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"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

Young Writer on Liberty Competition 2014

Written by Blog Editor | Monday 20 January 2014

The Adam Smith Institute invites you to enter our annual student competition, Young Writer on Liberty. This year's theme is:

Three policy choices to make the UK a freer country

Each entrant must write three essays in the style of the ASI blog, each no longer than 400 words, and each explaining a different policy choice that could make the UK freer, richer and happier. No policy choice is out of the question—indeed counterintuitive policy choices may be particularly interesting if backed up by strong arguments.

The winner will receive £250 and have their three posts published on our blog. They will also get a box of liberty-themed books and the opportunity to do two weeks of work experience here at the ASI.

Twos runner-up will also have their posts published on the blog, as well as receiving a package full of interesting books.

Last year's winner was George Kirby, who argued that we should legalise markets in organs, that there should be greater roaming rights in the UK, like those enjoyed in some Nordic countries, and that the UK would benefit from US-style federalism.

Entrants must be 20 or under on the closing date, 21st March 2014. Please submit all entries to schools@adamsmith.org. Good luck, and I look forward to reading all of your pieces!

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Deregulate banks for more competition

Written by Dr Eamonn Butler | Monday 20 January 2014

Sometimes politicians don't know how powerful they are. The UK Labour leader Ed Miliband, for instance, seems able to cause the London Stock Exchange to plummet just by speaking. First he promised price caps on energy companies, and their shares reeled. Then last week he promised to break up the banks, whereupon billions were wiped off their value.

As Jeremy Warner tellingly observes in Saturday's Daily Telegraph, Miliband is not the first in his party to want to get tough on bankers. When Gordon Brown became Chancellor in 1997, he instructed the OFT's John Bridgeman to investigate their supposed lack of competitiveness. Bridgeman refused on the grounds that he could find no sign of anti-competitive behaviour. So Brown set up his own inquiry under former telecoms regulator Don Cruickshank. As intended, he reported that the banks must be uncompetitive because they were making so much money on their capital. But "It didn't seem to occur to Cruickshank that the more plausible explanation for high returns was that the banks were operating on dangerously small levels of capital," writes Warner.

Anyway, by the time Cruickshank reported, the banks were making so much money, and contributing so much in tax to the Exchequer, that Brown no longer wanted to break them up. Indeed, he went the other way, suspending competition rules to allow Lloyds buying the near-insolvent HBOS, a "final act of folly" which taxpayers got the bill for.

There is indeed far too little competition in UK banking. America has 7,000 banks. In Britain, four banks control about 4/5 of the banking market, and five control 2/3 of the mortgage market. That is because of too much regulation, not too little. Regulation is a fixed cost. Big firms can bear it, small ones cannot. That is why the newcomer MetroBank is the first high-street bank to be created since Georgian times.

Miliband's prescription is typically statist. He wants to break up the big banks and "create two 'challenger' banks." Why two? Why not six, eight or fifteen? How does a politician – or anyone else – know how many banks (or energy companies, or carmakers, or supermarkets, or dog groomers and cafes, for that matter) we should have?

Obviously, the best thing is to leave such decisions to the market. But at present, the market is rigged, through regulation, in favour of big firms. It is right that there should be strong capital controls on large banks: if RBS or Lloyds skate on dangerously thin capital, they could bring down the entire financial system. If some tiny bank goes down, that is unfortunate, but not catastrophic, and we can deal with it just as we deal with any other small business failure.

So the solution seems obvious: have stringent enough capital regulation on large banks, and less stringent rules on small ones. That would encourage newcomers and innovators to enter the markets – not just two "challenger" banks but potentially dozens, even hundreds. And it would encourage the larger banks to break themselves up. Which they would probably do in a way that made much more business sense than any break-up engineered by clod-hopping officials employed by Business Secretary Vince Cable or would-be Prime Minister Ed Miliband.

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On why the US should have a market for kidney transplants

Written by Tim Worstall | Monday 20 January 2014

The second installment of my finding my extant prejudices supported by Gary Becker. This time it's his excellent article about the reasons why the US should have a paid market for kidney transplants. This is something I've written about here (and elsewhere) in our own UK experience so it's nice to see the work being done all over again for the US.

