The Pin Factory Blog

Forget E. coli and Yemen, the big news this weekend was Wayne Rooney’s hair transplant. At a whopping £30,000 for what turned out to be a bit of a thatched job, it was naturally the subject of some teasing. But think twice before you mock. Wayne Rooney’s hair transplant is, arguably, the key to the future of medicine, technology and civilization itself.

Let me explain. Technological advance usually works in the following way: someone has an idea for an invention, makes a very expensive prototype, and builds a few initial models at very high cost. A few wealthy ‘early adopters’ pay the huge cost, which pays the inventor’s rent for a few months and creates time and an incentive for the inventor to build better or cheaper versions of that product. Mobile phones are a good example of this: the earliest ones were absurdly expensive, bulky and primitive. The same goes for early desktop computers, laptops and cars. All began as preserves of the rich and were seen as wasteful indulgences; all are now essential to modern life.

Over time, innovations improve the product’s quality, reduce costs, or both. Mobile phones are now a fraction of the cost of 1980s phones, and can do a lot more than their predecessors ever could. The value of innovations like these is enormous, because a single innovation can never be used up like a physical good can be. A good idea can be literally priceless, because its applications are potentially infinite.

What does this have to do with Wayne Rooney’s hairpiece? Well, like the early adopters of mobile phones, Rooney has created another bit of demand for hair transplants, increasing the incentive for an innovator to come up with a cheaper or more convincing hairpiece. Ok, so hair transplants won’t save civilization, or even medicine. It’s a superficial procedure. But if cheaper hair transplants make people happier, there’s little more we can ask of them.

Other wealthy people like Rooney will spend their money on other frivolities, creating more demand for niche innovations that might seem useless right now. People with huge amounts of money to burn initially act as early adopters, creating demand for costly and difficult treatments that mere mortals could never dream of being able to afford. Needless to say, neither the NHS nor BUPA would ever pay for these early experimental treatments.

High-end demand for niche products allows these initial prototypes to make some money, giving innovators the breathing-room they need to make their products accessible to a wider consumer base. Big spenders allow many innovations that would never get off the ground to survive; what seems wasteful today might very well seem essential tomorrow. If innovation is the motor of progress then people like Wayne Rooney can be, improbably, the jump-start that that motor needs to get moving.

As FA Hayek and Ludwig von Mises knew, value is subjective. In this video, ad man Rory Sutherland explains how perception and context affect people's valuation.

The worst part of my recent trip round the Far East was the last hour – getting through the cesspit that is Terminal 3 at London's Heathrow Airport any morning or evening. The Vatican envoy described the experience as 'like landing in a third world country' and got roundly condemned as a racist. But even a non-racist must see the similarity – shabby, dirty, unloved, airless buildings seething with huge, confused crowds waiting in seemingly endless queues.

It's a great contrast to Shanghai, whose vast, glassy airport is reached by a 400kph Maglev.

Mind you, the socialists pride themselves in such prestige projects. The trouble is that they don't always work either. At Shanghai you walk the length of the terminal to the international check-in; the trouble is that the terminal is about third of a mile long. Then you have to walk a quarter of a mile back to get to the security check. I hate airports designed by airport designers, rather than airport users, almost as much as I hate the old bit of Heathrow, which seems never to have been designed at all.

There's a compromise, of course – airports (and other public facilities) that are uplifting (or at least, not depressing) and built on a human scale. It can't be too difficult.

Shanghai, of course, built its airport, and much else, for the 2010 Expo world trade fair. They recognised the importance of impressing visitors. I dread to think what the 2012 Olympics visitors will think when they step off the trade and into the middle of a directionless, sweating mass of humanity. The decision to spend billions on a high speed train to take 15 minutes off the London-Birmingham trip for the locals just can't be right. Better to spend it taking 45 minutes off the trip through Britain's premier airport for all those people who want to visit and invest in Britain, and who must wonder where they have dredged up.

I was slightly astonished when I read that "52 economists" had written to the Observer to say that the government's book-balancing, welfare-reforming strategy was all wrong. First, as unkind people say, there are three kinds of economist – those who can count, and those who can't. When 364 economists wrote to the Times to beat up Mrs Thatcher's economic strategy many years ago, they obviously got the number of days in the year wrong. At least this lot know how many weeks there are in a year.

But what really puzzled me is how any economists, never mind 52 of them, should say anything so daft. Plainly, we've been spending and borrowing far too long, and now it's chicken-roosting time. That's pretty obvious.

