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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

Laffer curve sighted in Ireland

Written by Chris Snowdon | Tuesday 20 December 2011

Earlier this year, Ireland’s Office of Revenue Commissioners made a shock discovery, albeit one which sounds slightly dull when put in the language of economics. They found that the price elasticity of cigarettes in Ireland is -3.6, which is to say that a 10% increase in price reduces sales by 36%. This came as a surprise because cigarettes—being notoriously addictive—are usually thought to have a consumption elasticity of less than -1.0, whereas a price elasticity of -3.6 implies that smokers are more price sensitive than people who buy jewellery, DVDs and toothpicks. This struck them as rather counterintuitive, to say the least.

Something was clearly up, and what had been going up was smuggling. Since 2002, the price of cigarettes has risen by 40% in real terms to 8.55 euros a pack and the black market has swollen accordingly. The -3.6 price elasticity figure only took into account legal sales, which have indeed declined significantly. The number of people smoking, however, has not. Smuggled snouts and privately imported baccy have made up the difference.

This is all as you might expect. The thin blue line of customs and excise officers is easily breached once prices in one part of Europe leap far ahead of prices elsewhere. Britain has had a similar experience, with more than half of all rolling tobacco being sold on the black market. None of this comes as a surprise to anyone, except possibly Deborah Arnott of the anti-smoking pressure group Action on Smoking and Health, who wrote in The Guardian in February that disparities in tobacco duty do not lead to smuggling and called for Britain to hike its ciggie taxes still higher.

My reason for mentioning this is not to point out the unintended consequences of sin taxes, but to report a rare sighting of a Laffer curve in a government document. While those on the left continue to debate its existence, Ireland’s Revenue Commissioners are taking the Laffer curve more seriously. They are candid enough to note that “cigarettes remain a sizeable source of exchequer funding. While it may be desirable from a public health perspective to abolish smoking, the €1bn in excise revenue from tobacco would be a significant loss from the fiscal perspective.” As such, they would like to maximise tax revenue and Arthur Laffer might have the answer:

Laffer suggests there may be an optimum tax rate that maximises tax revenue (the peak of the Laffer curve), moving either direction (higher or lower taxes) from that peak will lower revenue.

It seems likely that a Laffer type effect exists in the cigarette market in Ireland and the current level of taxation may be beyond the optimum. Therefore higher tax rates (higher prices) will lead to lower tax revenue.

They even provided a graph which shows a classic Laffer curve:

curve

There are plenty of arguments for and against high cigarette taxes. Some say that the government has a moral obligation to deter unhealthy pursuits while others think it is morally objectionable to exploit inelastic behaviour, ie. addiction. Leaving the ethical debate to one side, it cannot be denied that governments do receive significant sums of money from tobacco taxes and have done for many years. As Ireland’s customs wonks have now realised, this golden goose has reached the limit of how many eggs it can lay. Smokers, like drinkers, traditionally take a hit when economies tank, but governments in the highest taxing nations—including the UK—may have to start taking Arthur Laffer more seriously if they want to protect their income.

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Unwinding the Iron Lady

Written by Jan Boucek | Monday 19 December 2011

Recent weeks have seen a flurry of articles about the upcoming release of The Iron Lady, featuring Meryl Streep as Margaret Thatcher. A lot of these have been drearily predictable – superb performance of a dynamic personality but, heaven forbid, the writers could never vote for Thatcher and lament her destruction of a golden Britain that never was. One Guardianista admitted to being only six when Thatcher was ousted but still claimed to be opposed to everything she stood for.

Expect more of this when the film actually opens in early January but prepare to demand from such critics what, precisely, of Thatcher’s legacy needs undoing. Two decades and four prime ministers later, very little has actually been undone so here’s a shortlist of the possibilities:

