The Pin Factory Blog

It is the month of August, on the shores of the Black Sea. It is raining and the little town looks totally deserted. It is tough times, everybody is in debt and everybody lives on credit.

A rich tourist comes to town.

He enters the only hotel, lays a 100 Euro note on the reception counter and goes to inspect the rooms upstairs in order to pick one.

The hotel proprietor takes the 100 Euro note and runs to pay his debt to the butcher.

The butcher takes the 100 Euro note and runs to pay his debt to the pig farmer.

The pig farmer takes the 100 Euro note and runs to pay his debt to the supplier of his feed and fuel.

The supplier of feed and fuel takes the 100 Euro note and runs to pay his debt to the town's prostitute who in these hard times, gave her "services" on credit.

The hooker runs to the hotel and pays off her debt with the 100 Euro note to the hotel proprietor to pay for the rooms that she rented when she brought her clients there.

The hotel proprietor then lays the 100 Euro note back on the counter so that the rich tourist will not suspect anything.

At that moment, the rich tourist comes down after inspecting the rooms and takes his 100 Euro note, after saying that he did not like any of the rooms and leaves town.

No one earned anything. However, the whole town is now without debt and looks to the future with a lot of optimism..

And that, ladies and gentlemen, is how Europe and North America are doing business today.

An interview in the Daily Telegraph with Tourism Minister Barbara Follett prompted me to check out the new "Tourism Strategy" recently published by the Department of Culture Media and Sport.

The strategy is almost entirely devoted to making the Olympics a booster for tourism. More importantly, it shows just how true the old adage is about any pot of taxpayers' money being like honey for the busy bees of the public purse.

In her remarks about her plans, the minister revealed some unintentional truths about government support for tourism. Eight government departments have responsibilities relating to tourism, but she also pointed to five other publicly funded organisations and four QUANGO-managed initiatives chewing on the public purse to "promote" tourism.

Unravelling QUANGO budgets is as always nigh on impossible, but if we take an average of 50 staff members in each entity or initiative paid at the average wage of £25,000pa involved in the above that's £11.25 million in wages alone on this industry "support". If you double that for the cost of interference by the eight government departments you get a public-expense equal to almost exactly a quarter of the entire £85 million turnover of the industry.

How about disbanding them all. Taking that expense off National Insurance taxes in a staff intensive industry and you' could have a 20% price reduction on all UK holidays – which 95% of people say are overpriced.

Governments love to govern, but they so often achieve outcomes that are the opposite of their intentions.

The blame game is played very differently in China and the UK.  In China, the two executives most responsible for the tainted milk scandal get death sentences.  In Gordon Brown’s Britain, no one is to blame for the financial crisis.  Certainly not him nor the Governor of the Bank of England (who’s actually most to blame, see ASI Briefing Financial Crisis: Is regulation cure or cause?, nor Chairman of the FSA, nor any Bank director.  The blame lies, he says, with global events and market failure, all nebulous concepts that cannot be penalised.

In Brown’s world, an engine driver who ignores red signals and runs his train into another is not to blame.  It is a rail network failure.

The FSA was created, inter alia, to prosecute insider dealers.  How many have they prosecuted in 10 years?  Not one.

Obama has proclaimed a new age of responsibility.  Good for him.  Let’s see some recognition of personal responsibility here.  Let’s strip Fred Goodwin of his £500,000 a year pension and let’s put Mervyn King in gaol.

Robert Peston has released a publication entitled ‘The New Capitalism’, outlining his thoughts on why the crisis happened and what our post-recession economy will look like. Just like most of the BBC’s economic coverage this takes a very skewed view upon events.

Peston's claims that “Capitalism is changing in fundamental ways", even going so far as to suggest that it might be a change with more impact than the end of Communism! He states that, "For many years to come, what's happening will affect the relationship between business and government…" Quite. We will witness a greater distortion of capitalism in the form of further regulation, taxation and government debt. Naturally, the relationship between government and business will change, within the financial sector, but almost certainly not for the better.

The publication also claims that trade between ourselves and growing economies such as China exacerbated the problems:

“They were working to improve our living standards, because they made more and more of the stuff we wanted at cheaper and cheaper prices."

Although it is true that imports from China and other Asian economies grew, Peston has forgotten the fundamentals of trade. When trade occurs there is mutual benefit – the Chinese were not producing and exporting goods for only our benefit but also for theirs. The view that China’s only role in the past decades has been to work as a factory, churning out home comforts for the west, is naïve, archaic and dangerous.

It is fair to say that there is currently a lack of confidence in capitalism, the consensus within the media is that we need to boost regulation and control our industries to a greater extent. But during the boom years I can’t remember Peston, jumping off the bandwagon, telling us to slow down and warning us of the danger ahead.

