In which I fully support Natalie Bennett of the Green Party of England and Wales

I should, I suppose, support Natalie Bennett of the Green Party of England and Wales, given that I publicly supported her at the time of her election. But I do have a feeling that this support she's about to get from me will not be quite so welcome.

She's come out in an official party document demanding that everyone who rejects the science of climate change be fired from government: apparently elected or unelected.

Ms Bennett said: "We need the whole government behind this. This is an emergency situation we're facing now. We need to take action. We need everyone signed up behind that." Pressed on the issue, she agreed that even the chief veterinary officer should be removed if he didn't sign up to the view on climate change also taken by the Green Party. A policy document released by the party said: "Get rid of any cabinet ministers or senior governmental advisors who refuse to accept the scientific consensus on climate change or who won't take the risks to the UK seriously." Ms Bennett added: "It's an insult to flood victims that we have an Environment Secretary (Owen Paterson) who is a denier of the reality of climate change and we also can't have anyone in the cabinet who is denying the realities that we're facing with climate change." She said her party took the consensus view shared by many other organisation including the Intergovernmental Panel on Climate Change.

This is, of course, a betrayal of all that is holy about democracy and so we'll not be having with that. However, let us just put that to one side for a moment and think through, properly, what is the accepted science of climate change.

We can start with the SRES: these are the economic assumptions that go in at the beginning of the process. How many people will there be, at what level of wealth, using what technologies: these estimates produce the emissions numbers that then do into the climate models from which everything else is derived. We have four families of such scenarios and they run A1, A2, B1, B2. A largely stands for a capitalist economy red in tooth and claw, B for something more akin to a caring sharing social democracy. 1 means a more globalised economy than the one we have now, 2 means a more balkanised one, one more autarkic than at present.

In terms of human flourishing, the wealth of people in the future (and do recall that wealth is not simply more things or more consumerism, it is an expansion of the possibilities available to people),  then as we would expect the capitalist bit produces better results. But what's even more interesting is that a more globalised result produces better results than a more autarkic one. In fact, even in terms of emissions the globalised (whether capitalist or social democratic) families produce fewer emissions than the autarkic ones. Thus we can see that the science of climate change insists that we must increase, not decrease, globalisation.

This is not, to put it mildly, something that Ms. Bennett believes nor the Green Party of England and Wales. But under this stricture proposed by those very people we will simply have to fire from government everyone who opposes greater globalisation. Sad but there it is, we do have a planet to save after all.

We can go further as well. As My Lord Stern has pointed out (and as have eminences like Richard Tol, William Nordhaus, Greg Mankiw and, in fact, just about every economist who has bothered to look at the issue) the correct solution to the results that come from the IPCC is a carbon tax. Of some $80 per tonne CO2-e in fact according to Stern. And it's well known that UK emissions are around 500 million tonnes. And also that we already pay some swingeing amount of such Pigou Taxes: the fuel duty escalator alone now makes petrol a good 15p per litre more expensive than it should be under such a tax regime. And there are other such taxes that we pay, so much so that we are already, we lucky people here in the UK, paying a carbon tax sufficient to meet Lord Stern's target (which is, it should be noted, rather higher than what all the other economists recommend: we're not stinting ourselves in our approach to climate change).

We don't quite pay it on all the right things as yet, this is true, but the total amount being paid is about right. We just need to shift some of the taxation off some products and on to others. Less on petrol and more on cowshit for example.

That is, according to the standard and accepted science of climate change we here in the UK have already done damn near everything we need to do to beat it.

This, in turn, means that we now have to fire everyone who disagrees with this application of that accepted science. Which means we get to fire Ed Davey for suggesting more windmills for example. We don't need any other schemes, plans, subsidies, technological boosts nor regulations. As Stern and all the others state once we've got that appropriate carbon tax in place then we're done, problem solved. We just then sit back and allow the market to churn through the various options now that we've corrected the price system for externalities.

All of which I think is rather wonderful. Given that the Green Party is very much against globalisation then their demand is that no member of the party can ever be employed in a senior political or civil service role. For globalisation is a cure as the settled science of climate change insists. Indeed, it's one of the basic assumptions that go into the original models. And we also get to fire everyone who comes up with any scheme for regulation or subsidy, given that these are all contra-indicated by the accepted solution of the carbon tax. And finally, do note that we're already paying enough in green taxes, we've only got to tweak, in a minor manner, what we're paying them on in order to have completely solved the problem. And, as Ms. Bennett states, we now have to go and fire absolutely everyone who disagrees.

Which, given that I seem to be the only person who has actually read all of this guff, understood the implications of it and managed to piece it together makes me Prime Minister, doesn't it? Or Grand High Panjandrum or something? I seem to have convinced Matt Ridley of this over the years so perhaps he could handle the Lords for my new government.

So when do I get to meet the Queen?

Scottish rates aren't fair

Marcus Buist argues that Scottish business rates distort economic activity by reducing incentives to improve properties and due to the lengthy gaps between revaluations and proposes abolishing the system, considering a number of alternatives.