My very much back of the envelope numbers for the UK were that offering perhaps £20,000 as compensation to a live donor would reduce deaths from kidney disease and at the same time save the NHS a fortune. Beckers's (obviously, more accurate, for he is an economist and I am not) estimate is that the same results could be achieved in the US with a fee of perhaps $15,000:

We have estimated how much individuals would need to be paid for kidneys to be willing to sell them for transplants. These estimates take account of the slight risk to donors from transplant surgery, the number of weeks of work lost during the surgery and recovery periods, and the small risk of reduction in the quality of life. Our conclusion is that a very large number of both live and cadaveric kidney donations would be available by paying about $15,000 for each kidney. That estimate isn't exact, and the true cost could be as high as $25,000 or as low as $5,000—but even the high estimate wouldn't increase the total cost of kidney transplants by a large percentage.

They've also started exactly where I did: with the observation that Iran is the only place in the world without a queue for such trasnplants and Iran is the only place in the world with a paid donation program. It is possible to think that there might be a connection between these two things.

Paying for organs would lead to more transplants—and thereby, perhaps, to a large increase in the overall medical costs of transplantation. But it would save the cost of dialysis for people waiting for kidney transplants and other costs to individuals waiting for other organs.

More important, it would prevent thousands of deaths and improve the quality of life among those who now must wait years before getting the organs they need. Initially, a market in the purchase and sale of organs would seem strange, and many might continue to consider that market "repugnant." Over time, however, the sale of organs would grow to be accepted, just as the voluntary military now has widespread support.

Eventually, the advantages of allowing payment for organs would become obvious. At that point, people will wonder why it took so long to adopt such an obvious and sensible solution to the shortage of organs for transplant.

Or as I have been putting it for some years now, there are some problems that are simply too important not to use markets to solve them.

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Gary Becker on bureaucracies

Written by Tim Worstall | Sunday 19 January 2014

It's rather comforting to find one of your own heartlfelt prejudices backed up by a man with a Nobel, as I do here with Gary Becker's thoughts on the existence of bureaucracies:

Whether an organization is “efficient” cannot be defined in any absolute sense, but only relative to feasible alternatives. Therefore, it is reasonable to conclude that a large bureaucratic organization is efficient if it manages to thrive in a competitive sector; that is, a sector with easy entry of organizations with different decision-making structures. For if potential entrants were more efficient than the bureaucratic organizations, they would enter the sector and out-compete the bureaucracies.

Banks, oil companies, and manufacturers of large building equipment, to take a few examples, are in industries without major artificial restrictions on entry of competitors. Large bureaucratic firms, such as Caterpillar, JPMorgan Chase, and Exxon, persist profitably in these industries, sometimes alongside much smaller firms, like small banks, small equipment companies, and wildcat oil drillers that are generally more nimble. The persistence of these large bureaucratic companies suggests that their net advantages, taking into account their greater rigidity, are sufficiently great to enable them to survive the competition of smaller and more flexible firms. This is an application of the “Survival Principle” approach to efficiency developed decades ago by the Nobel economist George Stigler (see his article, “The Economies of Scale”, Journal of Law and Economics, October, 1958).

We might want to make sure that these firms are not using size in order to influence the regulatory environment, thereby gaining rents of course. But yes, this is a point I have made here several times, that as long as we have a market in organisations then we don't have to worry too much about which type of organisation is doing whatever job.

We can also extend this a little by thinking of Coase's "Theory of the Firm" where he points out that whether something is done by a firm, rather than a network of contracts (and by extension, by a firm, a bureaucracy or whatever) shouldn't particularly bother us. For, given the technology available at that time and place we'd expect competition to give us the most efficient method of performing that task. The organisational form therefore becomes a function of the technology available, market competition being the thing that adjusts such organisations.

Make sure we have ease of entry into a sector and we can pretty much leave the rest of it alone.

We're still left with the problem of why there's only one government at any time of course but that's a rather more intractable problem. Perhaps best solved by making sure that we've ease of exit from its clutches.