As an anticipant sun climbs over Westminster Palace, Members of Parliament flock to the capital and take up their seats for the new session of Parliament opening today. The mini-session before the summer recess saw the Government move quickly, issuing the Emergency Budget as a start on deficit reduction and passing the (mainly) excellent Academies Act. We at the Adam Smith Institute are hopeful that this session will be greeted with a similar flurry of reforming activity. In particular, we wish to see Parliament approve the following this session:

• Welfare Reform: Ian Duncan Smith seems to have the right idea; ensuring that work always pays by tapering away benefits at a constant rate. Whilst we recommend a more localist approach, a simplified system infinitely improves upon the status quo.
• The Great Repeal Bill: The scrappage: of ID cards, Contact Point database and restrictive business regulation, amongst other things, is to be welcomed by all of a socially liberal stripe. Yet, let’s just hope that the final text more represents the unofficial wiki-site than the botched ‘Your Freedom’ consultation.
• A Budget that reconsiders the role, and appropriate size, of the state: 2011-2012 will be a crucial year for setting Britain’s public finances on a sustainable trajectory. As we’ve argued before, our huge budget deficit requires us to comprehensively review all public expenditure with the aim of shrinking the state from its current, unsustainable 52.5% of GDP. This much seems likely, but ideally Parliament should pressure the Coalition to abandon its ring-fencing of Health and Foreign Development. Savings are possible in both of these departments.
• Further devolution: Although the Calman Commissions’ proposals were, as my colleague delicately put it at the time, “a bit of a dog’s breakfast”, giving Scotland greater fiscal autonomy is a step in the right direction and at least does away with the Barnett formula. Giving Wales greater powers in the devolved areas is also a good proposal. However, as I have blogged recently, these proposals do nothing to address the West Lothian question; we need an English Parliament.
• Election of local police chiefs: Currently, constables are upwardly accountable to Whitehall, spending far too much of their time jumping through mandarin hoops and chasing central targets. We’d like to see a return to community led policing, where officers are responsive to those they serve. It seems the surest way to avoid ‘Ciggybusters’ MK II.
• The Public Bodies (Reform) Bill: Finally, a bonfire of the quangos! This Bill promises to scrap many quangos and make the remaining more accountable to ministers. Although we prefer parliamentary accountability, any clamp down on these blights to productive activity is welcome. The bonfire could also be improved by using consumer protection agencies as fuel.

Although we’ll push further for reforms in this vein, any parliamentary session that approves all of them would be great by recent standards. Let’s hope that it is this one.

Arnold Kling has been blogging lately about a proposed new paradigm in macroeconomics that he’s calling ‘patterns of sustainable specialization and trade’, or PSST for short. Unlike the Keynesian paradigm, which focuses on aggregate demand shortfalls as the causes of prolonged recessions, Kling thinks that we should look at economic activity with a focus on comparative advantage. Many periods in history can be better understood, he says, if we look at people’s specializations and see recessions as periods where businesses and labour are out of sync with demand. Rather than there being an aggregate demand shortfall, a recession could be a time when people don’t want what labour and businesses are offering.

A recent (and simplified) example might be the Great Recession, as the 2008–present period has come to be known among some economists. Say there was a big demand for housing in the 2000s, so lots of people became skilled in construction and lots of businesses thrived in this sector. Once consumers’ tastes changed (let’s leave aside why for this post), there were a lot of people and a lot of businesses that were great at building houses without sufficient demand for those skills that all those people could stay employed at the same wage level. It’s likely that a lot of those former construction workers will have to reskill and find new work satisfying whatever consumers now want. Likewise, a lot of businesses will fail, and not just those directly involved with construction – the economy is so complex that businesses that have built themselves around construction businesses may fail, and so on.

This reskilling and reallocation of capital is aimed at finding new patterns of sustainable specialization and trade. And it takes time – the market is a discovery process where entrepreneurs experiment with different enterprises to see what succeeds and what doesn’t. It’s a messy process but it’s the only way of finding out what people really want. This process goes on all the time, but Kling suggests that if there are large-scale shifts in what people demand, recalibrations will have to take place across the economy. And you get a recession.

This isn’t a conventional Austrian approach to the business cycle, because it doesn’t require that a monetary expansion was the cause of the disconnect between demand and supply – all sorts of exogenous factors might cause people to change their minds en masse. Using this PSST paradigm would imply that financial stimulus packages might exacerbate and extend the recalibration period (ie, the recession). “Shovel ready” projects might inhibit the signals that let workers know that their skills are no longer needed, and prolong the pain of the recession. It’s an interesting perspective, and hopefully one that Arnold will develop in greater length sometime.

You can download an interview with Arnold talking about PSST at Russ Roberts' EconTalk podcast here.

So it’s off to the New World for 2 ½ weeks with a visit to friends and family in Toronto and then on to Arizona and Utah to soak up some of nature’s majesty. Seen through the prism of the Old World’s media, times are just as bad over there as they seem to be over here.

Fundamentally, both worlds are grappling with the same problem – societies that have been living well beyond their means for a generation. Rapidly ageing populations coupled with below-replacement birth rates are leading Europe and the Americas down a trail first blazed by Japan some 20 years ago. The debts for the good times are now due and the coffers are empty.

Even as this process ground on relentlessly, governments everywhere hobbled productivity with unrealistic minimum wages, working-time directives, market-distorting subsidies & taxes, pie-in-the-sky environmental objectives and regulation upon regulation.

