Markets don't fail

Led by the UK’s own prime minister, markets are under assault for causing all our current economic woes. Blaming “market failure”, David Cameron is trying to outbid Nick Clegg and Ed Miliband for policies to reform the market system.

But markets don’t “fail.” They respond rationally, quickly and often brutally to conditions as they find them. If they see a shortage of supply or an excess of demand, they’ll drive prices higher. Conversely, excess supply or falling demand drives prices lower. If you’re looking for villains, examine why supply is constricted or inflated or why demand is stifled or encouraged. But don’t blame the markets for responding accordingly.

For example, the onset of the financial crisis three or four years ago was largely due in the US and the UK to excessive demand for mortgages from people who couldn’t afford them. In the US, this was driven by government mandates to Fannie Mae and Freddie Mac to do just that – pump up demand for housing. In the UK, tight restrictions on construction limited supply to a market that quite rationally came to believe home ownership was a sound substitute for more productive investment.

In both cases, the bankers’ cost of funding was distorted by deliberately low official interest-rate policies, the implicit knowledge they wouldn’t be allowed to fail and lax competition enforcement that led to the likes of Royal Bank of Scotland swallowing up competitors. The  logical response by the markets was to divert money to housing, just as the politicians wanted. As soon as this folly became apparent, the banks bailed out as did the humble folk queued outside branches of Northern Rock, much to the dismay of policymakers.

In the current sovereign debt crisis, the financial system was actively steered into purchasing more government debt than they otherwise would have by distorting regulations. Big banks are given privileged and lucrative roles as primary dealers in the initial distribution of new bond issues as long as they buy consistent amounts. Pension schemes are often required to hold a sizeable chunk of “safe” government bonds while minimum capital ratios for banks specifically require such bond holdings.

This reliably inflated demand facilitated and encouraged ever increasing issuance of government bonds. Lo and behold what happened when the markets said enough is enough. They had been responding rationally to conditions as they found them and were quickest off the mark to realise the game was up. They didn’t “fail” - they just didn’t deliver what the policymakers had wanted.

In the greater scheme of things, the past week’s agonising about executive pay and bank bonuses is pretty minor except for the fact it’s generating yet more silly ideas. Everybody now wants to encourage “co-operative” groups to create a “John Lewis economy” whereby employees are also big shareholders. Talk about putting all your eggs in one basket. Not only does your income depend on the success of your employer but so do your investments and your pension. Isn’t that what the Robert Maxwell fiasco was all about? Just ask any former Lehman Brothers employee how it feels to have all your compensation from salary to bonus to pension dependent on your employer.

John Lewis, for now, appears to be a well-run company and God bless them. But imagine the unintended consequences if all companies, good and bad, were steered into a similar structure and some go bust as they will and should – more bailouts, more regulation, less mobility, less creativity. If the John Lewis model is so obviously successful, it would be more widespread naturally – there’s nothing to prevent workers or unions from buying into their publicly-listed employers’ shares. They don’t need government instructions to make them do so.


Economics is fun

Madsen starts a new ASI series today.  For a few weeks we'll be posting a short video of 2-3 minutes very week on the ASI's YouTube channel.  The theme of the series is that "economics is fun", and in each of the videos Madsen will be covering a different point about economics.  Far from looking and sounding like worthy but rather dull lessons, the videos are designed to be quite lively and entertaining.  Short and sweet are the bywords.  The series marks the release of Madsen's new book, "Economics Made Simple".

Happy Chinese New Year!

A happy Chinese New Year to all our readers, and especially to all the Chinese ones!  Today starts the Year of the Dragon, which bodes really well.  Dragons in Western myth are fierce creatures to be slain by knights and saints, but in China they are symbols of great power and bring good fortune.

Those born in a dragon year are reckoned to be full of energy and bubbling with creativity.

"The Dragon is the mightiest of the signs. Dragons symbolize such character traits as dominance and ambition. Dragons prefer to live by their own rules and if left on their own, are usually successful. They’re driven, unafraid of challenges, and willing to take risks. They’re passionate in all they do and they do things in grand fashion."

