Blog Review 962

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This is indeed the problem with anti-trust. Even lower prices are regarded as anti-competitive.

GM isn't just being hit by the current troubles. There's decades of bad management there too.

Taking note of the detail behind the stimulus plans: for example, it's taking an age to actually spend the money by which time we won't need to spend it, will we?

Sadly, troughing public sector employees is not a problem limited to the Westminster Parliament.

Sainsbury's profits rose, did they? That's Darling's VAT cut for you.

What we ought to be looking for in an economic theory.

And finally, unfair perhaps, but how some see the BBC.

Boom politics

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A report today by a committee of MPs – and we know what high standards they have – blames the banks' bonus culture as a major source of the financial crisis. The remuneration system, they say, worked to encourage bankers to go out and make deals, without worrying whether they were good or bad deals. They got the cash either way. But naturally, a lot of the deals they engineered were indeed bad.

That's true. But what brought on this bonus culture in the first place? The cause is actually down to the political system.

For the past twenty years, politicians really have believed that they were saving us from boom and bust. Any time there was a blip in the market, like the 1987 stock market slide, or after Russia defaulted on its debt, or most spectacularly after 9/11 – they 'saved' the system by flooding the world with cheap credit. Interest rates after 9/11, for example, came down from 6.5% to just 1%. With credit six times cheaper, people of course borrowed a lot more, buying houses, shares, securities, any asset they could. So many people were buying, that these assets shot up in value.

The response of the banks' management was rational. In this boom atmosphere, almost everything succeeded. Buy an asset today, it would be worth more tomorrow. Since all deals seemed to work, they naturally rewarded staff who made more deals. Of course, when the bubble burst, they all discovered just how dodgy some of these deals were.

But when you are looking at the causes of this crisis, you have to go behind the bonus culture, and not just stop there. What caused that culture was not 'greed' by the banks. They didn't all suddenly get together and decide to be really, really greedy. It was the politicians who engineered the boom that made this perverse culture seem perfectly rational. Physician, heal thyself.

Causes of the current crisis

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Credit contraction has featured in depressions since ancient times. The “Credit Crunch" we are currently experiencing is primarily due to three factors: (1) the natural human tendency to irrational optimism and pessimism in certain circumstances; (2) the creation of huge amounts of new money through bank credit expansion by central banks and the Fractional Reserve Banking system; (3) quasi governmental enterprises such as Freddie Mac and Fannie Mae in the US (involved in 95 percent of all 2007 US mortgages).

Factor (1)’s effects are obvious; these effects naturally cause and exaggerate cycles. People are optimistic on the way “up" (a boom) and pessimistic on the way “down" (a bust). This by itself, however, is insufficient to cause a boom of the type we have seen. Prices in general can only increase with either an injection of money into the market, or a decrease in the demand for money. If no money were created, a price boom in one market would coincide necessarily with falling prices elsewhere. This would lead to a natural and speedy reasserting of real preferences if some products were undervalued and others overvalued.

Factor (2) is less obvious. Direct government action, as well as its tolerance of fractional reserve banking, gives the illusion to business that more savings are held than there actually are;. Banks offer loans at lower prices due to their greater ability to do so (supply has risen with regards to demand) and this encourages greater investment. This leads firms and entrepreneurs to believe the consumption to savings ratio is more tilted towards savings than it actually is, and thus they invest more, and in more producer goods. Savings are necessarily future consumption, so businesses invest in anticipation of this, and because it costs less to do so. This “malinvestment" is revealed when the process of monetary expansion ceases. Then comes the “bust", and, as savers see through fractional reserve banks, there is a contraction of money and credit (deflation) as the bankrupt and unprofitable enterprises are liquidated through runs or closures. Factor (3) has worked similarly to (2), depressing the price of savings under their market price.

So it is essentially government interventions in the market, especially through central banking and artificial money creation, together with natural human tendencies, which created the bust whose effects we are now experiencing.

Smart meters or smart consumers?

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altThe government, in its wisdom, has now announced plans to install "smart meters" in all homes across the UK by 2020. These would allow consumers to see what their actual gas and electricity consumption is at any time, and also do away with meter readers, as readings can be collected wirelessly by the supplier. There would also - in principle at least - be no need for call centres to deal with complaints or revised readings.

