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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

Explaining the boom in the profit share in the US economy

Written by Tim Worstall | Thursday 23 January 2014

That chart is of corporate profits in the US economy as a percentage of GDP. And it's the cause of much muttering: see how the little guy is getting screwed over by the corporate giants etc.

But we also need to add this little observation to it:

it is important to realize that around 50 percent of the SP500′s earnings are generated overseas

Total profits for the constituents of the S&P 500 index are of the order of $1.1 to $1.12 trillion in this past year (not all have reported yet so difficult to be exact). And if 50% of them are overseas profits then that's $600 billion or so.

Or, when we put it into the context of US GDP, that's about four percentage points of GDP.

Taking that off the 11% of GDP that is US corporate profits leaves us with 7%, or much more like the long run average.

The rise in GDP of corporate profits has at least something to do with the increased globalisation of the economy rather more than it does with the oppression of the workers by capital. As so often, the devil is in the details of the measurement.

One such detailed point: we could assume that foreigners must also be making profits in the US and therefore there's 3 or 4% of GDP being paid out again to foreigners. But that's not actually quite how they measure it, there's an asymmetry here. Corporate profits are measured from Federal income tax returns: companies who have invested in the US will be reporting their US profits on such forms. As will US corporations who have made foreign profits. Thus this measure includes the corporate profits made in the US by foreigners as well as the foreign profits made by US companies.

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The machines are going to steal all our jobs!

Written by Tim Worstall | Wednesday 22 January 2014

The Economist has another of those breathless pieces worrying about what's going to happen when the robots come for all our jobs. There's one basic error in the piece and one slightly more technical.

The basic error is that they fail to note that when the robots have taken all our jobs then we'll all be incredibly rich. One of the comparisons they make is to the first industrial revolution and that's appropriate. So, let us think about what happened when the mechanisation of cotton production killed off the hand weaving (and linen although more slowly) industries. Yes, certainly, some people lost their jobs: but the entire population now became rich enough to be able to wear cotton underwear simply because the production costs of cotton fell so far. And only those who have suffered through the woollen kind will know how rich that makes us all.

It's a very, very, basic observation: if the machines are making everything then everything becomes extraordinarily cheap. This is the same statement as the one that the machines taking all our jobs makes us all very rich indeed.

The more detailed mistake is here:

But though growth in areas of the economy that are not easily automated provides jobs, it does not necessarily help real wages. Mr Summers points out that prices of things-made-of-widgets have fallen remarkably in past decades; America’s Bureau of Labour Statistics reckons that today you could get the equivalent of an early 1980s television for a twentieth of its then price, were it not that no televisions that poor are still made. However, prices of things not made of widgets, most notably college education and health care, have shot up. If people lived on widgets alone— goods whose costs have fallen because of both globalisation and technology—there would have been no pause in the increase of real wages. It is the increase in the prices of stuff that isn’t mechanised (whose supply is often under the control of the state and perhaps subject to fundamental scarcity) that means a pay packet goes no further than it used to.

So technological progress squeezes some incomes in the short term before making everyone richer in the long term, and can drive up the costs of some things even more than it eventually increases earnings. As innovation continues, automation may bring down costs in some of those stubborn areas as well, though those dominated by scarcity—such as houses in desirable places—are likely to resist the trend, as may those where the state keeps market forces at bay. But if innovation does make health care or higher education cheaper, it will probably be at the cost of more jobs, and give rise to yet more concentration of income.

This is Baumol's Cost Disease of course. Those things where it is more difficult to increase the productivity of labour in their production will rise in price in comparison to those things where raising that productivity is easier. Exactly those services like college education and health care complained about.

But...but...if we're now stating that we're worried about automation attacking the jobs in those areas we're in fact making exactly the same statement as that they're about to become 20 times cheaper. Just as happened with the widgets. You can't both complain about the price reductions that come from the robots stealing our jobs and also about increasing inequality. For if everything falls, over only 30 years, to one twentieth of the starting price then what the hell is there left to have any consequential inequality about?

Positional goods? Sure, the Louvre will still have the world's only Mona Lisa, there will still only be a handful of houses in Eaton Square but beyond that, seriously who cares? The end state, if the robots to start doing all the work, is that we get all the food, healthcare, clothing, housing (but perhaps not exactly where we might want it), education and all the rest that our greedy little hearts could desire.

And this is something that people think governments have to start having policies about?

Heavens preserve us. 

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What's the true free market monetary policy?

Written by Ben Southwood | Tuesday 21 January 2014

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.

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Motorways, pubs and nannies

Written by Dr. Eamonn Butler | Tuesday 21 January 2014

A new pub has opened in Beaconsfield, Buckinghamshire. That's news in itself, given that around 1200 pubs closed down last year, thanks (or no thanks) to the weight of retail and employment regulation that makes pubs so darn expensive to run.

But the Hope & Champion is of doubt interest, because it is in the Extra Motorway Service Area at Junction 2 of the M40. So the people who go there are almost certain to get there by car. So naturally there have been plenty of critics complaining that this initiative sends out all the wrong signals about drinking and driving.

