The Pin Factory Blog

There’s an old joke: How do you know when a politician is lying? His lips are moving. So it is with this government’s supposed commitment to economic growth, and the ludicrous immigration cap that it intends to implement. The idea is so economically illiterate, so wilfully illogical, that it makes me wonder if the people proposing it understand that their policies will actually have an effect on people’s lives, or if they simply don’t care. As policies go, it’s less a case of cutting off your nose to spite your face, and more like cutting off your left arm so your right arm doesn’t have to compete with it.

On top of the immigration cap that the government has already proposed, the immigration minister Damian Green has said that only a “tightly controlled minority” of the 100,000 allowed in will be able to stay for longer than five years. So, the immigration cap keeps numbers down, and the “no settling down” rule reduces the quality of the people who can come in by putting off anybody who wants to integrate or settle down.

Immigration is good for the economy. Increasing the complexity and size of the workforce allows greater specialization and efficiency, and living in a relatively stable and free society can unlock the potential of innovative immigrants who would otherwise be wasted at home. To deny this is to deny the benefits of free trade – an example of faith-based economics that has no basis in fact or theory, and should have no place in contemporary politics. Some worry about the burden on the welfare state – a worry that ignores the fact that immigrants are net contributors to the state – but this could be addressed by limiting the welfare services available to new immigrants. The social arguments against of immigration amount to a form of coercive social engineering: you may own your property but you cannot rent or sell it to this person, because he's from a different country.

Capping immigration will hurt the economy no less than putting up protectionist barriers to trade or banning firms from hiring more than a certain number of staff would. Today’s idea is similar – not just anti-growth, but anti-economics. It is a rejection of the use of reason in policymaking in favour of kneejerk populism. I’ve always suspected the government’s commitment to economic growth to be empty. If this excuse for a policy makes it into law, I’ll be certain of it.

Some background on Paul Romer's Charter Cities idea. For what it's worth, I think this could be the most important idea in the world right now. If Hong Kong-like cities began to grow in places like Latin America, the Caribbean, West and East Africa and South-East Asia, the economic and political impact would be seizmic. The goal of giving every family on the planet the choice to move to a prosperous, free city is ambitious and achievable, and would change the world for the better. Here's hoping the Honduran Charter City is the first of many. 

Previously on the ASI Blog: Let a dozen Hong Kongs bloom. Watch Paul's previous TED talk here.

The environmental movement has often discredited its cause by resorting to alarmism underpinned by poorly substantiated claims. It’s a pity. Not many people nowadays deny that human behaviour has an effect on the Earth's ecosystem. But, equally, no serious environmentalist who aspires to influence policy can advocate a return to the Stone Age. The environmental movement can be, and should be, a pro-market movement in which you, as a consumer, determine the policy.

Pollution and climate change in general affect consumers in two ways: firstly, if firms must change their production patterns to become more environmentally friendly then you, as a consumer of goods, will face higher prices. Secondly, if firms fail to change their production patterns, you as a consumer of clean air will receive a lower quality product. Clean air affects your quality of life now, and the consumption of limited non-renewable resources affects your quality of life later. If we put the histrionics and baby seals aside, there is no reason why a little old fashioned economic logic can’t make everyone, as global consumers, better off.

The problem right now is that there is no existing market mechanism to ‘price’ environmental degradation. Yes, different people value it differently, but that shouldn’t be a barrier to exchange. Other markets handle infinite different valuations to determine a price at the intersection of the supply and demand. Why, therefore, has as a market for this not emerged?

An externality is a benefit or cost to an external party that results from the action of unrelated party. Pollution is an externality. According to Coase’s theorem, if the rational parties with properly rights that incorporate externalities are able to engage in costless bargaining, an efficient allocation should emerge regardless these externalities. In short, markets should be able to account for externalities.

However, the problem with the market place for clean air is that property rights of the parties involved are ill defined. For example: My roommate believes that she has the right, as a co-paying member of our flat, to listen to Swedish House Mafia until 4AM. I know, however, that she does not. Our negotiation process will inevitably degenerate into whining, screaming, and maybe armed assault with a hairbrush, because our property rights at the beginning is not clearly defined. If we both agreed that house music was an inalienable right irrespective of time and place, then I might be willing to bribe her by doing her dishwashing or with chocolate. In short, we could establish a mutually agreed upon ‘price’ by which to trade a unit of house music.