The cost is estimated as £7bn, or roughly £15 per household for each year from 2010 to 2020. Energy companies claim that £10 of that would be funded by their own cost savings, while the remainder would be more than offset by savings made by more aware consumers. Maybe, but experience suggests that costs are probably underestimated and savings overestimated. For example, it seems inconceivable that all 26 million electricity and 22 million gas meters would work perfectly all the time, so call centres would still be needed to some extent. And what will be done about the people who have prepayment meters?

Experience also suggests that smart meters will polarise people into those who become obsessed with turning off all possible devices (but many of whom are probably already obsessed by energy saving) and those who simply ignore them. The impetus for the move comes, not surprisingly, from the government plans to reduce carbon dioxide emissions. The claim is that energy use would be reduced by 2%. The likelihood is that such savings will not materialise and, by the time all the meters have been fitted, carbon dioxide will no longer be seen as the driver of climate change. The energy companies (and smart meter manufacturers) will gain, but meter readers and call centre employees will lose.

Martin Livermore is the Director of The Scientific Alliance

Regulation gamekeepers

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Maybe the best poachers are ex-gamekeepers but one has to wonder why the Tories, when seeking new guidance for regulation in general and the Financial Services (FSA) in particular should turn to the previous gamekeepers of regulation who so conspicuously failed, namely Sir David Arculus and Sir Philip Sassoon respectively.

Sir David Arculus is a past Chairman of the Government’s Better Regulation Task Force. This was long on motherhood statements (“regulations should be better rather than worse") but ineffective in substance. The number of regulations rose to an all time high on his watch and, as the National Audit Office confirmed, the Impact Assessment process became a tick the box exercise as distinct from the robust challenge it was billed to provide. Sir David’s argument was that his influence would be greater in confidence and “within the tent". Some modest improvements have been made to process but regulations pour out unchecked and no public evidence of any success exists. Specifically, UK impact assessment was and remains entirely divorced from the EU regulatory system it was supposed to challenge – see “Worlds Apart: The EU and UK Regulatory Systems" published by the British Chambers of Commerce this month.

Sir Philip Sassoon was until recently a senior Treasury mandarin and closely connected with the FSA which has so manifestly failed the nation in its fundamental role.

I have no quarrel with Arculus or Sassoon both of whom are intelligent, knowledgeable, well connected, and well-intended people. The issue is why the Tories, when seeking new solutions, should turn to two people steeped in, and largely responsible for, the present conventions. Ask a bus driver how to get to Brixton and he will tell you the route he has always taken.

Both the Arculus and Sassoon reports have good points to make. No doubt some marginal improvements could be made but they are thinking within the box they have created. A conspicuous problem with the existing systems is the number of unrelated committees dealing with volumes of paperwork to no effect. They are unconnected with each other and, because they are merely advisory, unconnected with planet earth. What does Arculus recommend? More advisory bodies. Symptomatically, these reports pay little attention, and make almost no direct reference, to the other reports in their areas, some of which were commissioned by the Conservative Party.

Blog Review 961

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A very seriously good thing to do about aid. Instead of what works, why not start publicising what we know does not work?

If entrepreneurship is indeed genetically determined then we've all got some thinking to do. Maybe Greg Clark was right?

Star Trek may be just a movie franchise, but which other such gives you proper economics?

Why is it that lefties know so little economics? Because those predisposed to be lefties get turned off by all that talk of self interest perhaps?

For example, what is actually wrong with the Equal Opportunities Bill?

A measure of how silly the ethanol programme is. Better to burn the corn than make the alcohol to burn.

And finally, how to really educate a child.

Hard times at BT

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altBT’s full-year results today have been dominated by confirmation that a further 15,000 jobs are to go, after a similar amount were cut during 2008/09.

The City will not be surprised by these cuts given BT’s poor finances and many problems. Indeed, the share price has recently been at its lowest since the initial flotation in 1984.

The adjusted figures for 2008/09 - though uninspiring - could have been worse, given the state of the economy.