Well, pubs in the UK are licensed, precisely because we know the potential problems that can go with alcohol consumption. But the fact is that the local police did not object to the licence, nor did the local authority. And the local paper is giving the new pub splash coverage. So local people don't think there's a problem here.

The real problem is the message that the critics send out, yet again – that the political class in Britain thinks the adult population of their country are completely incapable of making their own choices, and that their lives have to be micro-managed for them. This pub, like most others these days, is basically a restaurant that also serves alcohol. It opens at four in the morning and starts selling alcohol at nine - though apart from one stalwart getting stuck into a pint for the cameras, most people there this morning were getting stuck into nothing more life-threatening than a Full English Breakfast. And if a group of people want to stop off the M40 for lunch or dinner, why should the passengers be denied the pleasure of a small sherry just so that drivers are 'kept away from temptation'?

Weatherspoons, the pub owners, are a responsible chain. Their menus carry Drink Aware slogans and information. Their staff do not serve people who have already had enough. People know that there are legal limits on drinking and driving - and they know that even drinking below the legal limit can slow down your reactions. So most drivers who visit the pub, alone or with a group, would probably not have alcohol anyway, and their passengers would probably not want them to.

So as the police and local authority figure, there's no problem. The only problem is all those people who deem it their business to treat us like children.

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On why I just love the latest Oxfam report

Written by Tim Worstall | Tuesday 21 January 2014

You'll have seen the stories about this latest Oxfam report all over the place. The bottom 50% of the world has the same wealth as the top 85 people etc. This is presented as if it's an obviously bad thing and yet I cannot quite bring myself to agree with that conclusion. Here's the list of evidence they compile:

Almost half of the world’s wealth is now owned by just one percent of the population.

• The wealth of the one percent richest people in the world amounts to $110 trillion. That’s 65 times the total wealth of the bottom half of the world’s population.

• The bottom half of the world’s population owns the same as the richest 85 people in the world.

• Seven out of ten people live in countries where economic inequality has increased in the last 30 years. •

The richest one percent increased their share of income in 24 out of 26 countries for which we have data between 1980 and 2012.

• In the US, the wealthiest one percent captured 95 percent of post-financial crisis growth since 2009, while the bottom 90 percent became poorer.

OK, let us just, for the sake or argument, accept all of that as being true.

So, what else has been going on in the world over this same 30 odd years of excessive neoliberalism? Actually, no, let's just look at one other thing the Oxfam reports tates first:

Some economic inequality is essential to drive growth and progress, rewarding those with talent, hard earned skills, and the ambition to innovate and take entrepreneurial risks.

OK, so let's also take that as being true, just for the sake of argument. So, what has been the effect of the world moving in the direction Oxfam describes it as having done?

Well, we've had the greatest reduction in absolute poverty in hte history of our entire species, as I've noted here passim ad nauseam. We've also had global inequality falling even while in country inequality rises. So we could certainly make a case that we've got the right amount of inequality to drive that growth and progress that we actually desire.

For we do want the poor to become richer, don't we? We want hundreds of millions, nay billions, to climb up out of historical peasant destitution and into the bourgeois pleasures of three squares a day and a change of clothes? And if inequality is, per se, a problem then we'd like it to be reduced globally and not just within some arbitrary lines on the map that make up nations?

So, erm, it would appear that the very things that Oxfam are complaining about are producing exactly the goal that we at least desire and Oxfam should at least be considering desirable.

Which leaves us with only one question left. Just why are they complaining about this?

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Hannan, Law and Innovation

Written by Dr. Eamonn Butler | Monday 20 January 2014

I was struck by a passage in Daniel Hannan's new book How We Invented Freedom And Why It Matters. As a UK Member of the European Parliament, he is always asking other MEPs why they think new rules are needed, in banking, working hours, herbal remedies and much else. As he says:

"The response is always the same: 'But the old system was unregulated!' The idea that absence of regulation might be a natural state of affairs is seen as preposterous. In Continental usage, 'unregulated' and 'illegal' are much closer concepts than in places where lawmaking happens in English."

This is a profound point. We've all heard about the differences between British (specifically, English) and Continental Law. In English, Common Law, rules are decided by courts in response to some 'specific problem' arising. In Continental, Roman Law, rules are laid down by the authorities. So in Britain, things are presumed to be permitted unless there is a law to stop them. On the Continent, things are presumed to be prohibited unless there is a law to allow them.

I always figured that such traditions explain why the British are more enterprising, and why they have a much lower opinion of their authorities: to them, politicians and officials just get in the way of what you want to do. To a continental, though, they are people you need to coddle and get onside in order to do what you want to do.

But Hannan's illustrative conversation explains much more: specifically, why the European Union generates so much regulation. To the Continental mind, for something to be permitted, there must be a law – or a set of regulations – permitting it. If you are doing something that is not regulated, you must be up to no good. Indeed, it is cheeky of you not to have asked permission in the first place.

In slow-moving societies, this might work tolerably well. But when you are facing rapid social and economic change, as we are today, the Continental presumption of required consent cannot possible respond fast enough, because every innovation has to be considered and ruled on. In the English tradition, by contrast, you can innovate as much as you want unless or until it infringes other people's rights. Facing the international competition that we do, that seems a much more promising system.

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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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