Introduction

Although the UK as a whole is at last escaping recession, there is great regional disparity in the growth figures. Scotland has performed relatively well through all of this, but despite strong growth in some sectors the recovery remains uncertain.  It is clear that the current level of poundage in Scotland, though no higher than the level in England, has forced many firms to close, and hampered the ability of many other firms to save or to invest in restructuring the supply side of their business. A large number of empty commercial properties have become involved in a rates trap, whereby the revenue gain from returning them to the commercial market would be less than the amount they currently earn from any long term lease they may be under while sitting empty. The scheduled 5.6% rates increase from the first of April 2013, will exacerbate the problem, imposing an effectively arbitrary burden on private firms. Although the Scottish Government has determined to delay any reappraisal of business rates until 2017, it is vital that proper consideration is given to which reforms, if any, should be implemented. The substantive area for debate, however, remains the structure of local government finance.

Property taxation as a whole is essentially a Medieval and Victorian solution to the problem of local government finance, and is perhaps no longer appropriate given the increased demands on public spending and the changed business environment.  Additionally, it is unclear whether devolving powers over the level of taxation to local government would encourage fiscal responsibility or instead permit a short term binge of ‘tax and spend’ that would go unpunished at the ballot box. While local accountability and local control are at the heart of our philosophy, this principle is secondary to our desire for low taxation as a means of maximising personal freedom.  It is impossible to argue, from a truly liberal perspective, that semi-local socialist fiefdoms should be allowed to impose whatever burden they chose on taxpayers, or that this form of local control should trump control by the most local of all agents: the individual themselves.

Why Abolish Non-Domestic Rates?

The desolation of the Scottish high street is a social as well as economic tragedy.  Like council tax, business rates are levied on the basis of property value and not income. As a result, falls in consumer spending and profitability have no impact on the tax status of commercial properties. As town centre businesses operate the most valuable properties in proportion to their incomes, their share of the burden of rates is disproportionally great. The price of maintaining a presence inside towns and cities can become discouragingly high, leading to closures of ordinarily profitably stores. This exodus from the central business district further reduces the appeal of surviving businesses, leading almost inevitably to further closures and further unemployment. It is unsurprising that a sense of ennui and malaise should set in amongst local residents experiencing this process.

Property taxation requires regular revaluations of commercial property in order to accurately assess a fair tax bill. These valuations, however, are costly in both political and financial terms and so are routinely postponed.  Consequently, long term shifts in business activity and property value go unnoticed by the assessors, further distorting the link between ability to pay and the actual rates payment. A similar problem has emerged with the council tax system, which bases its charges on the domestic property market of 1991. The subsequent boom in property asset values was uneven across the country, though particular pronounced in the south east of England, London and Aberdeen. Homes in these cities are charged on the basis of valuations they have long since superseded. Businesses and homes located in beyond the areas that most immediately benefited from the credit bubble might well wonder why the tax system should deny them a competitive advantage through lower rates bills.

The retail letting market in Scotland has moved in the direction of long term leases to chain stores. These leases are often high value, and thus represent a sustainable means of paying the rates. As consumer demand falls however, and firms seek to consolidate their business, many of these stores will be closed even while the lease is maintained. The high level of poundage prevents long term rental agencies from returning their empty properties to the market at lower rental values. The present system encourages these landlords to keep existing leases in place in order to raise sufficient sums to pay rates, even if that property remains vacant. These leases remain unbroken as rental agencies are unable to find new customers for their properties, as prospective business are both unable and unwilling to pay the overhead cost of rates.  The business demand for property in recession is all too often depressed bellow the fixed costs of rates, and as with all interference with natural market pricing, business rates suppress the latent urge to regenerate empty properties. While there are reliefs offered to reduce the rates trap, these have been recently curbed from a 50% reduction to a new regime whereby firms are liable for a full 90% of the charge.  CBI Scotland have rightly labelled this “a tax on distress” as it hampers the efforts of new enterprises to regenerate business areas that been made vacant.

Property taxes are out of step with modern business environments. Large profits may be made in industries with a lower rateable incidence than less profitable businesses that are still dependent operating out of rateable properties. The total effect of NDR skews the market and places a regressive burden on many key industries. This economic distortion not only blunts growth, but harms the social fabric by penalising small and traditional businesses. While the promotion of low taxation is vital for the creation of jobs and wealth, market distortions created through an uneven tax base and a complex system of reliefs are not to be welcomed.  As the current system of reliefs is complex; the administrative cost to business in determining which reliefs are available is considerable. In addition, taxpayers are required to fund the administrative cost to the Scottish Government and unitary authorities. When spoken to, few council workers in either finance or business rates departments seemed to understand even the basic outline of how business rates are collected; a finding which confirms the present inadequacies in the structure of local government finance. Equally, the tax advantage for charities damages the ability of for-profit business to compete on the high-street. This can lead to high-streets being stripped of all shops bar those who operate with charitable status. The current patchwork of reliefs distorts the market by favouring certain industries for political reasons. The Renewable Energy Relief, for instance, encourages the construction of inefficient forms of renewable power at the expense of potentially cheaper alternatives. This relief benefits the already wealthy over smaller businesses, which are less able to afford entry into the renewables market. The cost of multiple reliefs comes at the expense of lower marginal rates of poundage which would be of benefit to a greater number of businesses. While the Scottish Government may wish to boast that the reliefs programme is more generous than equivalent schemes in England, this claim has to be balanced against the reality that this political gesture comes with the opportunity cost of fairer taxes for everyone.