On the back of 3% revenue growth, underlying EBITDA (Earnings before Interest, Tax, Depreciation and Amortization) - a key City metric - remains within the £5 billion to £6 billion band that has been the case for years. Underlying earnings per share were down by 19% compared with 2007/08.

However, BT’s adjusted figures continue to be overshadowed by two very unwelcome legacy issues.

First, BT’s Global division has been forced to make enormous provisions for some poor contracts, most notably within the much-criticized NHS IT programme. Moreover, this division is also facing restructuring costs of a total £700 million over three years.

Secondly, like British Airways, BT’s pension deficit remains an eternal problem. It has now agreed to contribute over £500 million a year for the next three years to top up its pension fund.

In addition, confirmation of a 59% dividend cut and net debt of over £10 billion is bound to unsettle investors.

More generally, unlike its EU counterparts – Deutsche Telekom, France Telecom and Telefonica – BT does not benefit from rising returns from a mobile telecoms business; its Cellnet/O2 operation was demerged some years ago.

In summary, challenging times for BT. And, given the high hopes when it became the world’s first mass privatization in 1984, BT’s plight is very disappointing for UK plc.

Tax Freedom Day

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Tax Freedom Day 2009, the day in the year when the average Brit has earned enough to pay his tax bill, is today, May 14. That's the earliest date since 1973.

But of course, it's not really lower taxes that have shifted Tax Freedom Day so much earlier in the year (although the temporary VAT cut has helped). Rather, it's that the economy is in serious trouble and less tax is being paid.

Along with the headline Tax Freedom Day figure, we also calculate a secondary figure every year, based on what the government actually spends, rather than merely what it collects in taxes. And when you factor in this deficit spending, Tax Freedom Day 2009 does not come until June 25 - the latest figure since 1984. To put it another way, you'd have to work for the taxman for another 42 days to pay off the bills the government is running up.

That gap of 42 days is wider than it was at its previous peak in 1975. It probably represents the biggest gap between revenue and expenditure since the Second World War. That's really no surprise when you consider that the government is now overspending at a rate of £20m per hour, twenty-four hours a day, seven days a week. And needless to say, it means we're going to be paying higher taxes in the years to come.

We've have an early morning here at the ASI doing media work for Tax Freedom Day. Eamonn Butler talked to John Humphreys on the Today Programme, while I appeared on Radio 5's Wake Up to Money (click here and fast-forward to 22.45 to listen). By coincidence, ASI Fellow Nigel Hawkins was on the same programme in his everyday guise as an investment analyst. Fast-forward to 6.20 to hear him talking about BT.

Clean the trough

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altThe MP expense debacle is proving to be another costly blow to a damaged system. The taxpayer has lost the most; a lot of our money has been illegitimately wasted. Not only have our pockets been hit, more seriously trust in the whole parliamentary system has plummeted. Post-‘expensegate’ polls have shown natural revulsion against the actions of the main parties. The existing system designed for MPs, by MPs, for the benefit predominantly of MPs is failing. Reform is needed to ensure efficiency, and instil a sense of trust.

Firstly, the issue of expenses must be dealt with. The most important measure is improving transparency. As of today, I know of no easy mechanism to police and monitor expenses. We must know where our money is going! Expenses should be available online, in detail, in an easy to read, search, filter, rank, and order format. Whilst we are at it, why not do the something similar for government departments, Quangos and audit the Central Bank for good measure. Once all details of any abuses are public, we should change the rules to limit what can be claimed in future.

Secondly, we should focus on restoring faith in Parliament. The most important short term action should be the removal of Speaker Martin, and a change of the rules so the Speaker is elected by secret ballot. Further reforms should work to strengthen the true power of individual MPs, and restore Parliament. Further reforms are well detailed in Carswell and Hannan’s book, ‘The Plan’.

Finally, if we want efficiency, we should place greater emphasis on the market to provide our services. This does not translate into ‘quasi’ privatisations where contracts are not open to competition, and conditions are set artificially by government, but to schemes that return genuine choice to consumers or are fully private, e.g. educational vouchers. Government functions that remain should be localised where possible, increasing accountability and choice.

Government, and opposition, can only regain trust, by displaying the dignity and transparency befitting their role. It is time to clean the trough.