Dragons also tend to be natural leaders, and are self-sufficient.  They do, however, have quick tempers.  Since we have two of them in the ASI, Madsen and Sam, it can get rather messy in the office when they scrap and breathe fire over everything.

Seriously, though, the omens are good for those of an optimistic bent.  The year of the Dragon is reckoned to be the year for great deeds, innovative ideas and big projects.  At New Year we can put the past behind us and look to the future and the new projects that it brings and the new successes that it promises.  A Happy New Year!


On getting very annoyed indeed about this living wage thing

Zoe Williams had a stab at trying to understand the living wage idea this past week.

What nobody in any of these corners would ever advocate is state spending as an alternative to fair wage settlements. The left would say: set a minimum living wage, make it decent, enforce it, unionise. The right would say: let the market determine wages; if people aren't paid enough, they'll stop spending and the supermarkets themselves will realise that boosting pay packets in the middle will yield better profits than one huge pay packet at the top.

Sadly, she failed to grasp what the economically literate would say about the problem of low pay in the UK. Which is, as I've mentioned here before, the following:

The difference between what we are told is a living wage and the current minimum wage is almost entirely the amount of tax and national insurance that must be paid (quite despicably) on such low wages. It isn't that wages are too low for the low paid: it is that taxes upon the low paid are too high.

If you want the poorly paid to have more money in their pockets then stop bloody taxing them so much, draining money from their pockets.

This really isn't rocket science you know. The income tax and National Insurance qualifying incomes should be up and around the £12,000 a year level (something we have been arguing here for years). There's a certain political sense in linking the minimum wage and that tax free allowance. For, of course, if the State says that it's immoral for you to earn less than that then why does the State get to stick its hand in your pocket and steal some of that?

And yes, it is still true. If those working full time full year on the minimum wage were not paying income tax and national insurance then they would indeed have incomes within spitting distance of that so called "living wage". And once all those campaigning for that minimum wage note this fact then I'll start to take notice of anything else they might have to say: but not until then.

Why not a "John Lewis" education sector, Mr Clegg?

According to the Deputy Prime Minister, employee-owned companies such as John Lewis tend to perform better than other companies.  This is hardly news, as the majority of successful companies around the world have been using employee share ownership schemes for decades to help attract, incentivise and retain key staff. However, Clegg's desire to promote and encourage more companies to follow their lead, raises an intriguing question - if employee-owned companies tend to perform better, why not employee-owned schools?  Why not extend the idea of 'responsible capitalism' into education?  As teachers play such an important role in children's schooling, then any incentives which can encourage teachers to perform better, clearly have enormous potential to do good.

This idea is not as far-fetched as some may think.  For example, in 2000 Richard Vedder (Distinguished Professor of Economics at Ohio University), published a short publication titled "Can Teachers Own Their Own Schools?", in which he presents a bold plan to allow teachers to become the owners of schools, thereby acquiring an attractive financial stake in the  education process.  His proposal draws inspiration from Margaret Thatcher's privatization of government council housing, privatization reforms in Latin America, and the E.S.O.P. (Employee Stock Ownership Plan) movement in the United States and he concludes that if teachers could become shareholders in different chains of for-profit schools then this would help to foster "vibrant school communities with increased parental involvement and the innovation and efficiency essential to produce educational excellence".

Unfortunately in the UK the Deputy Primate Minister still wants to discriminate against, discourage and restrict all for-profit companies from investing in education, which means that the sector as a whole will be denied the benefits of having employee owned schools.   It is also important to note that this is only one of numerous different benefits which for-profit companies could bring to the education table, if only politicians such as Nick Clegg would give them a fair and equal chance.  Nick Clegg's on-going approach to education does not represent 'responsible capitalism', but deeply 'irresponsible government'.

The Face the Difference Report from the Fair Pay Network

This report from the Fair Pay Network. It's really very cute indeed. Cute as in naive, childlike innocence.

Poor peeps who get poor wages working in supermarkets should get higher wages because it's just right that they should get higher wages. There is absolutely no acknowledgement at all that the amount of labour required, the number of jobs there are to be had, the number of people who will, can be or might be employed, is not a fixed number. They're seeing the whole thing in entirely static terms.