Conversely, any desire for reform must be measured against the political and financial cost of restructuring the tax system. Tax simplification can easily be labelled a tax increase by political opponents, as in the case of the “pasty tax” and the “granny tax” following the 2012 budget. The desire for reform of the operation of reliefs must be measured against considerations that rural areas and selected small businesses benefit from targeted reliefs, and that challenging these business perks, if handled indelicately, could be politically difficult. Many of these businesses are vital community hubs; closure of these businesses due to higher rates bills would have considerable social implications.  Any reforms would have to be piloted with considerable care in order to ensure that they carry public opinion with them. The political dimensions of reform will most palatable if marketed as a means of saving jobs and high streets from continued decline, emphasising the positive role for economic freedom in revitalising Scotland’s excluded towns. Policy implementers face a further dilemma, as once there is common agreement on the need to abolish rates, the issue of with what should they be replaced emerges. As no option offers an immediate panacea for growth and revenue, the decision as to which policy option should be selected is difficult indeed.

The Next Steps Forward: Options for reform

The rates system is unfair, and illiberal. Non-domestic rates should be replaced with an alternative form of business taxation based on income, land value or total sales. These alternatives could potentially use existing information such as VAT returns or corporation tax receipts to calculate the local tax due. This should ideally save additional administration costs that would be necessitated by taxing business on some new basis.  It might be possible to abolish business rates altogether if a proportional increase was made to the headline rate of corporation tax or significant cuts were made to public spending. This could further save on administration costs and the dilemma of double taxation of income. Unfortunately, this model would eliminate the possibility of local control and accountability.

Abolition with an Increase in Corporation Tax:

Such a model provides the greatest administrative savings for both private and public sectors. Moreover, the corporate tax model is more responsive to market forces than business rates. Resultantly, businesses would be more able to absorb economic shocks, while providing a proportionally fairer rate of tax for the high street. Conversely, increases in headline rates of corporation tax may discourage business investment in Scotland, putting certain Scottish businesses at a competitive disadvantage when compared to other EU and UK companies. Further, this option jars with the present localism agenda, taking little account of regional variations or preferences. Regrettably, tax avoidance by major firms might well discredit this form of taxation, as small and medium sized enterprises perceive themselves to be paying an unfair proportion of the overall tax take. The greatest concern by far remains that firms might relocate elsewhere or decline to invest further in any Scottish centres of industry. Scotland’s market share of UK wide FDI employment has risen in recent years to 16% of the UK total, with 30% of this investment directed at manufacturing. Scotland is therefore highly dependent of foreign direct investment; any shift in investment behaviour away from manufacturing in Scotland would be harmful Scottish employment and prestige. It might be possible abolish rates outright without raising taxes, but only if the Scottish Government or 32 local authorities were prepared to find £2.252 billion in savings, which would cover the tax take for 2011-12. While public spending at national and local levels remains wasteful, this reduction in would still be a considerable undertaking. There is currently little appetite in Scotland for further reductions in public expenditure, beyond the still popular reductions in welfare spending being pursued at Westminster. This option is equally impractical and sadly must be dismissed at the present time.

Business Income Tax

BIT shares in many of the advantages of the previous option; however, it could additionally be altered in line with local decision making. Despite these advantages, intelligent solutions would have to be found to avoid the problems of double taxation of the same income at national and local level. Furthermore, taxes levied on profits are relatively easy to avoid and evade. Tax avoidance not only robs government of revenue, but is unfair to businesses that pay the intended amount. BIT could prove to be distortionary, favouring large companies who are more readily able to advantage of loopholes in tax policy. As a local tax however, it would remove the need for raising the marginal level of nationwide taxes. Further, it might induce a culture shift in local authorities, as they are weaned off dependency on block grants. Central grants encourage a statist mind set, by creating a political pressure for ever more spending that seems, at least to local electors, to be ‘free’. When councils are required to raise their own revenues, incentives emerge to be efficient with their resources in order to tax their residents less.