The tragedy of the global commons therefore stems from tragically poorly defined property rights. Our current allocation of consumer goods –in short, our current lifestyle, is inefficient because market prices do not reflect the true costs and benefits of the production and consumption of goods. Do factories have a right to pollute? Do children have a right to clean air? What balance should be struck between the two? These seem like nebulous questions, but a clear answer to each is necessary for the success of any market-based strategy to climate change.

Whatever your thoughts on the European Court of Human Rights’ warning to the government that it must permit prisoner voting or face penalties, the question of prisoner voting itself is an interesting one. To be honest, I am of two minds on the matter. Is it legitimate for a group to form a compact that provides certain rights and revokes them as a form of punishment? Absolutely; a consenting adult can enter into agreements that restrict their range of action and otherwise bind them. We could justly punish theft with drawing and quartering if we all agreed to it in advance. The denial of the right to vote is a longstanding policy, and someone who chooses to hold up a gas station, say, should know this.

On the other hand, no one ever did enter into such an agreement with the British government, either to be governed by its laws or to be punished upon breaching them. At the point where a “social contract” is imposed upon us, one of the few means of recourse that we have is voting. Prisoners, whose liberties are already restricted and who generally lack political capital, ought be able to participate in the democratic process. There also appears to be very little purpose to restricting the right to vote: no one particularly enjoys voting – denial of conjugal visits probably stings a bit more for the average convict – and jail time is a more powerful deterrent.

The conversation will doubtless continue in Westminster. MPs voted in February, 234 to 22, to maintain the blanket ban. Though he was avowedly against prisoners getting the right to vote, the Prime Minister has said, “we are going to have to sort this out one way or the other.” It will be interesting to see how it all works out; British prisoners may be enfranchised despite the best efforts of the government to prevent same.

I have a short article in this week’s House Magazine (which is not online, sadly) on the Green Investment Bank, arguing that the Bank will fail precisely because it cannot fail. Government support for a firm virtually guarantees that the firm will become a wasteful, inefficient and fail to do what it is supposed to. As a friend emailed:

The idea of un-failable banks reflects idea of un-testable theories. Both are very unlikely to do what they're supposed to do.

This is quite right. I’d go further to say this applies to all market actors. When there is risk-taking in the market, individual failure is the key to overall success.

Economic activity can be thought of as a discovery process: each firm is trying to find out what customers want and how to supply it in the cheapest way possible, to make the most profit for itself. Profit comes when a firm finds a market imperfection and corrects it. Here’s an example. Suppose people in Lambeth are buying watermelons for £5, and you find someone in Battersea selling them for £2 and can transport them over for £1. You have a chance to make a profit by selling them for (say) £4.95. An information asymmetry has been resolved thanks to your self-interest as an entrepreneur. Get it wrong – say, the transport costs are higher than you expect – and you fail.

The strength of capitalism is that it allows these information asymmetries to be resolved by rewarding success and punishing failure through the profit and loss mechanisms. There’s an incentive to try something out (profit) and an incentive to be careful (loss). By weeding out the sustained loss-makers, it emulates natural selection in its tendency towards firms and actors that are suited to the environment in which they live. We live in a confused, chaotic and complex world where information is dispersed. The environment – resources available, consumer tastes, etc – and the information describing that environment is constantly changing. Because of this, markets rarely reach equilibrium, but they tend towards it if allowed to work properly.

So, how do we allow them to work properly? By allowing the feedback mechanisms to transmit information. I see entrepreneurs less as enlightened geniuses (though, of course, some are) and more as risk-takers: they try something new out and, if it works, they flourish. If it fails, they die. This system of natural selection has proved to be considerably better than state planning, the “intelligent design” theory of economics. It's a shame that, with his Green Investment Bank, Vince Cable is rejecting Darwin and Hayek once again and practicing faith-based economics instead.

ScottishPower, which was controversially acquired in 2007 by Spain's Iberdrola, the world’s leading renewables generator, has announced some very sharp price increases. From August, ScottishPower’s retail customers will pay 19% more for their gas and 10% more for their electricity. On average, this represents a near £200 annual increase. The other five integrated energy suppliers – EdF, E.On, RWE, Scottish and Southern Energy and Centrica – are also expected to announce major price rises.