  • Re-open the coal mines and send the noble working classes back underground to face an early death from accident or disease. The mines will need a subsidy, of course, but we could switch these from green energy schemes and support instead increased output of carbon dioxide.
  • Simply hand the Falklands over to Argentina, apologise and offer up a couple of aircraft carriers as compensation. We’re building some now for which we have no plans.
  • Speaking of war, Thatcher never invaded a foreign country so perhaps we should pick up on some of her successors' examples in Bosnia, Afghanistan and Iraq. Of course, our reduced military capabilities limit suitable candidates but there must be some minor evil we can correct - mineral exploration in Greenland, say, or money laundering in Belize.
  • Re-nationalise privatised companies from airlines to gas to telephones to electricity to you name it. Increased waiting times for delivery and service would do much to calm our frenetic pace of life. The recent success of Northern Rock, Royal Bank of Scotland and Lloyd’s point the way.
  • Discourage competition and innovation. Do we really need our horizons broadened by cheap flights to every corner of the world? What was wrong with the stodgy fare in the supermarkets before Tesco, Sainsbury’s, Asda and Morrison’s got down and dirty?
  • Eliminate quality in our manufactures and banish those foreign devils from Toyota, Honda, Nissan, BMW and Tata. Bring back British Leyland so we get to know our local garage mechanic better.
  • Make the pips squeak again. There’s too many smart and creative types flouncing around London so let’s get those marginal tax rates back up to 70%. Just think of the parking spaces this will free up.
  • Re-purchase former council housing but only pay the original selling price. That’ll teach those contented families to aspire beyond their station.

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New at AdamSmith.org: Law and order in Kenya – BABS Security Services Ltd

Written by Zachary Caceres | Monday 19 December 2011

My first real encounter with the Kenyan police came late one night on a motorcycle. I rounded a corner in the darkness of Langa-Langa, a large neighborhood on the outskirts of the city of Nakuru, Kenya. I was sleepy and my dinner-host – a young Kenyan named Dickson – had stuffed me full of delicious local cuisine. The motorcycle's headlights illuminated a Soviet-era military truck with several heavily-armed men scattered around its edges. All of them peered with hostility from the shadows cast along its camouflage lining. I felt my stomach sink. They muttered something threatening in Swahili -- one thrust his assault rifle skyward and stepped out to block the road. I tapped the driver on the shoulder “Twendeni! Let’s go!” I shouted over the engine. We accelerated past, the men in the truck yelling after us. "Who are they?" I asked. "The police," he said.

Many times the police are conspicuously absent with most of their resources devoted to protecting formal, well-established (and usually well-connected) firms and streets near City Hall or in a city’s central business district. But private security is everywhere in Kenya. A local bar and mzungu (Swahili for ‘foreigner’) haunt proudly displays on its entrance: “Protected by Robinson Security.” Two stoic guards in pressed blue uniforms frame the open gate of a supermarket in Nakuru. Before entering a night club, a friendly but stern door guard frisks those entering. Indeed, throughout Kenya’s cities and along the roads to and from the capital, cars emblazoned with security services roll past stalled motorcycles and traders hawking their wares to trucks ensnared in Nairobi’s impenetrable traffic.

Read this article

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Government price fixing: health care edition

Written by Tim Worstall | Sunday 18 December 2011

You'll all be aware of the horrors with which the introduction of vaguely market like things into the NHS is causing our lefty bretheren. The idea that prices might be fixed by the supply and demand of something just makes them shudder. Surely they cry, government, the wise, fixing them would be better? After all, we don't want to end up with a health care system like that of America, do we?

Well, actually, no, we probably don't want to end up with the American health care system which is just why we don't want the wise, the government (sorry, that conjunction just makes me laugh so I've repeated it) fixing those prices. We'd much rather let markets do that for us.

For there's a very interesting recent paper which shows that the US health care system expensive as it is, is expensive because of government price fixing:

This raises the question of what exactly changed in the 1980s. Daeho Kim, a graduate student at Brown University, offers a provocative hypothesis in a new working paper. As Kim explains, a 1983 Medicare reform created the prospective payment system, or PPS, which offered fixed reimbursements for the use of a medical technology. If a physician decides to use bypass surgery as a cardiac treatment, she won’t be paid on the basis of what it cost her to perform the surgery. Instead, she’ll be paid the national average cost. This way, there is a strong incentive to beat the national average cost of performing bypass surgeries, thus lowering, in theory, systemwide costs.

But something quite different seems to have happened. A big part of the story is that providers can choose from a number of different cardiac treatments, some of which are more expensive than others. PPS encouraged them to focus on the treatments where the marginal cost — the cost of providing one more treatment, in this case — fell below the average cost, even if there are more cost-effective treatments available. Kim suggests that PPS may account for one of the most distinctive aspects of the U.S. health system — our extraordinary overreliance on costly treatments.

In short, the bureaucrats fixed the prices for a specific treatment but left the doctors and hospitals free to choose an expensive specific treatment over a cheap one. With the obvious effect that everyone now gets the most expensive possible treatment for whatever condition it is that they have.