Land Value Tax

Although LVT is essentially a property tax, it is levied on the value of the site, and not the capital value of the property built over it. Consequently, the tax penalty for improvements is removed.  Taxes, when levied on income, naturally discourage productive enterprise; a land value tax by contrast punishes economic inactivity. Beyond the economic impact of such a reform, there may also be a resulting change in values. The philosophical underpinnings of LVT are largely conservative, valuing hard work and individual enterprise in the tax code. Though it can be postulated that the tax system should be morally neutral, these are undoubtedly positive behaviours that are essential for the functioning of a truly liberal society. As this is reform would represent a tax reduction and not a direct subsidy, its moral favouritism partly justified.  The practical points of implementation however, may prove more difficult. It is incoherent to imagine how the value of a site can be considered as being distinct from the improvements made around it; in essence all property taxes have to factor in the capital value of the property being taxed. It would be absurd to assert that the values of sites in commercial city areas are worth equivalent sums to sites in deprived or rural areas. Therefore, implicit in LVT is a further burden on prosperous or commercially viable business sites which are necessarily more valuable. Certain industries, such as agriculture are land intensive, and might be rendered unviable by this shift in taxation. Nor is it clear that once taken out of productive use these sites would be returned to economic activity. Such pressure on rural areas could result in land having to be sold for development, harming green belt or rural areas. It is doubtful whether LVT would aid town centre regeneration, as non-domestic rates already penalise the owners of vacant properties, containing congruent incentives to maximise profit over the value of property. It is the long term lease arrangements in combination with high fiscal overheads that prevents the return to commercial use, and these problems could not be ameliorated by this selected model of taxation. Indeed, as property taxes as a whole discourage landowners from letting properties to new owners as the rental income is often lower than fixed sum they pay in rates; this problem may well be aggravated by a land value tax. Moreover, the policy would require routine revaluations which are politically treacherous. Without these revaluations however, accurate taxation of land would be impossible. LVT would prove a politically and economically disruptive policy that suffers too many of the faults of NDR to be worth the cost of reform.

Local Sales Tax

A local sales tax could be modelled on, and take advantage of the existing system for calculating and collecting VAT. It should therefore have only a minimal impact in terms of business administration costs.  VAT contains effective anti-avoidance measures, by compensating businesses for tax already paid. As such, businesses have an incentive declare their full liability. By comparing LST returns against VAT returns, local finance departments could be relatively certain that they were being paid the full sum due. Unlike VAT, it would be possible to operate LST without repaying firms for the tax already paid, reducing further any manipulation of the tax system by predator firms. The standard VAT exemptions could broadly be maintained, including the threshold for payment, this would effectively act as an allowance for small and rural businesses. Sales taxes do not penalise either work or capital accumulation, having the advantage of being the most economically efficient method of raising revenue. In the long run, this will provide for higher growth rates and employment. As income and capital taxes reduce the ability of companies to restructure their production, they greatly slow the ability of an economy to recover from an economic recession. Unlike taxes on business, sales taxes are more readily noticed by the public; as a consequence this option best supports local accountability.

Why Localism?

Devolving power over local government finances is usually met with only lukewarm support. In Scotland, prominent business groups, such as the CBI have opposed it as a measure of reform. As with the community charge, there is a risk that centre-left authorities, of which there are many in Scotland, raise spending in the run up to the introduction of the new tax. The resulting tax levied on businesses would be unexpectedly high, with the political fallout damaging the central rather than local government. This could result in the whole package of reforms being abandoned, with damaging consequences for Scotland’s high street. If voters do not change their vote according to the actual policies of their council, then the devolutionist agenda will have failed to provide the keystone of accountability. These problems could potentially be resolved by introducing a nationwide cap on the level of poundage. Rate capping is an established policy in Scotland, having been applied to domestic rates through-out the 1980s. This would prevent local authorities from raising their charges above a certain amount; ensuring individuals would be protected from irresponsible behaviour by certain authorities. A further measure of mandatory spending restraint during the transition period may also be necessary in order to avoid opportunist increases in taxation justified by higher spending.

By contrast, there is also great opportunity for certain local authorities to pursue measures to increase our freedom from taxation, as councils compete to attract businesses to their area. Not only would tax policy be changed, but additionally the other policies of local authorities towards businesses and consumers. Transport and parking present major problems for town centre shoppers, often these difficulties are the result of a local decision that was made regardless of the impact it might have on the business community. With greater financial dependence on these same businesses, it will be in the interests of ever council to ensure that local enterprises continue to flourish. Simultaneously, the dependence on central authority will be reduced. With the reduction in financial powers over local authorities, these bodies will be free to innovate with new methods of providing public services. Scotland lags far behind Europe and the UK in the structure of its public bodies, freedom to change will at least provide a certain impetus to reform in the interests of higher quality.

The pooling of resources nationwide is a palpably unfair policy. The popularity of localism must be that money raised in one area should be spent in that same area. Major cities such as Edinburgh and Aberdeen, and rural authorities such as Perth and Kinross lose millions of pounds in revenue to both the Scottish Government and to spendthrift neighbours. This is partly concealed in the official figures which show revenue collected by local authorities gross with any public utility revenues they may collect from other authorities. This method of calculating the tax take by local authority is used for Fife; South Lanarkshire; Highland; Renfrewshire; Falkirk; and West Dunbartonshire. In the case of South Lanarkshire, when revenues are collected net of public undertakings, an almost balanced account is revealed to include a shortfall of £153 for the financial year  2011/12 rising to £165 million in 2012/13. This is a deficit that must be paid for by the hard-pressed rate payers in other authorities. While this generous donation is coerced from other councils, net recipient authorities will make little attempt to be prudent with their spending. When this fact is fully known, residents cheated of revenues by nationwide pooling of resources will recognise the need for powers and resources to be devolved.