Yah boo sucks! to high profits and high executive pay, Hurrah! for raising the workers' wages.

No, I'm sorry, it really just doesn't work that way. It really is necessary to address, even if only to reject after having given us the empirical evidence that justifies such rejection, what a change in the relative prices of labour and capital will have upon the employment of labour. Or, if you want to put it another way, how many jobs will be lost by increasing the price of labour? And I'm afraid that you cannot say "none". That really isn't a believable answer.

See those self-check out lines? That's a sign that, at the margin, labour is already more expensive than capital in servicing the needs of some customers. See the Aldis and Lidls? Where they don't in fact do shelf stacking, they just cut the top off the manufacturers' boxes and you help yourself? That's a sign that at least for some shoppers that the labour that goes into shelf stacking isn't worth it. We have simple and direct evidence that, at that margin where all economics happens, the price of labour is already leading to substitution by capital, to doing away with certain labour altogether. Raising the price of labour will only move more currently employed labour over this line, to where it is more profitable to substitute the labour or even do without it entirely.

If the report had mentioned, even to dismiss as excessive or not believable, that a 10% increase in wages (just to pluck a number from the air) would lead to a 5% reduction in jobs (or 10%, or 1%, any number at all really, just acknowledging the relationship between the price of labour and the amount of labour demanded) then we might be able to take it seriously. Better wages for 800,000 people and none for 90,000 of the 890,000 employed in the sector is a position that can be argued about, defended from certain angles, attacked from certain others. But they don't mention it, not even to dismiss it.

There is an airy assumption that there are no costs to such an action, only benefits. Which means that they are ignoring the core truth at the heart of economics, that there are no solutions, there are only trade offs. Thus they're not being serious and we cannot take the report, the campaign or them seriously. Into the dustbin of history with them.

Bloody immigrants, coming over here and paying our bills

This morning the Telegraph ran a story about migrants who claim welfare benefits: 370,000 migrants on the dole. But that headline masks the real problem, which is the availability of welfare. Welfare isn’t being given out too readily because of immigration; welfare is being given out too readily because that is government policy.

If someone offered you money for nothing you would have to be principled beyond the ordinary to refuse the money. But before they are anti-welfare, people are anti-immigration. There is, in most countries, a correlation between high immigration and a small welfare state, as Bryan Caplan has shown. People are only prepared to subsidise natives:

I know we’ve seen this graph a lot of times before, but the point cannot be made enough: immigration has a positive effect on an economy, welfare doesn’t. People who oppose immigration readily conflate the two and see only the bad effect.

As if immigration caused welfare! The poll on the Telegraph website showed 60% saying immigrants should get no benefits, and 33% saying they should get benefits in proportion to the taxes they have paid.  Even if they have worked and paid taxes, people want to stop immigrants claiming benefits. But we know that immigrants contribute more than they take out, taken as a whole group. Sam has written about the net contribution made by immigrants in terms of taxes paid and services used. Immigrants might claim benefits, but they have already more than paid for them. If the Telegraph has a problem with welfare costing money, they ought not to point the finger at immigrants.

Articles like Damien Green’s in the Telegraph yesterday make no mention of this. As with the Migration Advisory Committee report that recently found an “association” (which was said in the report not to be a causative link) between immigration and unemployment, this is an example of the government putting the cart before the horse. Policy does not follow fact, it follows party preference. Even though it might be the case that some immigrants come here and lazily claim benefits, stopping immigrant access to benefits won’t solve the problem. That will be done by stopping benefits. Indeed, if we restrict immigration as much as the government wants to we may start to miss our welfare budget being subsidised by those immigrant who came over here and paid our bills …

A likely retort to this is that those jobs denied to immigrants would, in turn, be populated by the resident workforce.  But we must remember that immigration is about the division of labour. There is no guarantee (quite the opposite) that if we removed all immigrants the jobs they do would still be there to be done by natives. A few facts from the report whence this headline came might serve to redress the balance in this argument:

  1. Whilst 370,000 people on welfare originate from without the UK, 5.5 million people of working age are on welfare.
  2. 16.6% of working age UK nationals claim a working age benefit compared to 6.6% of working age non-UK nationals.