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Bubbles and balloons

Written by Sam Bowman | Saturday 18 January 2014

Quite a few people criticised the title of my last post — There was no British housing bubble — on the basis that, even if there was no overconstruction of housing (and thus no Austrian-style distortion in the structure of production), there was a bubble in the sense that prices rose rapidly, and so on. 

But is this right? I suppose it depends on what you mean by a 'bubble'. As far as I can tell, there are at least three different meanings of the word 'bubble':

  1. A speculative bubble, like the Beanie Baby craze. As Arnold Kling put it recently, "If investors who are buying the asset have estimates of the discounted present value of the income from that asset that imply a negative real return, then it is a bubble." 
  2. An Austrian-style bubble that distorts the real economy by incentivising production in an area where much of the demand is illusory (typically created by credit expansion, according to the Austrians).
  3. A government-created rise in price above 'real' (or endogenous) factors. 

Take the third kind of bubble, which I think is what we are currently seeing in the British housing market. A ban on the construction of new houses would cause the price of housing to rise significantly, for instance (and this isn't a million miles away from current government policy). Though the government policy is probably very harmful, given that it exists it is perfectly rational for markets to drive the price up, and that price should stay up for as long as the political factors dictate. The policy might be crazy, but the market's reaction isn't.

Let's take a look at historical UK house prices (in real terms).

Clearly, prices were above trend in the 2000s and then fell after 2008, but compared to the early 1990s prices are still extremely high. I'm willing to believe that quite a bit of that rise was a type-1 or type-2 bubble, but unless you think we're still in the midst of that kind of bubble (which could pop at any time), it's not the whole story and doesn't even seem to be most of the story. (As some commenters have pointed out, some aspects of this price increase were likely attributable to foolish financial wizardry, probably driven by regulation.)

More likely, that rise in house prices since the 1990s, since it is still high, is a type-3 bubble — a sensible reaction by markets to foolish government policies constraining the construction of new homes. I can't explain why this rise only took place in the 1990s (population growth and decreases in household sizes may explain this, but I don't know), but unless you're saying that right now markets are wrong and you know better, that rise doesn't seem like the sort of unsustainable bubble that leads to sudden crashes.

Type-3 bubbles are different to type-1 and -2 bubbles in that they do not run the risk of sudden crashes. A type-3 bubble is created by government fiat and it can only be undone by government fiat. This difference is sufficiently great that I suggest a new term for type-3 bubbles: "balloons". A term like that might communicate the fact that prices have been blown up by human agency and, unlike bubbles, require an active popping or disinflating before they go away.

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It could be that climate change just isn't worth worrying about

Written by Tim Worstall | Saturday 18 January 2014

As you all know I'm perfectly willing to go along with the idea that climate change is indeed a problem that we are doing something about and that that something should be a carbon tax. All of this being based on the dual points that I know nothing about the science of all of this but a great deal about the economics. So, if the scientists tell me that it's happening then OK, here's what we should do about it.

And it's worth noting that this makes me entirely mainstream: think of that, a subject where Worstall is in fact entirely mainstream. It's what the Stern Review says for example.

However, the next IPCC report may well end up with my changing my views on this. Here's a taster from a recently leaked version:

Containing the concentration to 480 ppm “would entail global consumption losses” of 1 percent to 4 percent in 2030. That range would rise to 2 percent to 6 percent in 2050 and then to as much as 12 percent in 2100 when compared with scenarios that don’t involve fighting climate change, according to the document.

The only argument in favour of doing something about climate change is that not doing something will be even more expensive than doing something. And the calculation was, from the Stern Review, that we should be willing to spend 1-2% of global GDP each year in order to avoid a near catastrophic 20% decline in it when the changes occur. But it's important to note that that 20% decline is only a possibility, even Stern didn't say it was a certainty.

But now we've got the IPCC apparently saying that we're going to be losing 12% of GDP globally in order to avert the possibility of a 20% decline. That's not a cost benefit analysis that makes sense.

Which leads us to a quite delightful possibility. That the next IPCC report on hte dangers of climate change is actually going to end up proving that we shouldn't do anything about climate change. For the doing things will be more expensive than the damages we suffer from not doing anything.