Final thoughts

It seems clear that the best interests of Scotland demand reform of business rates. That power should be devolved is a vital part of the process of transforming the culture of Scottish political life; centred on the principle that power should be held closest to the people that it affects. Local authorities have endured decades in which there has been an erosion of their powers and responsibilities. It is no coincidence that as the size and impotence of local government has grown they have seemed ever more distant and less able to govern. Restoring the place of local government in Scotland is predicated on greater financial independence and freedom to respond to diverse local social and business environments. It may be possible to avoid the pain of a new tax if business rates are retained but with significant alterations to their structure. If property taxation is to be implemented, it must be coordinated with real market conditions and values rather than the results of long redundant revaluation reports. Moreover, any system of reliefs must be considerate of the impact that such policies have in disrupting the overall market. The renewables subsidy, which offers discounts of up to 100% off rates, must be discarded, and many other rates amalgamated so as to offer a clearer picture of how much firms really owe. Yet ultimately, this patchwork solution to local government finance will never be as satisfactory as the abolition of rates. Of the replacement options, a local sales tax is preferable to any local corporation tax. Sales taxes carry less of a fiscal deadweight to private enterprise, and are therefore more likely to promote the values that are necessary for success. Moreover, a sales tax linked to VAT returns will be more likely to reduce avoidance, ensuring both a more equitable environment for firms that do pay the amount due and maximum returns for the community.  The level of sales tax would be held down by the Scottish Government nationally, which would ensure investors and foreign business could be guaranteed a reasonable tax climate, while also allowing prudent authorities to do yet more to protect town centre shops. Scotland’s towns and small cities have for too long been held back by the heavy burden of business taxes, tax freedom will allow for local renewal and a release of Scotland’s enterprising and creative potential. It is in this spirit that I consider reform of rates an urgent national priority.

How Scotland could flourish by unilaterally keeping the pound

Between 1716 and 1844, Scotland had one of the world’s most stable and robust banking systems. It had no central bank, no lender of last resort, and no bank bailouts. When banks did fail, it was shareholders who were liable for paying back depositors, not taxpayers. Scottish GDP per capita was less than half of England’s in 1750; by the end of the era in 1845 it was nearly the same. Now that George Osborne has ruled out a currency union if Scotland votes for independence, the Scots have an opportunity to return to this system more seamlessly than any other place in the world could.

As I said to the press this week, there’s nothing really stopping Scotland from continuing to use the pound unilaterally. (Unless the remaining UK introduced strict foreign exchange controls, which would be absolutely crazy.)

What the Chancellor's announcement actually means is that the Bank of England (BoE) would no longer consider Scottish interests when it determines monetary policy and that illiquid Scottish banks would no longer be able to use the BoE as a Lender of Last Resort.

I’m not sure that the first point really matters at all. Scotland’s five million people can’t have much of an influence over the BoE’s policy for the UK’s 63 million people as it is. And, frankly, I’m not sure the BoE knows what it’s doing well enough for it to matter whether it cares about you or not.

The second point is the interesting bit. George Selgin has pointed to research by the Federal Reserve Bank of Atlanta about the Latin American countries that unilaterally use the dollar. Because these countries – Panama, Ecuador and El Salvador – lack a Lender of Last Resort, their banking systems have had to be far more prudent and cautious than most of their neighbours.

Panama, which has used the US Dollar for one hundred years, is the most useful example because it is a relatively rich and stable country. A recent IMF report said that:

By not having a central bank, Panama lacks both a traditional lender of last resort and a mechanism to mitigate systemic liquidity shortages. The authorities emphasized that these features had contributed to the strength and resilience of the system, which relies on banks holding high levels of liquidity beyond the prudential requirement of 30 percent of short-term deposits.

Panama also lacks any bank reserve requirement rules or deposit insurance. Despite or, more likely, because of these factors, the World Economic Forum’s Global Competitiveness Report ranks Panama seventh in the world for the soundness of its banks.

I suspect that there would also be another upside. Following Walter Bagehot, central banks are only supposed to lend to illiquid banks, not insolvent ones. Yet since the start of the Eurozone crisis the ECB has clearly made significant bond purchases to prop up both insolvent banks and insolvent governments. This may have been a lesser evil than letting them collapse altogether, but it’s hard to say that this kind of moral hazard is not present.

So, given that some countries do survive and even flourish without a central bank, how would Scotland do it?

The basic mechanics, I think, would be this: in a hangover from the old free banking period, Scottish banks currently issue their own banknotes. After independence, they could continue issuing their own notes that entitle the bearer to GBP on demand. BoE pounds, in other words, would be the 'base money' that Scottish banks use to back their own private currencies, in the same way gold was used during the last Scottish free banking era.

A banknote from a Scottish bank would be, in effect, a promissory note redeemable on demand in BoE-issued pound sterling. (Scottish notes are already promissory notes, but issuance is closely regulated by the BoE.) Of course, there should be nothing stopping banks from issuing notes redeemable in something else, like US Dollars, gold, Bitcoins, or Tesco Clubcard points. Scottish banks would have to arrange private clearing houses, as they did in the last free banking era, to provide loans to illiquid banks, or they could follow Panama in simply maintaining very high reserves.