Now one could argue that having the wise, those in government (it is to laugh again!), fixing the  prices right this time would beat that problem. That is, in part, a bet that your average drone at the UK Department of Health is cleverer than your average drone at the US equivalent: good luck with that one.

But the real answer to that is that it isn't in fact possible to calculate, in the absence of a market, what is the correct price. For as Hayek pointed out, the whole thing is just too complex for that: the market is what we have to use to calculate the correct price. Thus it is impossible for the wise governors (titter) to ever get the price right: which is why we don't want them setting prices.

I'm perfectly happy for there to be government involvement in health care. I can see a valid place for social insurance, I'm entirely fine with tax-financed health care of some kind. But in order to get the right amount of the best of it we're going to have to let the idiocy of the interaction of the marketplace replace all those very clever people in offices setting the prices for us.

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Forward to the Middle Ages!

Written by Tim Worstall | Saturday 17 December 2011

It is really quite marvellous how all of these various things we're supposed to be doing to save the planet are exactly the things we used to do which damaged the planet so badly. As Matt Ridley points out when talking about what we're supposed to do to keep warm when we can't burn coal or oil:

To replace coal, the government projects that by 2020 Britain will be generating electricity from burning up to 60m tonnes of biomass, mainly wood, about five times the timber harvest that Britain could conceivably produce.

Now "five times the harvest we could possibly produce" means that we would be over using that resouce. Denuding these islands of trees in fact. Which is what we actually did do all those centuries ago and what impelled us to go and conquer a quarter of the world in order to gain resources (no, really, we did things like go to war against Denmark so that we could have access to the Baltic timber to replace what we'd burnt) and also to start digging up coal in the first place.

Because there was no wood left, see?

It may well be that out there somewhere is the technology that can wean us off coal but it's almost certainly not going to be the one that we abandoned to embrace coal in the first place , is it? For the clear and obvious reason that the last time we did it there wasn't any wood left which is why we stopped doing it.

Guys, you know, "Forward to the Middle Ages" is meant to be a joke about the more extreme greenies, not a blueprint for the government to follow.

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2012: The end of the world as we know it?

Written by Sam Bowman | Friday 16 December 2011

Our panel discussion of what the next year has in store for us was surprisingly philosophical: Jamie Whyte discussed the redistributionism built in to democracy and Brendan O'Neill gave a rallying cry against "middle class miserablism". More concretely, Alex Massie discussed the US presidential election (it'll get bad, and then worse) and Douglas Carswell gave a short-term pessimistic, long-term optimistic vision of things to come in British politics. His economic outlook was remarkably Austrian too — reason enough to be optimistic, if you ask me.

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Zero-sum thinking on immigration is hurting the economy

Written by Henry Oliver | Friday 16 December 2011

Just as we are about to see a large export of highly educated British citizens to the other side of the world, we are going to bring in fewer people to study here. Australia is currently enjoying a commodities boom. Mining is expanding as minerals are exported to China, and construction projects are benefitting from this as infrastructure projects grow. But there is a shortage of 20,000 engineers in Australia. These will come from South Africa, India, and Britain.

So as we export trained engineers to Australia, and they export commodities to China, you would expect us to see an opportunity: Britain could use its large education sector to train people from all over the world, bringing in large amounts of investment and skill. It would then be part of a new, growing market, attracting wealth to its major cities – and it could keep some of the best of the graduates to work here. Right?

Wrong. We are making it more difficult for people to get a student visa in a bid to keep total immigration low. And as of April 2012 we are going to abolish the Post Study Work Visa. This has already had an effect: MBA applications to the University of Manchester’s Business School are down 18% in anticipation of that.

France has taken a similar approach. And all those students will end up in places like Spain, whose immigration policy is still liberal. Or worse, they will go to Australia. After seeing a drop in applications of 25% Australia reinstated students’ right to work, and sped up the application process. And they’ve just made it easier to get a Post Study Work Visa, as well as allowing people to stay for longer after studying. We are making ourselves uncompetitive in an international market. We will be neither training the mobile workforce, nor attracting them to come and work here.

Immigration limits rely on the zero-sum fallacy that the amount of labour in a market is fixed. That is the reasoning behind the UK’s limits on the number of agricultural workers allowed in from Bulgaria and Romania – to protect British jobs. But it is not fixed, it is flexible: as the market grows so does the demand for labour. And the market grows through the expansion of the population which, in turn, is afforded greater flexibility to innovate, work hard, be more productive, and discover new opportunities.