So I spent an hour doing a very quick Google check on the 52 that had signed the letter. [Continue reading] 

Two stories from the UK point up some troubling choices. First, the government wants shops to stop selling 'inappropriate' clothes to pre-teens. It's worried about the 'sexualisation' of young girls. Second, there are calls for a 'proper watershed' on TV following some very sexy talent-show routines.

I believe in personal freedom, and think that people should be able to buy whatever clothes they like, for themselves or their family, and watch whatever TV they want at any time they choose. But while I believe that mature minds can handle freedom, I am not so sure that child minds can. Human beings have a protracted childhood in which we learn from adults how best to choose and to conduct ourselves. It is long and difficult process, and we don't always get it right.

So there is a case for some protections on children. We might decriminalise drugs (another story in the news), for example, but would we really want to allow children to buy drugs, or even for them to see drugs being traded? Again, I would like to see prostitution decriminalised, but would I like to see brothels next door to schools? No, not really. And as for TV – well, parents know how hard it is to keep a constant eye on what kids are watching, so a watershed is quite a popular idea.

That's paternalist, but children need a bit of paternalism. But paternalism is best delivered within families, and by self-control in the media, rather than from governments and regulators. If politicians are worried about the sexualisation of our children, they should perhaps first reflect on how the state has intruded into the family, and undermined family culture and responsibility. Then butt out and let ordinary decent people decide what is best for their own children.

An extraordinarily useful and mind boggling chart for those worried about inequality.

A little background. Branko Milanovic, from whom the data comes, is a researcher into inequality. He tells us that there are three ways of measuring this globally. We could use the average income of each country and then compare these averages, this is Concept 1. Not all that useful as we're thus comparing the 400,000 people of Luxembourg as one unit with the 1.3 billion of India as one unit. Concept 2 takes these averages and then weights them by population. Thus we transform the 50 ish units representing the 900 million of Africa into something we can compare to the 1.3 billion of India. Concept 3 is much more difficult to calculate but is much more informative: treating the world as one unit and comparing incomes across the world.

Which is what leads to the remarkable, astounding even, result above. Using ventiles (ie, 5% chunks of the population) and plotting what the actual living standards of each group is, in real terms, compared with the real terms living standards of others around the world. Yes, it's adjusted for purchasing power (PPP) and so on. And what's remarkable, astounding, about the result is that....

Yes, it really is saying that the bottom 5% in the USA have a higher income, a higher standard of living, than the top 5% of Indians.

Capitalism red in tooth and claw, an entire nation quite uncaring about those left behind, produces a higher standard of living for the losers of the rat race than 50 years of socialism (and 20 years of playing catch up) does for the winners.

Clearly, those who concern themselves with the incomes of the poor should be arguing for more reddish toothiness in our capitalism then.

In the comments under my blog on ‘Interest rates and the price system’, Robin Staple asks, “how come, at the moment, a large depression has been avoided, and how come this wasn't avoided in 1929? Is it not due to increased intervention?” It’s an interesting question and, as I said in the comments, not one that it is easy to give a hard and fast answer to.

As Steve Horwitz points out in this excellent article, there were lots of different policy factors that contributed to the Great Depression. Yes, the Federal Reserve failed to ‘intervene’ when the money supply shrank rapidly just as demand to hold money was rising. The result was a severe, deflationary monetary contraction. That was bad. But just as much if not more of a problem was that the Hoover and Roosevelt governments did intervene to prevent wages and prices from falling. By stopping businesses from adjusting to changed market conditions, the government caused very low investment and very high unemployment, and turned a recession (that is, a necessary remedial phase in the business cycle) into a depression. And of course, these policy mistakes coincided with the rise of protectionism. The combination of all three factors – two interventions and one non-intervention, if you like – is what made the depression so severe.

Applying all that to the current state of affairs, I'd say the following. We haven't let the money supply collapse. We haven't tried to prevent prices or wages adjusting to changed economic circumstances. And we haven't tried to shut down international trade. All those things have helped prevent recession becoming depression, and explain why we're in a better situation than in the 1930s.

On the other hand, we have repeated one of the mistakes of the Great Depression, which was to ramp up public spending in a misguided attempt to stimulate the economy. Hoover did it, and Roosevelt did it on a grand scale. It didn’t work then, and it hasn’t worked now. All fiscal stimulus ever achieves is to reallocate resources from one part of the economy to another. And since the government is in charge, you’re normally taking from the productive, the wealth creators, and giving to the unproductive, the wealth consumers. That can only hold us back in the long run.