No bank would have monopoly privileges: any ‘bank’ could issue notes and it would be up to the market to decide whether to accept them as money or not. As Selgin explains here, banks free to issue their own notes will set their reserve ratios according to people's demand for money, stabilising nominal spending.

With respect to other regulations, I quote Selgin again:

It is, in any event, desirable that there be no Scottish public authority capable of bailing out insolvent banks and of thereby introducing a moral hazard. Deposit insurance should be resisted for the same reason. Foreign banks should be admitted, by way of branches rather than subsidiaries, and should enjoy the same rights as Scottish banks. (Of course the major "Scottish" banks are themselves no longer really Scottish anyway.) Finally, re-establishing some form of extended liability (though not necessarily unlimited liability) wouldn't be a bad idea.

We take no position on Scottish independence — it is up to Scottish voters to decide. And while a return to free banking in Scotland may seem fanciful, this week’s announcement makes it much more likely. Keeping the pound and treating it as the ‘specie’ on which banks can base their notes would make the transition virtually seamless for the average Scot, while giving them a banking system that is unrivalled anywhere in the world for being stable, open, and free.

Price fixing doesn't work Part XVII

Thailand is finding out, in a most painful manner, what happens to those who try to fix prices:

Thailand, once the world’s biggest exporter, is short of funds to help growers under Prime Minister Yingluck Shinawatra’s 2011 program to buy the crop at above-market rates. After the government built record stockpiles big enough to meet about a third of global import demand, exports and prices have dropped, farmers aren’t being paid, and the program is the target of anti-corruption probes. Political unrest may contribute to slower growth in Southeast Asia’s second-largest economy.

In order to curry favour with the rice farmers who compose a substantial part of the electorate prices were fixed and fixed high. The inevitable thus happens, magically more is produced than anyone wants to consume and here at least it is looking like the government will go bust over it. "Produced" is of course a flexible word: there are long running reports of rice being smuggled over the Burmese border to take advantage of those high Thai prices.

This really should not be a surprise to anyone. For prices are information, they're information about how many people want to consume how much of what and similarly about who is willing to produce. Changing the prices will change those desires and thus kick the system out of sync.

And it really is always the same: Thai rice, the world's supply of tin back in the 70s, the EU food mountains and wine lakes, Red Ed's idea to subsidise wind and solar power prices. If you set the price high then there will be a glut on the market that someone, somewhere, is going to have to buy at those high prices in order to maintain those high prices. That is, as we all know, the poor bloody taxpayer. If you set the price too low as with Venezuelan toilet paper or Red Ed's idea to freeze power prices then the good in question becomes in dearth. More people want to consume it than there is supply for them to consume.

And if, of course, you manage to set prices where supply does indeed meet demand then why the heck are you wasting your time setting prices? The market will achieve that for you without your lifting a finger.

The error really does come from failing to realise that prices are not something for us to manipulate, they're information that we need to process.

On the rise of the robots

I'm astonished to find yet another person getting this wrong. Martin Wolf:

Fourth, we will need to redistribute income and wealth. Such redistribution could take the form of a basic income for every adult, together with funding of education and training at any stage in a person’s life. In this way, the potential for a more enjoyable life might become a reality. The revenue could come from taxes on bads (pollution, for example) or on rents (including land and, above all, intellectual property). Property rights are a social creation. The idea that a small minority should overwhelming benefit from new technologies should be reconsidered. It would be possible, for example, for the state to obtain an automatic share in the income from the intellectual property it protects.

This is all about what happens when the robots steal all our jobs. And everyone, just everyone, is arguing that when they do then the capitalists will have all the money. For they, of course, own the robots. Thus we should tax the snot out of capital and the capitalists and the world will be a better place. It all sounds a bit Marxist to me to be honest, this idea that there is some class of capitalists that we must tax.

There are several reasons why I don't think this is going to happen:

1) My favourite economics paper. Looking at who benefits from Schumpeterian innovation, that's the same thing as the technological change we're considering here. The answer is that we the consumers get 97% of it and the entrepreneurs get 3%. Now why should we, getting 97% of the increased living standard from technological change, then want to tax the snot out of those people bringing it to us and only getting 3% of that new value created?

2) Does anyone at all really believe that the robots are all going to end up being owned by one class of people? In this age of open source stuff? Is this what's happening with 3D printing? Of course it damn well isn't: people are pottering about in sheds with these technologies. As soon as we do have robots that make robots (the necessary stage for them to take all our jobs) there will be designs for such robots that you can make at home. We'll all be robot owners and why would we want to tax the snot out of ourselves?

3) The assumption is that capital will become more productive in a robot world. That's why we'll have to tax the snot out of capital. And capital will indeed become more productive: which is why its value will fall. Yes, you read that right. When something becomes more productive this is equivalent to stating that we've made more of it. Thus more productive capital means we have more capital and the price of something that becomes in greater supply falls, not rises.

4) The last time we mechanised a significant area of life was probably farming back in the 1920s and 30s. Agriculture become significantly more productive. What happened to the price of land? Yup, it sank like a stone and the farmers have been on the public teat ever since.