As I wrote recently, the economics of immigration is based on the division of labour. It only benefits the economy in the long run and can be shown to boost real wages of residents and nationals. Short term negatives, whilst the market adjusts, are more than compensated for by the long term benefits. John Bercow got it right in the Independent in 2005:

Immigrants are incoming assets … in a global economy, their labour is vital both to tackle severe skills shortages and to fill long-term vacancies. Immigrants are not taking jobs that British workers could fill, but jobs which British workers are unable or unwilling to do … the idea that immigration is an intolerable burden on the taxpayer and the welfare state is baloney. Immigrants give far more than they take. It is estimated that they make a net contribution to the economy of £2.5bn …

And it is the same with students. As the economy becomes more global we trade more and more with other countries; as China imports minerals from Australia, generating a construction boom, demand for British engineers increases. And just as that point we decide to stop training engineers, and to stop letting them stay here post study, in order to “protect” British jobs. It’s as if London was buying lots of wheat from East Anglia, who then banned Yorkshire men from coming to help get the crop in. East Anglia would lose out, especially if London could just buy the wheat from Wiltshire, or on foreign markets. And the Yorkshire men would go and work in Wiltshire (or wherever) whose crop would be harvested quickly, increasing their productivity, making them more competitive when it came to selling the wheat.

Unless we attract the top international talent and allow it to study here and work we will not be a part of the global market. Global demand for high-level education is huge, and people working in a global economy will be willing to pay.
As it is we are going to lose our skilled graduates and potential students to countries like Australia, which is all too aware that the wealth it is earning from the commodities boom is only going to increase as the gap in its labour market is filled with our engineers. If we stop supplying engineers Australia will look elsewhere. Or train them themselves under their newly liberalised visa rules.

In 2009 the UN calculated that only 3% of people live outside their country of birth. There is huge potential waiting to be discovered. Michael Clemens explains, with the example of migration from poor countries, why we all benefit from migration:

emigration of less than 5 percent of the population of poor regions would bring global gains exceeding the gains from total elimination of all policy barriers to merchandise trade and all barriers to capital flows.

Clemens also points out that the American population has quadrupled since 1914, and much of that was due to immigration; but America has remained the leading economy in the world. Indeed, Reinhart and Rogoff tell us that America’s share of world real GDP increased in the same time period (1914 – 2008) from 18.93% to 21.41%. Immigration didn’t damage America; limiting it might be damaging Britain.

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I used to be a productive member of society like you...

Written by Anton Howes | Thursday 15 December 2011

Skyrim damages the economy according to Geek Dad writer Dave Banks. His explanation is worth a read, gushing with praise for one of the most immersive and impressive video games yet, and finishing with a petition to politicians to ban Bethesda from making such great games. But it should be read as a parody, as one of the best and most culturally relevant mock petitions since Bastiat pretended that the sun was putting unprotected candle makers out of business.

Unlike Bastiat's petition, this one has a more modern target, pointing out the skewed priorities of many economists and econometricians. While capitalists are most often accused of being obsessed with economic efficiency and making money, the true materialists are the Keynesians and statists. In fact, free-marketeers and particularly the Austrian school instead focus on human action and preferences, and would see the decision to lock yourself in a room for the 300 hours of Skyrim's estimated game-play as perfectly valid.

Some may not approve, and others may tell you to get a life doing something 'productive'. To top it all, you may well not be the best, most rational decision-maker. But you still know yourself best, and you often unconsciously act on it; after all, your definition of 'productive' may involve clearing Dwemer ruins, mining ore on a snow-swept mountainside, and absorbing dragon souls.

People like Owen Jones who decry the 'funemployment' of the wealthy forget that the whole point of work is to pay for leisure. They're right that work sometimes brings its own therapeutic benefits, and perhaps a degree of dignity, but the free market and the progress of technology have allowed our generation to have more leisure time than ever before. Rather than being good for its own sake, employment is the cost of leisure, as defined by our personal preferences and decisions.

The money earned doesn't just provide some security and standard of living, but also gives us the opportunity to pursue our own happiness. If that happiness involves 'wasting' your time becoming a thane or slaying virtual vampires, then how else were you going to spend it? On vapid consumer spending to 'boost the economy'? There's something inherently wrong about the idea, as if you're working for others at your own expense; and the value of Mr Banks' parodic petition is in making it so obvious and repugnant. So let's give ourselves a deserved break and have our virtual adventures, before we take the metaphorical arrow to the knee and are stuck back at work on a Monday morning.

