid, motivated purely by that joy of giving, blood donors. What the paper finds is that if some people are paid to donate then this dissuades others from giving without payment. Sort of a, well, if they're getting paid, why shouldn't I attitude perhaps?

On the specific subject of blood I think it's pretty clear that altruism works better than money. When the American system began to insist that blood must be labeled as paid or donated, demand for the paid blood dried up (yes, sorry). So if the users would prefer donated and we can get enough from civic mindedness, then by all means, let's use the system that works.

However, this paper takes one more step and compares the underlying question to Cameron's "Big Society".

Understanding the interaction between voluntary and paid is a key part of correcting government interventions which are held to crowd-out individual actions. For example, the current UK government has advocated the notion of a “big society”, which, although rather unclearly defined, appears to have altruistic behaviour as a central theme.

Quite: and their finding about blood is that paid donors crowd out unpaid. If people know others are being paid then they become less willing to donate. This isn't true of non-monetary rewards but is of monetary.

Which is really rather an interesting finding for the Big Society, isn't it? That we've an army of state functionaries paid for by gouging the taxpayers' wallets is actually deterring people from volunteering. We do have crowding out of charitable and voluntary impulses entirely as a result of others being paid to do those same things.

Note that non-monetary rewards do not do this, only monetary.

So, if we cull the State, move the things that need to be done into the voluntary sector, we'll find more people willing to do these things precisely and exactly because we've culled the people being paid to do them. And we've got the perfect non-monetary rewards to hand as well: called the honours system. BEMs to KBEs, the same work gets done and we've lightened the burden upon the pockets of the populace.

What's not to like?

With so much bad news from the financial markets, it is becoming difficult to see the wood for the trees. This is my attempt to identify the main economic problems we face, and to explore their policy implications.

Problem 1. Sovereign Debt

Put simply, governments throughout the West have borrowed, and continue to borrow, too much money. They have become accustomed to living far beyond their means, and seem to be unable to stop. Some countries have already hit the point of no return, while others are fast approaching it. What the markets are most concerned about is the prospect of sovereign default – that is, governments holding up their hands and saying, “sorry, we just can’t pay you back.” Sovereign defaults in major economies (like Italy) would likely have disastrous knock-on effects.

Problem 2. An exposed financial sector

The reason sovereign default is such a big problem is that governments bonds have long been considered more-or-less the safest kind of investment. They form the ‘security’ part of most portfolios. Indeed, one of the main ways we have tried to make our banks safer since the financial crisis is to force them to invest more in government bonds. So if the sovereigns go, so do many of our banks. And there does come a point where more bailouts just aren’t possible.

Problem 3. Sclerotic growth

Normally, one wouldn’t be too worried about sovereign debt. Governments are seen as going concerns, with extremely secure revenue streams. How can you run out of money when you are legally entitled to force people to give it to you? The difficulty comes when your growth rates are so low that there isn’t enough money to give. Then you have a big problem.

Of course, I’ve long argued that a quick bounce back from the recent recession was unlikely. Those countries that experienced a major credit-fuelled boom were left with severe economic distortions. Unsustainable bubbles had built up in financial services, housing and construction and the public sector. Given that these sectors form a major part of many country’s GDP figures, and given that a necessary part of the economic adjustment process was that these sectors would shrink, it was always hard to see where significant growth was going to come from.

But there’s also a broader point here. We may actually be witnessing the inevitable breakdown of the modern, bureaucratic welfare state. Countries are finding themselves with too many unproductive people for a dwindling stock of productive people to support. To put it more colourfully, the parasites are taking over the host, and they are slowly strangling it to death. [Cont'd...]

Local authorities in England are sitting on £800bn worth of the strangest assets – pubs, golf courses, cafes, stadiums, even an airport. And Communities Secretary Eric Pickles says they need to be better managed.

Not like him to be so wet. They should be sold. Councils argue that these assets produce rent that can then be used on front-line services such as social care. Phooey. We all know that councils are rotten at running businesses. These assets would produce more return for the community by being transferred to the private sector. Councils should be supporting people who need support, and that should come out of national and local taxation. It shouldn't come from councils trying to be entrepreneurial money-makers. They just can't do it.

Of course, the sclerotic over-centralised rules under which local authorities are managed means they can't just flog their restaurants, hotels and cinemas (yes, really) and use the money to cut council tax; it would have to go into other capital projects. That should change. Fine if councils can't just sell up and have a one-off spending splurge, but silly if they have to over-invest in capital assets. Why not just say they can return the value to local council tax payers over, say, a ten year period? Then we can get better-managed local assets – businesses, they should be – and a ten-year cut in taxes too.  

The chart above shows the relative revenues of Netflix – a popular mail order DVD rental and movie streaming firm in the US, similar to LoveFilm over here – versus Blockbuster, the DVD rental giant. Netflix's convenience put Blockbuster out of business. Why drive to the local video store when you can do it over your computer?

But everybody knows that. The important thing about the graph above is the relative revenues for Netflix and Blockbuster at their peaks. Blockbuster, at its height, was pulling in $6bn of revenue. Netflix is making about a third of that. As Go-Digital says,

When the inefficiencies of having retail locations, moving physical inventory, and maintaining overhead/staff are cut out of the ecosystem, far less revenue is needed to support the system.

Consumers are watching as many – if not more – films than ever for less money and time than ever, for a third of the cost. The money that had been spent on (now unneeded) overheads can go on other things. Be sure to avoid the broken window fallacy – the saved money will go into other productive things that people want. As Blockbuster falls, something else people want will rise. And, at the margin, lower costs mean that there should be more movies made per dollar spent.