Vast numbers of cheap robots would lead to our lives improving immeasurably: so why is everyone running around insisting that it will then be necessary to tax the snot out of the capitalists?

Markets do set rates: A reply to Julien Noizet

Financial analyst and blogger Julien Noizet has replied to my article on mortgage rates on his blog. It is a good piece, worth reading, but I still think I am right. It is perhaps true that Noizet is right too, because my claim was really very modest: in total, mortgage interest rates do not mechanically vary with the Bank of England's base rate; we can show this because the spread between them and the base rate varies extremely widely; and since we have very strong independent reasons to expect that market forces largely drive rate moves, that should be our back-up explanation. The implication of this I was interested in was that this meant a hike in Bank Rate wouldn't necessarily drive effective rates up to a point that would substantially increase the cost of servicing a mortgage and hence compress the demand for (London) housing.

Even if the first graph in Noizet's blog post did appear to support his narrative that effective market rates follow Bank Rate moves, I'm not sure why these disaggregated numbers matter given that the spread between overall effective rates on both new and existing mortgages varied so widely. If it turns out that specific mortgage types varied closely with Bank Rate but the overall picture did not, then markets still control effective rates, they just do it via a changing composition of mortgages, not by changing the rates on particular products. The effect is the same—and it is the effect we see in the Bank's main series for effective rates secured on dwellings. But the graph, to me, looks a lot like mine, despite the effect of new reporting standards: mortgage rates are about a percentage point from the base rate until 2008, then they don't fall nearly as far as the base rate in 2008 and they stay that way until today. If other Bank schemes, like Funding for Lending or quantitative easing were overwhelming the market then we'd expect the spread to be lower than usual, not much higher.

His second big point, that the spread between the Bank Rate and the rates banks charged on markets couldn't narrow any further 2009 onwards perplexes me. On the one hand, it is effectively an illustration of my general principle that markets set rates—rates are being determined by banks' considerations about their bottom line, not Bank Rate moves. On the other hand, it seems internally inconsistent. If banks make money (i.e. the money they need to cover the fixed costs Julien mentions) on the spread between Bank Rate and mortgage rates (i.e. if Bank Rate is important in determining rates, rather than market moves) then the absolute levels of the numbers is irrelevant. It's the spread that counts. But the whole point of my post is demonstrating that the spread changes very widely, and none of Julien's evidence seems to me to contradict that claim. Indeed, Noizet's very very good posts on MMT, which stress how deposit rates are much more important as a funding cost than discount rates for private banks, seem at odds with what he's written in this post. And supporting this story is the fact that the spread between rates on deposits (both time and sight) and mortgages changes much less widely. If we roughly and readily average time and sight on the one side and average existing and new mortgages on the other, the spread goes no higher than 2.3 percentage points and no lower than 1.48.

In general with the post I don't feel I understand the mechanisms Noizet is relying on, perhaps I'm misunderstanding him, but the implications of his claims regularly seem to contradict our basic models of markets. For example, he says that a rate rise would lead banks to try and rebuild their margins and profitability. But I can't see any reason why banks wouldn't always be doing that. The mortgage market is fairly competitive, at least measured by the numbers of packages on offer and the relatively small differences between their prices. I don't think Julien has presented any mechanism to suggest why banks would suddenly want to maximise profit after a rate rise but wouldn't beforehand—or why they'd suddenly be able to ignore their competitors but couldn't beforehand. It's possible there is one, but I can't see that he's explained it. Overall I suspect I've missed something crucial, so I welcome any more comments Julien has on the issue.

Why we can't plan the economy part DXVI

This is a lovely little tale from Paul Ormerod in City AM:

Igal Hendel and Yossi Spiegel document the evolution of productivity over a 12 year period in a steel mini-mill, producing an unchanged product, working 24/7. The steel melt shop is almost the Platonic ideal from a national accounts perspective of output measurement. The product – steel billets – is simple, homogenous, and internationally-traded. There was virtually no turnover in the labour force, very little new investment, and the mill worked every hour of the year. Yet despite production conditions which were almost unchanged, output doubled over the 12 year period. As the authors note, rather drily, “the findings suggest that capacity is not well defined, even in batch-oriented manufacturing”.

This is a product of the point that Hayek made, that all knowledge is local. This increase in production from the same assets and workforce came not because anyone outside the plant had anything at all to do with it. There was no governmental either mandate, nor advice on how to do it. There was no technological breakthrough, no scientist involved, no research. Simply people getting better at doing something simply by doing that thing. And note that production doubled in 12 years just from this factor.

This isn't something you can do by plan nor is it something that can be accomodated in a plan: for obviously it's not true of all processes all the time. Another blow struck against the idea that the centre can possibly detail how an economy should work.

Yes, we do indeed still need the centre, there are some things that can only be done there. But as I've remarked before we should be using central government only for those things that both must be done and can only be done by central government.