You don’t need to go far from the newspapers to find some sensible analysis of the figures. On Jonathan Portes’ blog, Not The Treasury View, he compares the results of the government report to the most recent Labour Force Survey, and the results are fascinating:

  1. migrants represent about 13% of all workers, but only 7% of out-of-work claimants;
  2. migrants from outside the EEA represent about 9-10% of all workers, but about 5% of out-of-work claimants
  3. foreign nationals from outside the EEA represent about 4.5% of all workers, but a little over 2% of out-of-work benefit claimants.

And Matt Cavanagh did great work on the Today programme this morning explaining that only 2% of the migrants who claim are not entitled to do so – that’s 1/1000 of people on benefits. He also pointed out that migrants are less likely to claim benefits than British people. And despite those few on benefits, “migration is overwhelmingly good for the economy.” Immigration isn’t the problem; the problem is the size and administration of welfare. 

Whig also wrote about this yesterday.

Thank you

Every year the Think Tanks and Civil Societies Programme at the University of Pennsylvania compiles its "Global Go To Think Tanks Report", which ranks the leading public policy research organizations in the world. For another year, the Adam Smith Institute has performed exceptionally well:

Top Think Tanks – Worldwide (US and Non-US)
No. 20

Top Think Tanks – Worldwide (Non-US)

Top Think Tanks in Western Europe

Top Domestic Economic Policy Think Tanks

Think Tanks with the Greatest Impact on Public Policy

Think Tanks with Outstanding Policy-Oriented Public Policy Research Programs

Top International Economic Policy Think Tanks

We're thrilled with these results. From everyone here at the ASI, to everybody who has supported us through donations, attending events, writing, reading or spreading the ideas we hold dear: thank you for helping to make this happen. We're determined to build on what we've achieved so far, and make 2012 our best year yet.

Immigrant benefit claims are an argument against the welfare state, not an argument against immigration

Research released by the Department for Work and Pensions reveals that an estimated 371,000 non-UK nationals were claiming work-related benefits when they first registered for a NI number. Sir Andrew Green of Migration watch was quick to use this as a means to lobby for stricter controls on immigration.

The BBC article quotes Keith Best of the defunct Immigration Advisory Service as stating that ‘it was "very, very difficult" for migrants to claim benefits in the UK. He said you have to have "status" to claim and you were not entitled if you came in as a student or on a work permit, for example.’

However, as the DWP research points out:

‘Non-EEA nationals who are subject to immigration control within the meaning of section 115 of the Immigration Act 1999 are excluded from income-related benefits. This prevents access by persons, for example, who are subject to public funds conditions or do not have lawful status.  People given certain types of leave to enter or remain in the UK may be eligible for income related benefits, including people who have been granted:-

  • Refugee status;
  • Exceptional leave to enter or remain;
  • Humanitarian Protection; 
  • Discretionary leave; or
  • Indefinite leave to enter/remain’

Furthermore, under EU law EEA nationals with ‘worker status’ are automatically eligible for the same benefits available to UK nationals. Nationals from accession states can also be eligible for benefits, a condition which has prompted the most lurid newspaper stories about Bulgarian Big Issue sellers. It should also be observed that these benefits are only those administered by the DWP and do not include the health, housing and educational benefits which are far more easily accessed. Migrant access to these services provokes protest from prior residents who, justifiably, feel they have a prior claim and are being ‘queue-jumped’ or excluded. Benefits are, therefore, the cause of some of the friction between immigrant and pre-existing communities who perceive themselves in competition for state largesse. Surely the solution is to remove the source of the tension altogether?

Simply reducing immigrants’ access to benefits would be difficult because of EU and other legislation. In some cases it would simply be impossible; the NHS for instance, but we should also remember that transportation is heavily subsidised. It would also represent discriminatory treatment of immigrants – why should they be denied certain benefits available to others especially as such benefits are not based upon a contributory principle?

To my mind, however, the logical conclusion of this research is not tighter controls on immigration. I am a supporter of freedom of migration but this is actually irrelevant to the issue at stake here, contra Sir Andrew Green. This is an issue of state benefits and not migration. From an anti-migration perspective removing state benefits as a whole would be a more effective means of ‘selecting’ which migrants we would prefer to have than those currently being put forward (short of free movement, Gary Becker’s solution may be the best I’ve seen).