Given that Centrica’s domestic gas share is well over 40%, its gas pricing policy will be particularly carefully scrutinised. The media has expressed surprise and anger at these price increases. However, they are hardly unexpected. Most importantly, wholesale gas prices, which are a vital component of the UK’s energy mix, have risen in recent months. This trend heavily impacts electricity generation costs: gas-fired plant is now increasingly dominant.

Looking forward, it is difficult to see much relief. With new nuclear-build a decade away at best – the Fukushima accident makes this even less likely – the UK is becoming ever more dependent on gas generation. Any new coal-fired plant is seriously compromised by environmental issues, and the considerable expense of addressing them. And renewable generation is hardly cheap, especially if the cost of back-up plant is included. Furthermore, Germany’s planned exit from nuclear generation by 2022 is widely expected to push up long-term gas prices.

Ofgem has calculated that the UK’s energy investment bill over the next decade – assuming no major U-turns on environmental commitments – will be around £200 billion. Much of that investment is due to be undertaken by the six heavily-indebted integrated energy companies.

Hence, the prospects for lower energy prices are slim. Driven also by rising food input prices, as confirmed recently by several leading supermarkets, inflation remains well above target. Serious energy uncertainties and rising inflation are a potent combination for any government. Anybody remember the 1970s?

Ever since monks had to take vows of chastity, obedience, and poverty, it has been assumed that in order to be saintly you have to be poor. This misconception has prevented many would-be-do-gooders such as charities and NGOs from harnessing the power of the profit incentive in their quest to change the world. However, the supposed sin of capitalism can deliver development results that are nothing short of miraculous. One particularly successful development trend has been microfinance, the issuance of small loans to would be entrepreneurs unable to secure credit from a conventional banks. A poverty solution that rests on hard work, innovation, and expanded market access? Perhaps microcapitalism would be a better term.

The original version of microfinance, as pioneered by Nobel Peace Prize winner Mohammad Yunus and his Grameen Bank, operated along a non-profit model. A recent reincarnation, however, still seeks to expand the access of the poor to credit – all while turning a profit. And while the non-profit groups are forced to rely on scanty donations from elderly hippy couples, for profit microfinance organizations can attract big name investors like George Soros and Goldman Sachs—big names means big contributions, and more capital means more loans can be given out to more people.

Recently, the microfinance industry, and in particular its for profit variety, has ballooned. Even conventional banks have launched microfinance branches, which by all accounts have become some of their highest performing areas. However, the industry’s growth has not been welcomed in all quarters. Local and national governments in India and Bangladesh have sought to regulate and even take over the microfinance organizations operating within their borders. This invasive regulation is defended as a response to ‘predatory lending’ and suspected ‘corrupt practices’. The Reserve Bank of India has decreed that microlenders cannot receive priority sector credit unless they agree to accept a hard cap of 26% on their interest rates. Furthermore, in the Indian state of Andhra Pradesh, local officials have actually instructed borrowers not to pay back their loans. Government manhandling such as this sends investors running – stocks in the microfinance group SKS have lost nearly 75% of their value since last year’s peak. The entire industry is now at risk.

Yes, microfinance banks may be lending to the poor at rates that a conscientious objector in the developed world might not agree to. But, in many communities, microfinance remains the only viable means for the poor to secure credit. The answer is not to regulate microfinance by imposing crude caps on their interest rates, but rather to allow microfinance to blossom into a profitable industry. As profits encourage more firms to enter the market, companies will be forced to compete for consumers, forcing down the interest rates. The free market therefore can achieve the very result that regulators seek, all while creating an environment in which both the consumers and the firms benefit.

The Global Commission on Drug Policy, which was launched last week, has an impressive roster of supporters and a very noble aim: to bring an end to the utterly pointless war on drugs. But there’s one thing that worries me, and that’s that much of the talk is about decriminalizing drugs, rather than legalizing them.

Now don’t get me wrong: decriminalization would be a step in the right direction. Why anyone should be punished – often at great public expense – for ingesting a particular substance is beyond me. Indeed, I’d go further: why should anyone be punished for peaceably selling a substance that someone wants to buy?

But mere decriminalization isn’t enough. It would still leave drug gangs making huge profits from the trade in narcotics. It would still mean users couldn’t be sure of the strength or purity of the drug they were consuming. It would still lead to the kind of shady street dealing that blights neighbourhoods and provokes violent turf wars. It wouldn’t eliminate the illegality premium that pushes drug prices so high that they drive addicts to commit crime and give gangs a powerful incentive to run around killing people.