A lie can be half way around the world before the truth has got its boots on

This is a little story close to my heart in the day job:

"I think there is a great commercial potential on the moon," he added, citing significant reservers of helium 3, which is rare on Earth and which could be developed into a clean energy fuel ideal for nuclear fusion. The lunar soil is also rich in coveted rare earth elements: 17 chemicals in the periodic table that are in an increased demand because they are heavily used in everyday electronics. "There are a vast amount of opportunities for a wide variety of companies not only in America but across the globe," Gold insisted, emphasizing Europe and Japan, as well as the US Congress, are enthusiastic about a return to the moon.

The lunar soil may indeed be rich in rare earths: I have no idea myself but it could be. However, absolutely no one, ever, is going to try and mine rare earths on hte Moon and then return them to Earth. It simply isn't going to happen.

What I think has happened here is that people have absorbed the stories of the past few years about impending shortages of the rare earths. All that stuff about China reducing exports of these metals so vital to modern electronics. And thus there's a feeling that any deposit of them, even somewhere as inaccessible as the surface of the Moon, must be something that people would want to exploit.

The problem is in the initial story: yes, China did limit exports but that does not mean that there's any shortage of these minerals here on out little planet. Several of them, individually, are as common as copper down here. And we produce millions upon millions of tonne of that each year while we use only 140,000 tonnes of all 17 rare earths together. There's simply no long term shortage.

And there's absolutely no way therefore that anyone's going to try and mine the Moon for things that can be had down here for $10 a lb.

My major point here being that these people are apparently basing their plans about lunar mining on something that simply never will be mined up there: at least not for returning down here. And it's inevitable that if you start basing your plans on untruths then your plans are going to fail at some point.

Quote of the week

"The miracles of the past three and a half centuries – the unprecedented improvements in democracy, in longevity, in freedom, in literacy, in calorie intake, in infant survival rates, in height, in equality of opportunity – came about largely because of the individualist market system developed in the Anglosphere. All these miracles followed from the recognition of people as free individuals, equal before the law, and able to make agreements one with another for mutual benefit."

– Daniel Hannan
How We Invented Freedom & Why It Matters

Why financial regulation fails

The supposed prime objective of banking rules and regulation is to protect and reduce risk. As the credit crisis has clearly demonstrated regulation has failed to do so. Despite this the proposed solution is more regulation.

Rules and regulations are focused on mechanically risk weighting loans and allocating capital against that perception of risk in a prescribed formula that sounds complicated and is complicated. The capital charade and secrecy with government backing for large banks and almost all deposits means market scrutiny is all but removed from the banks. Detailed P&L and balance sheet data only goes to a few regulators opposed to the many that deposit, invest and research the banks thus limiting market review, risk assessment and analysis.

There is also a major skill set asymmetry with the many PhD brains of the banks easily able to outwit a few £60,000 a year PRA and BoE staff. Consequently the SIV CDO3, inverse IO and many other regulatory compliant but circumventing structures and strategies are created. The fixed formula driven official capital ratios all look to be unchanged at a level we are told is strong. The risk weighting of a loan to a business that is 1000% geared with no sales is the same as a loan to a 1% geared business that has a 50% operating margin from 50 year government contracts. The market would never be so simplistic and will always look forwards opposed to regulators that tend to look backwards. The market would allow much more leverage for genuinely low risk lenders and require much less for high risk lenders.

Today all banks essentially work to a very similar core capital ratio. The regulation based system allows banks to disclose as little as possible to as few as possible, complicating obscuring and circumventing. A market based system would encourage transparency, simplicity and full disclosure to as many as possible. Without regulation there would be little restriction on new banks being created and consequently there would be more specialists and more competition.

The abolition of regulation would make banks less risky. With banks that are too big to fail and deposit protection all banks can borrow cheaply regardless of the risks they take. Removing this will require banks who want cheap deposits to prove they are worthy of them. A market based pricing structure will be created with each bank having to fight for its funding. With very low real deposit returns the demand for disclosure, balance sheet transparency, simplicity and capital strength will be high. Where this is not the case real returns for depositors will be high.

With depositors now determining how much capital is required for any given deposit cost the subordinated debt now, now not ranking in line with the depositors will be priced based on the preference and equity capital structure. Today return on equity is maximised by reducing equity as much as the rules will allow with there being no correlation between capital strength and funding cost. In a market driven world the key funding cost will fall as equity increases. The correlation analysis below shows not only that pre-crisis capital and risk were inversely correlated, but also that risk and return were even more strongly inversely correlated. The strongest inverse correlation is, however, between Growth and Risk.

With rules based regulation that evolves slowly and usually only changes after a major problem banks can easily manipulate their balance sheets to comply with the letter if often not the spirit of the regulation. With the market/depositors setting a bank’s funding cost, the risk perception and analysis of anything new, complicated, or unclear should immediately impact the bank. Consequently the banks focus will shift to genuine economic profit based risk and reward analysis opposed to regulatory arbitrage.

Over time better banks will secure more funding at better terms rewarding appropriate risk assessment with those who operate inappropriately way failing. Evolution will be returned to the banking sector by the removal or regulation. Largely unregulated sectors such as retail have evolved rapidly providing customers with the Amazon service they desire replacing the Woolworths service they do not.