It would certainly eliminate the present absurdity of incentivising migrants to come to the UK, especially those who are likely to be a burden rather than an asset, and then erecting costly means of screening them. It would also radically alter the cost-benefit equation of immigration – without a state welfare system an immigrant would only be an economic asset. They would probably find fewer vacant jobs to come for – without the high marginal withdrawal rates created by the state benefits system we would find a far larger number of those currently in receipt of benefits willing to enter the job market fully. We need hardly repeat the fallacious idea that migrants are ‘taking our jobs’, as if there were a fixed amount of employment in the economy.

The root of the problem here is the existence of the benefits themselves and not the fact that migrants are claiming them. As the DWP research remarks, over 5.5 million people in the UK are claiming DWP benefits (of a working age population of around 29 million) so that migrants only constitute 6.4% of claimants. Education, health, transportation etc are ‘freely’ available to all. If social welfare, health and education were entirely or even largely based on private contribution mechanisms then the issue would not even arise or would only arise in a very few cases.

As Hayek observed in The Constitution of Liberty, ‘There is clearly no merit in being born into a particular community, and no argument of justice can be put forward in favour of a particular individual’s being born in one place rather than another... Rather than admit people to the advantages [gained by the reallocation of wealth] that living in their country offers, a nation will prefer to keep them out altogether.’ This latter option is a mistake, even if it were available. Of course, such an outcome as that hoped for here is hardly likely, but it does serve to demonstrate one of the many unintended problems that the welfare state creates. The solution to them is to eliminate the cause and not to try and treat symptoms.

Bird in a gilded cage.jpeg

Stuck in a rut

The McKinsey Global Institute’s latest report on debt and deleveraging contains the following diagram, which shows combined public and private debt in the ten largest developed economies over the last 20 years:

In case the image is unclear, the sharply rising dark blue line is the United Kingdom’s total debt. Only Japan keeps us from the top spot. For someone like me who broadly subscribes to the Austrian theory of the business cycle (for a musical explanation, click here) this is a very troubling image.

Simplifying somewhat, unsustainable booms usually have their roots in government or central bank action, which is amplified by the commercial banks, and serves to push market interest rates below their ‘natural’ level.

This distorts the economy: people borrow more and save less, and those sectors of the economy which are fuelled by availability of cheap credit – housing and finance, for instance – grow rapidly. This creates a vicious cycle. As the bubbles grow, more and more resources are sucked towards these sectors rather than others. The boom, though ultimately unsustainable, is self-reinforcing and the economy becomes increasingly unbalanced.

Then comes the credit crunch. Maybe the central bank raises interest rates, or the financial regulator increases capital requirements, or maybe a particular market (think sub-prime mortgages) tanks and sets off a confidence-sapping chain reaction. Whatever the trigger, the bubble bursts. Or as the song I linked to above has it, “the boom turns to bust as the interest rates rise”.

Now, what should happen here – assuming government policy is ‘neutral’ – is the liquidation of bad investments, deleveraging, and the reallocation of resources so that they realign with changed consumer preferences. This may be a painful process, but is also a necessary, remedial one. A return to real, sustainable growth cannot and will not happen until this adjustment and recalculation has taken place.

What the diagram above suggests very clearly is that this adjustment has not happened: on the macro level, no significant deleveraging has taken place. Total debt is, of course, only one metric among many – but the story this picture tells is nevertheless a persuasive one. 

So why hasn’t the economy adjusted the way I claim it should have? One word: policy. We bailed out the banks, and we’ve propped up housing and other asset markets with low interest rates and quantitative easing. Indeed, the coalition government’s entire economic strategy is to keep interest rates as low as possible and boost lending. The necessary economic adjustment hasn’t been allowed to happen, and so we’re stuck in a rut.

The silvery-grey line on the McKinsey diagram contains a worrying indication of our economic future: are we going to end up like Japan, and have to endure a decade or two of stagnation? Or will renewed crisis in the Eurozone bring matters to a head? The answer to those questions may become clearer as 2012 progresses.