I think this pattern might hold elsewhere, too. Since getting a Kindle e-reader in June, I've read more books than I did in the entire year up to that point.

Although costs aren't falling yet – it's a proprietary Amazon device, and they're keeping the costs high while subsidising the cost of the device itself – the shift to e-readers means that authors will eventually be able to bypass publishers and significantly increase their profit-per-purchase. Like the rise of Netflix, this will probably mean less money spent on overheads and more spent on actual content.

This is one of the great virtues of technology-driven economic growth. As fewer people have to drive trucks and staff video stores, they're freed up to do other things, and more money goes directly to the creators of movies, books and other works of art that we treasure.

It is not uncommon to observe a fellow citizen who, in an extraordinarily self-righteous manner, points out how people of other countries suffer under censorship. It is regrettable that this affection for the freedoms of the inhabitants of these other countries rarely extends to the freedoms of our own.

Jon Stewart of the Daily Show recently exclaimed that ‘England is awesome’ in one his broadcasts. This particular segment of his show is, however, illegal in Britain. The problem? He used footage of Cameron and some quite unfriendly MPs in the chamber to support his admiration for the British Parliament, and it is apparently illegal to use parliamentary footage in a satirical/comedic context in Britain. This is ridiculous to say the least, but this form of censorship is unfortunately not limited to our politicians.

The monarchy is another institution that is overly protected against witty minds. One recent example of this occurred a few months ago when the Australian Broadcasting Corporation intended to air a satirical Royal Wedding Commentary. Clarence House, the official residence and office of Prince Charles, reportedly ruined these plans, and certain coverage restrictions were suddenly put in place. It was now the case that footage from Westminster Abbey could not be used ‘in any drama, comedy, satirical or similar entertainment programme or content’.

If you are the current or future head of church and state, you should expect to be the target of satire and comedy. And so should politicians. Restrictions of the kind considered above only make the satirical coverage more sharply ridiculing. For example, in their coverage of the royal wedding, Jon Stewart and his team decided to use an animation of the ceremony instead. The hilarious (but not 100% family-friendly) result can be found here.

When the politicians and the monarchy are too touchy, we ought to stand up against censorship. Luckily, the rules do not seem to apply to other countries, so I will browse the Internet and enjoy an uncensored version instead. Or, alternatively, I could catch a plane to one of ‘Chad, Somalia, Saudi Arabia, Syria, and Yemen’ where, Jon Stewart claimed, they do not censor a satirical news show.

The UK’s anaemic 0.2% growth in the second quarter unleashed the predictable cries from the usual suspects for a Plan B to the government’s fiscal austerity. Labour’s Ed Balls rattled off his well-worn criticism that the austerity measures are too much too fast. Of course, none of these Plan B advocates acknowledges that government spending hasn’t been cut at all yet. Just the opposite. For the fiscal first quarter (April-June), government spending, excluding interest payments, rose 2.6% to £143.7 billion.

To be sure, the growth figures were disappointing and the challenge for the government is to accelerate growth without losing sight of the two fundamental problems afflicting the British economy: over indebtedness by both the government and individuals and inadequate provision for an ageing population, again by both government and individuals. Until both are well and truly under control, no amount of dithering, forestalling or otherwise ignoring will restore consistent and productive economic growth.

The kind of rehab Britain needs isn’t a quick short-term affair. For the serious addict, treatment starts with detox to flush out the poisons as only the first step to long-term recovery. As any reforming addict knows, rehab is an ongoing, if not perpetual, program if it’s to have any long term success.

And for the UK as a whole, detox has only just begun - willingly or unwillingly, consumers are cutting back spending and boosting savings. The household savings ratio has bounced up to around 5% in the past year, more than twice the rate in the period preceding the onset of the financial crisis. Meanwhile, the UK government has also mapped out a long-term strategy to reduce borrowing. Again for its fiscal first quarter, central government net borrowing is down 2.8% on a year earlier.

It’s not at all clear now whether individuals and the government are just sweating through this inconvenient detox stage in the hope of resuming their old ways as soon as decently possible. Successful longer-term rehabilitation means individuals sustaining a proper savings rate, weaning off housing as a substitute for productive investment and factoring in the increased pension and care costs from extended longevity. The government’s role is to facilitate and incentivise such behaviour while destroying stockpiles of profligacy and dependency narcotics.

The FT reports that:

Hungary’s government is trying to introduce legislation that would allow the state to charge three former prime ministers with “criminal” mismanagement of economic policy after the national debt spiralled upwards in the last decade.

Superficially attractive as this might be, it is of course completely wrong. You cannot justifiably convict someone of doing something that was not a crime when they did it – especially not in a fairly blatant attempt to use the power of the state against your political rivals.

Nevertheless, this does raise an interesting issue: how do you deal with the fact that politicians typically only think as far as the next election, and as such do not as a rule pay much attention to the long term effects of their decisions?

Short-termism in politics is a chronic affliction, manifesting itself both in inaction (let’s not bother reforming social security – its eventual collapse is going to be someone else’s problem) and in action (let’s have a fiscal giveaway now and worry about the deficit once we’ve bought ourselves the next election). But is there anything we can do about it?

It’s an imperfect solution, but I think the only realistic way to counter political short-termism is to place on government the kind of legally binding restraints that we outline here. Force governments to balance their budgets over a defined period; prevent them from raising new revenues without direct electoral approval; make them account honestly for all future liabilities; and so on.

Politicians would still think short-term. They’d still focus on winning the next election. But the less discretion you give them, the less damage they can do.