Maybe I need to clarify my point on the money supply. Doesn’t intervention to prevent monetary contraction contradict my whole free market perspective? I’m not so sure. As people like George Selgin and Larry White have pointed out, a free market banking system (with fractional reserves but no central bank) would not allow a massive monetary contraction, but rather would respond organically to an increase in the demand for money by increasing its supply. So perhaps it makes sense for a central bank to try and mimic what would happen in a genuine free market.

Of course, that’s easier said than done: central bankers don't have the right incentives, and they don't have the right information. Indeed, since the demand for money (or velocity) cannot be observed directly, and can only be measured by reference to the other parts of the MV=PT equation, manipulating the money supply to offset changes in demand is an extremely tricky – if not impossible – business. But perhaps, in extremis, when a massive bubble has burst, and you are facing a depression, some imperfect monetary intervention is the lesser evil.

So, summing up, I'd say no fiscal stimulus, no attempts to control prices and wages, and no protectionism. Ever. But if you are facing a big monetary contraction, then yes, do something to increase the money supply. Just don’t make a habit of it. And once you're through the worst, start working out how you can get back to a proper free market monetary-financial system. Otherwise, you’ll just have to go through it all again a few years down the line.

It's been said that a Frenchman is one who when observing something working in practice will ask, yes, but does it work in theory? Ronald Reagan adapted this truth to make it a quip about economists. Somewhat cruel but possibly fair, as this paper makes clear:

Many stock market analysts think that in 1929, at the time of the crash, stocks were overvalued. Irving Fisher argued just before the crash that fundamentals were strong and the stock market was undervalued. In this paper, we use growth theory to estimate the fundamental value of corporate equity and compare it to actual stock valuations. Our estimate is based on values of productive corporate capital, both tangible and intangible, and tax rates on corporate income and distributions. The evidence strongly suggests that Fisher was right. Even at the 1929 peak, stocks were undervalued relative to the prediction of theory.

Ed Prescott received his Nobel Prize in economics the year after this paper was published. Which goes to show that not everything written by incredibly bright people is necessarily incredibly bright.

For the basic rule of thumb of any science is that when theory conflicts with reality it's theory that is wrong, not reality. And when we apply this insight to economics, to markets, we really do need to remember this insight.

For example, in theory, the grand plans of pointy heads, of the exquisitely educated politicians and bureaucrats who rule us, are more efficient than the messiness of us each going our own way. Yet that's not how it works out in practice. Similarly, there are many who insist that the price of something (say, rent, or food,) "ought" to be such and such in theory. But attempts to make reality accord with the prices fixed by that theory inevitably fail. Messily and with huge pain to all involved.

So worth keeping in mind what was possibly Hayek's greatest insight (not that he phrased it quite this way). When markets tell you that your theory is wrong it's the markets who are right and your theory which is wrong. This most especially applies to prices, for markets, not your theory, are what determine what prices are.

I went to a lunch at the Legatum Institute yesterday to hear Ed Stringham talk about private governance. Ed's argument is that many of the transactions that take place in today's economy happen without the involvement of the state to keep people playing by the rules. Things like reputation are a much bigger factor in keeping contracts enforced and stopping firms from committing fraud, because they reduce the potential for future exchange. Ed aims to write a book of case studies of this "private governance" phenomenon.

One example he used was of Jonathan's Coffeehouse, a private club that preceded the London Stock Exchange. In the 18th century, the government refused to enforce stock exchange contracts, seeing them as a form of gambling. Nevertheless, the Coffeehouse became a centre of commerce and contracts were usually upheld voluntarily. If you were a trader, you could rip somebody off once, but would be barred from the club. For people whose livelihoods were based on stock trading, it wasn't worth it.

The same phenomenon exists today in a whole range of exchanges. When I go to a restaurant and get a bland meal, it's practically certain that I won't sue. Does this mean that profit-maximising restaurants will constantly give out bland meals? No – if it serves bad food, I'll stop going and tell my friends not to go either. Reputational capital, so to speak, is enormously valuable, and losing it can be worse than just losing a court case. As a side-point, the reason that restaurants in touristy areas are usually so bad is down to this fact as well. Tourists typically don't know anything about the restuarants they go to – could things like TripAdvisor bring an end to tasteless, expensive tourist food?

Credit cards are another example of private governance. Dispute resolution is typically left to arbitration and mediation, without recourse to the courts. But there is a "shadow of the state" – it's possible that someone will bring an extreme case to the courts, which may make people more willing to comply with a mediation outcome. It strikes me that this might be the biggest problem with some examples of private governance – that people only acted well because they knew there was a slim chance of a very costly lawsuit – a sort of reverse moral hazard. This isn't always the case – certainly not in the stock market or restaurant examples – but it is a problem for others. The shadow of the state looms large.