Probably, given that that 20% decline in GDP is indeed only a possible event, not a certain one.

And yes, I am aware that that picture of the polar bear is not one drowning because of the melting ice.

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There was no British housing bubble

Written by Sam Bowman | Friday 17 January 2014

Marcus Nunes graphed the Housing Stock to Population ratio in the US recently, showing that housing reached something like a steady-state in the US from the mid-1980s onwards. As Philip Stephens says, “The constructing in US housing was exactly what was needed to maintain the housing-population ratio in the face of increased population growth. You cannot have an “unsustainable boom” without oversupply.”

This is what the UK looked like over this period (my thanks to Daniel Knowles for the data):

The long-term trend (black dotted line) is attributable to the tendency in recent decades to smaller households, but what’s interesting is that, not only was there no spike in the run-up to 2008, the growth of dwellings over population actually fell below the trend. This is not what we would expect to see if there had been a bubble in housing production.

Dwellings data is a little bit unreliable, though – splitting a house into two flats creates an extra dwelling – so it might be better to look at the amount of new houses that were actually built. Here’s a chart showing the number of residential construction permits granted over the past forty years:

And here’s the ratio of new residential construction permits over population across the same period:

These charts show that housing construction was actually well below historical levels in the 1990s and 2000s, both in absolute terms and relative to population. It is difficult to see how someone could claim that the 2008 bust was caused by too many resources flowing toward housing and subsequently needing time to reallocate if there was no bubble in housing to begin with.

What this suggests is that the Austrian story about the crisis may be wrong in the UK (and, if Nunes’s graphs are right, the US as well). The Hayek-Mises story of boom and bust is not just about rises in the price of housing: it is about malinvestments, or distortions to the structure of production, that come about when relative prices are distorted by credit expansion.

What did cause the crisis? Jeffrey Friedman has shown that bank regulation (most notably, the Basel accords) was one of the major factors that led to the financial crisis, and Robert Hetzel has outlined a convincing theory that central bankers’ tightening of monetary policy in early-to-mid 2008 was the overriding cause of the world’s economic collapse. There is also the possibility that financial investment in the housing market was a simple error.

I was once convinced that the Mises-Hayek story about the boom and bust was true, but the evidence does not seem to bear this out.

Update: A lot of people seem to be implying that Austrian Business Cycle Theory (ABCT) means: Easy money -> high prices ("bubble") -> bubble burst, people lose money. This is incorrect. ABCT relies on distortions to the structure of production (that is, the "real" economy) which have to be liquidated over a period of time following the point at which it becomes clear that they are not good investments. If a 'bubble' just meant that people had lost money it would not cause a long-running recession, it would just mean that overnight a lot of people had lost money (like a stock market crash). The reason the recession takes time according to the ABCT is that resources have been invested in a sector where price signals take a considerable amount of time to adjust after a credit-induced malinvestment bubble and so it takes a while for people to determine which investments are 'mal'.

In short: There may have been a price bubble in British housing market, but there was not the production bubble that ABCT predicts.

PS: I am interested in seeing these data for countries like Ireland and Spain, where the Austrian story may be more valid. It is also possible, as Anton Howes has pointed out, that a regional breakdown would show that there were bubble-like expansions in housing supply in certain parts of the UK, which the country-wide figures hide. If you have these data please let me know, either in the comments or by emailing me at sam@adamsmith.org.

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People just aren't as stupid as the bureaucrats think

Written by Tim Worstall | Friday 17 January 2014

It's claimed as one of the great victories for enlightened (sorry) regulation, the way that the EU and US have both banned the incandescent light bulb through bureaucratic action. The ban came about by raising the efficiency standards required: this meant that the traditional bulb could no longer be sold.

The argument in favour of doing things this way was, in public at least, that everyone's too stupid (or, in a more polite manner, subject to hyperbolic discounting) to realise that the new bulbs will actually save them money in the long term by consuming less electricity. There are also the more cynical in the industry who insist that it's actually a case of regulatory capture. The light bulb manufacturing companies managing to get us all away from using cheap as spit bulbs and onto something with a decent margin on it.