By contrast, proper legalization would take the gangs and the violence out of the drug trade. It would give places like Mexico and Colombia the chance to become prosperous exporters rather than failing narco-states. It would take the thugs and the peddlers off the street corners, and stop junkies beating up grannies for spare change. If drugs could be produced, distributed and sold like alcohol, or even tobacco, the world would be a happier and more peaceful place.

I’m not saying legalization would usher in a utopia. Some people would ruin their lives and their families through addiction. Others would behave anti-socially when under the influence. Others still would experience severe reactions to drugs their systems couldn’t handle. It’s important that we acknowledge these truths. But it’s also important to remember that all that happens now, and much more besides. Prohibition only succeeds in making matters worse, and in drawing countless innocents into the crossfire.

It’s time to end the drug war. It’s time to legalize drugs.

I’ve been trying to cut out politics news from my reading this week. That might seem strange, given my line of work, but I think the news stories of the past couple of days have underlined how empty most political news really is. The news stories about the government's justice U-turn focus on what a political mess it is for David Cameron. L
ikewise, the NHS stories of the last few weeks have given more time to discussing Andrew Lansley and the electoral damage to the Prime Minister than discussing the reforms themselves.

Journalists and government press men have a habit of focusing on the political sides of a news story, rather than policy. This is understandable – most people care more that their team wins than how it does – but it’s not very useful if you care more about how people's lives are affected by events than being able to wave your party's flag. Economics blogger Eli Dourado made the point on his blog recently, arguing that the importance of politics is overrated:

“Taking a commercial or economic perspective on history can show you how much politics has been oversold. [The IEA's Stephen] Davies shows that, for instance, the invention of mass production, the shipping container, the birth control pill, and the Internet have been arguably more important over the last century than any presidential election.”

If economic innovation makes so much more of an impact on people’s lives than politics, who cares who wins the next election? As Eli argues further on in that post, politicians can rarely act on their preferences. Even if we had an economically literate liberal in charge instead of David Cameron, his or her freedom action would be tightly constrained by public opinion and Parliament. (This point is truer in the US than the UK, which has a less strict separation of powers, but still pertinent.) A constrained executive is necessary in a free society, but it implies that politics might not as important as the energy many people devote to it.

Instead of political news, I’m spending more time reading about technology (sites like Wired, New Scientist and H+), development economics (Paul Romer’s charter cities, debates about what the South Sudanese government should do first) and the history of culture and commerce (PDF). Most of the day's political news is so irrelevant that, so far, I haven't missed it at all. 

Here’s an interesting development in higher education. The New College for the Humanities (NCH), an independent university college, was launched this weekend. Once opened, the NCH will be the UK’s third private university, the latest in a trend that began with the University of Buckingham in 1976.

The NCH will charge £18,000 in tuition, twice the top rate for public universities. Let the furore begin. University and College Union (UCU) general secretary Sally Hunt claims that the move will “entrench inequality within higher education” by serving only the “select few”.

Despite a quarrel over the title “university college”, the NCH will presumably go ahead. And so it should. Our current system respects a parent’s right to send his or her child to private school. It makes no sense to try to stop young adults from choosing private universities.

More than this, there are distinct benefits to private universities. They can launch innovative programmes and attract top talent in a way that their public competitors, reliant upon government funding and beholden to political climates, cannot. See to this effect the professorships of Richard Dawkins, AC Grayling, and Sir David Cannadine at the NCH.

Hunt says, “While many would love the opportunity to be taught by the likes of AC Grayling and Richard Dawkins, at £18,000 a go it seems it won't be the very brightest but those with the deepest pockets who are afforded the chance”. The charge that high tuition merely makes private universities bastions of social snobbery is a common one, but unfounded.

Universities trade on their reputations in academics. They have to take the best people, regardless of their ability to pay, to maintain the brand. At more established American universities, private financial aid is quite generous. Yale assists over half of its undergraduates, with an average grant of $34,400 toward tuition of $55,850. The NCH will offer assistance to 20% of its first cohort, with plans to expand this.

Also in the news recently was a BBC story on a tuition fees funding gap that will cost the government – meaning taxpayers – an additional £95m a year. Apparently a matter of getting their “sums completely wrong”. This makes the private sector look especially good, and the timing of the NHC launch is particularly auspicious.