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The consumer failed to deliver last year!

Written by Sam Bowman | Thursday 15 December 2011

This week I have been reading The Consumer Failed to Deliver Last Year and Other Fables, a short (33-page) monograph of essays by Terry Arthur, who has written for the ASI on occasion. The monograph itself was originally published in 1993, but its timeliness has earned it a new edition, published by LCF Research. It's an engaging, enjoyable read, and very ably dismisses some of the myths that pass for received wisdom in most people's understanding of economics and investment.

Terry's great ability is to use simple, step-by-step reasoning to expose bad, confused ideas for what they are. On the idea that interest rates are simply the price of money (which implies that the government can manage them without many problems), he is gentle but brutal. Would you swap 10 packets of cornflakes for 20 tomorrow? Probably. Would you swap 10 packets for 20 in fifty years time? Probably not, if you like cornflakes. You have an internal weighing scales that, in choosing how many extra packets you would want to forgo having them right now, determines your time preference for cornflakes.

Time preference is a hugely important concept in economics, and one that I would wager very few economics journalists are aware of, let alone being able to explain as clearly as Terry. Why is this concept so important? Because, as Terry explains, ignoring it leads to state money printing which drives booms and, inevitably, busts.

The underlying lesson throughout is the sensible and very Austrian view that saving, not spending, is what makes us richer. The latter half of the monograph deals with investment, applying this sort of thinking to what people should actually do with their money. Is risk-taking the only way to reward? Bearing time-preference in mind, there's no reason that that should be the case. Bears (like me) will appreciate the clear-sighted, fundamentals-focused approach Terry takes. It's a very good read, and well worth a look. It's available from Amazon now.

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Europe's road to serfdom

Written by Vuk Vukovic | Thursday 15 December 2011

The deal was struck. The EU and the eurozone are on a new path towards a more strict fiscal union. And with the deal, it is very likely a move towards a double speed Europe, or a union within a Union. Britain has isolated itself from the new treaty by a veto from its PM David Cameron. Whether such a move is good or not for the UK, only time will tell. It would be frivolous to make predictions now, as it is likely that Britain will remain a part of the EU, only now left out of some main decision making and possibly regulatory standards. This isn’t necessarily bad, as Britain mostly suffered under various EU labour and financial market restrictions, but it is an open question on how Britain might suffer politically.

The treaty agreement itself is much more a plea towards fiscal discipline and austerity than it is a solution to Europe’s major problems. It lacks a long term strategy apart from hope that within a fiscal union there will be less scope for irresponsible behaviour and everyone will have to act as Germans. If they were treated as Germans by the bond markets before, now they will finally have a chance to act like ones.

The budgets of eurozone members need to be balanced or in a surplus. This will be introduced in each country’s legal system and possibly be overseen by the European Court of Justice. If any country breaches the 3% deficit ceiling (which was the initial requirement for the euro introduction) it will suffer automatic consequences and possible sanctions unless, of course, the majority of other nations oppose. I see room for political mischief once more.

The financial measures in place were designed to increase the firepower of the eurozone institutions to rescue the currency and its most endangered member states. There is a new rescue mechanism, the European Stability Mechanism which is to hold €500bn, and there is an additional €200bn to arrive through the IMF.

The problem with the current plan is that it requires more and more bailouts, which essentially implies more and more debt accumulation. The socialist foundations of Europe are falling apart simply because they refuse to realize (or are unable to realize) that socialism and the welfare state are unsustainable, once you run out of other people’s money, that is. The dependency of peripheral nations is causing the highest burden on the eurozone. Its core members don’t have sympathy towards these countries, they require bailouts to save their own countries’ banks who plied up on peripheral debt due to Basel capital requirements – another example of European regulatory oversight that ended up increasing systemic risk of the financial sector rather than decreasing it.

As long as the EU officials close their eyes on the only plausible solutions left – defaults that will end further bailouts and dependency – Europe will remain in dire straits. More socialism and more faulty policies that caused the current situation cannot be the answer to its problems. The response must come from a different perspective – just like it did in the 1980s. The question is how much longer will it take for the policymakers to realize they are on the road to serfdom. 

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