An optimistic view would be that a general consensus in most countries of the nature of the problem has taken hold but each country’s response has been different. The first casualty, Iceland, immediately admitted the errors of its ways and just bit the bullet. The EU’s Mediterranean members seemed to be in denial for the longest time in hopes that something will turn up – mostly German money. The EU’s masters – Germany and France – are putting their faith in yet another grand master plan for the European project.

Here in the UK, the consensus on deficit reduction is largely holding with the argument being mostly about speed and depth. The test will come as the modest cuts now in the works actually come into effect over the coming years.

Over in the U.S., the hangover from fighting two wars while spending at home like there’s no tomorrow hasn’t been cured yet. They haven’t even agreed on a course of treatment. In time-honoured American fashion, it’s taken the grass-roots Tea Party movement to grab the politicians by the scruff of the neck to force recognition of the real problem. America usually gets it right in the end but time is running out.

That leaves Canada. From afar, it seems like an oasis of sanity in a tempestuous world. The country went through its fiscal crisis back in the early 1990s and, amazingly, seems to have learned its lesson. The banks are solid and government debt mostly manageable. However, it’s extremely dependent on exports of commodities to America and Asia and, ultimately, its economic fate will be determined in Washington and Beijing.

It’s been a good year for pessimists in the Old World. Let’s see if the New World offers any relief.

An accident waiting to happen?

I have to say one good thing about the Lib Dems: of the three main parties, they are the only with a single policy that will directly benefit me. As well as taking three and a half million people out of income tax altogether, their plan to raise the personal allowance to £10,000 would leave me about £700 a year better off. I certainly wouldn’t say no.

There are other good things in their manifesto too. Of the three main parties, I’d say they have the best plans for reforming the NHS, which include, inter alia, slashing bureaucracy and funding people to go private if the NHS can’t treat them within a set time. The Lib Dems are also strongly committed to civil liberties, and are undoubtedly the most localist of the major parties – they are more likely to disperse power from Whitehall than the Tories or Labour. All good stuff.

But for me there’s a problem: the Lib Dems’ desire to bash the bankers and soak the rich. According to the Spectator’s Martin Vander Weyer, Vince Cable’s response to business leaders opposed to the forthcoming national insurance rise was as follows: “I find it utterly nauseating, all these chairmen of FTSE 100 companies being paid 100 times more than their employees, lecturing us on how we should run the country.” And that seems indicative of a broader anti-business, anti-market sentiment.

As Allister Heath put it in City AM:

[T]he top rate of capital gains tax will be hiked to 50 per cent (from 18 per cent), crippling investors, private equity firms and landlords; £5bn a year will be raised by restricting pension tax relief to the basic rate, which would devastate the pensions industry; £1.7bn would come from the “mansion tax”, a class-war inspired form of double taxation which would slap a 1 per cent annual tax on homes worth over £2m a year, forcing thousands to sell their homes; £3bn from increased air passenger duty, further hitting tourists and business travelers.

The Lib Dem plans on capital gains tax probably deserve a blog post of their own, but suffice it to say for now that I regard the idea of more than doubling a tax on entrepreneurs and investors, just as we are emerging from a recession, as lunacy.

One last point: like many libertarians, I often hope for a resurgence of classical liberalism in the Liberal Democrat Party. And indeed, I know for a fact that there are lots of genuinely free-market, limited government Lib Dems, so maybe it will happen one day. But on the basis of their 2010 manifesto, we are certainly not there yet.

And not a party in the traditional sense, but in the political. A recent addition to the political landscape (and to some extent a welcome one) is the UK Libertarian Party. It's so newborn that there’s little in the way of policy on their website, but we should be able to safely assume that it will be based on the idea of self-ownership and limited government, and most importantly: freedom! But does the creation of this party mean that the libertarians are moving towards becoming part of the establishment? Or is the establishment becoming more liberal, so that now is the correct time to expose the libertarian ideas to the public on a wider basis?

The most recent exploration of this theme came from the Libertarian Alliance, who've long been at the forefront of libertarianism in Britain. They recently asked the question in the inaugural Chris R. Tame Memorial Prize, "Does Britain need a Libertarian Party?" The winning entry can be read here and the author's answer is that there is no current need for a libertarian party. The author abhors the idea of libertarians becoming involved in the state machinery and argues that rather than squander time becoming part of the problem, libertarians should concentrate their efforts on spreading the ideas of liberty.

The arrival of Nick Clegg and David Cameron to the leadership positions of their respective parties has seen a sprouting of liberal (in its original meaning) ideas, albeit ones still couched in the language of the state. Perhaps a libertarian party can push them towards removing the state from people's everyday lives. It remains to be seen what can be achieved with a libertarian party, since as with any party it will be a mixture of all the creeds of libertarian thought. The problem is assembling policy that is truly libertarian, yet appealing to all within and without.

The surest way to make the state smaller is to explain and champion individual freedom and win the hearts and minds of the many. Hopefully a libertarian party will be able to help in that.