But there's an interesting new paper that puts that first explanation to rest:

It is often suggested that consumers are imperfectly informed about or inattentive to energy costs of durable goods such as cars, air conditioners, and lightbulbs. We study two randomized control experiments that provide information on energy costs and product lifetimes for energy efficient compact fluorescent lightbulbs (CFLs) vs. traditional incandescent bulbs. We then propose a general model of consumer bias in choices between energy-using durables, derive sufficient statistics for quantifying the welfare implications of such bias, and evaluate energy efficiency subsidies and standards as second best corrective policies if powerful information disclosure is infeasible. In the context of our theoretical model, the empirical results suggest that moderate CFL subsidies may be optimal, but imperfect information and inattention do not appear to justify a ban on traditional incandescent lightbulbs in the absence of other inefficiencies.

To translate that for you: people aren't as dumb as the bureaucrats think. We're all perfectly capable of working out whether the energy savings will make up for the higher initial cost.

This has a number of implications in hte larger world as well: for example, it means that bureaucratic regulation on car mileages (like CAFE in hte US) is contra-indicated. A simple tax on petrol will drive up average mpg because we're not all as thick as bricks. Assuming that climate change really is a problem that must be dealt with then a carbon tax is going to do the job. For we're not all so dim that we cannot work out the utility of using fossil fuels or not given the change in prices.

That is, we don't need to be regulated into behaviour, we can be influenced into it through hte price system. Something that really shouldn't be all that much of a surprise to us market liberals: for we're the people who already insist that people do indeed respond to price incentives in markets.

Now all we've got to do is convince our rulers of the righteousness of this point: so they can stop writing those darn regulations.

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Comment: Minimum wage increase will hurt the poor

Written by Blog Editor | Thursday 16 January 2014

Commenting on the Chancellor's backing for an above-inflation rise in the National Minimum Wage, the Adam Smith Institute's Research Director Sam Bowman said:

"A minimum wage increase will hurt the poor, particularly young people and vulnerable groups like migrant workers. Most of the empirical economic evidence has found that increases in the minimum wage cause increases in unemployment. The evidence also suggests that minimum wage increases lead to slower job creation for low-skilled workers.

"Minimum wage work is usually a stepping-stone to something better where employees can acquire human capital. There is also evidence to suggest that minimum wages stop young workers from acquiring the skills that allow them to get better jobs in the long run, so today’s increase could have far-reaching harmful effects by keeping people in low-paid jobs.

"One way to actually help low-income workers would be to raise the income tax and National Insurance threshold to the current minimum wage level, which would give these workers a take-home pay equivalent to a minimum wage. That would require spending cuts or tax rises elsewhere, but it would be a responsible and effective way to improve the lot of the working poor that would carry none of the unemployment risks that this minimum wage increase does – in fact, it would create jobs.

"Increasing the minimum wage runs an indefensibly high risk of creating more unemployment and harming the people that supporters of the increase want to help. Even if the immediate impact is not large, this increase will lead to a long-run decline in job creation and standards for Britain's poorest workers. It will hurt the very people it is supposed to help."

For further comment please email media@adamsmith.org.

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Planning and living costs

Written by Dr. Eamonn Butler | Thursday 16 January 2014

Interesting piece in newgeography.com about Britain's antiquated planning policies. Public opinion on them seems to be changing, driven largely by rising price houses. People figure that maybe it's time to build more houses. That was, of course, the conclusion reached by Kate Barker's study on housing a decade or more ago.

And planning restrictions impose other costs too. Not just our homes but our shops and other facilities become more squashed and crowded, and food and other essentials become more expensive – planning rules mean they have to be transported long distances, and planning delays put up suppliers' costs.

And yet, says the American author, England and Wales are less crowded than Ohio, with its rolling hills and famland. Only 9.6% of England and Wales is urban, compared to 10.8% of Ohio.

An average house in the UK cost about three times the median income in the 1990s. In the London green belt it is now seven times that. Our houses are now 30% smaller than they were in the 1920s, before the planning laws; with the obvious exception of Hong Kong, our new homes are some of the smallest in the world - 'rabbit hutch homes' as Communities Secretary Eric Pickles described them. It is indeed time to have this debate.

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