Meanwhile, over here in reality Sweden shows how laissez faire capitalism makes people rich

As we all know Sweden is burdened with an extraordinary tax burden, one so heavy as to crush all things of beauty within that country. But that's the price that has to be paid for the glories of an icy social democracy of course.

As many fewer know Sweden (along with Denmark) is, underneath that tax burden, actually a rather more economically liberal place than either the UK or the US. That's how they can manage to cope with that staggering tax burden and still have economic growth. But there are still those who think that Sweden gained its current wealth as a result of that tax burden that finances that social democracy. And Johan Norberg has an excellent essay out showing that this last part of the story simply isn't true. Sweden grew to wealth under something very much like laissez-faire. It's only once wealth was achieved that the tax burden rose:

Sweden had the fastest economic and social development that its people had ever experienced, and one of the fastest the world had ever seen. Between 1850 and 1950 the average Swedish income multiplied eightfold, while population doubled. Infant mortality fell from 15 to 2 per cent, and average life expectancy rose an incredible 28 years. A poor peasant nation had become one of the world’s richest countries. Many people abroad think that this was the triumph of the Swedish Social Democratic Party, which somehow found the perfect middle way, managing to tax, spend, and regulate Sweden into a more equitable distribution of wealth—without hurting its productive capacity. And so Sweden—a small country of nine million inhabitants in the north of Europe—became a source of inspiration for people around the world who believe in government-led development and distribution.

But there is something wrong with this interpretation. In 1950, when Sweden was known worldwide as the great success story, taxes in Sweden were lower and the public sector smaller than in the rest of Europe and the United States. It was not until then that Swedish politicians started levying taxes and disbursing handouts on a large scale, that is, redistributing the wealth that businesses and workers had already created. Sweden’s biggest social and economic successes took place when Sweden had a laissez-faire economy, and widely distributed wealth preceded the welfare state.

This is the story about how that happened. It is a story that must be learned by countries that want to be where Sweden is today, because if they are to accomplish that feat, they must do what Sweden did back then, not what an already-rich Sweden does now.

I thoroughly recommend the entire piece. And do note the most important point: wealth first, then worry (if you so wish) about the equity and the fairness. Get this the wrong way around and you'll never have the wealth to worry about the distribution of.

Why Britain should embrace entrepreneurship

Guy Myles, managing director at Octopus Investments, welcomes The Entrepreneurs Network, a new think tank set up by the Adam Smith Institute.

It’s hard being an entrepreneur. You work every hour God sends. You have people depending on you for their livelihoods. And you’re taking levels of risk most people couldn’t even contemplate.

On top of all that, you probably feel you’re on your own. Within your company, it may be you’re the only one shouldering real responsibility, while the wider world can feel like hostile territory, where you go into battle all by yourself – fighting for finance, for customers, for less red tape, and most of all for recognition.

It’s crazy that we as a country should let entrepreneurs feel unloved or isolated in this way. After all, we’re relying on them to create the jobs and sales that are helping to get the UK economy back on its feet. And they deserve to have their voice heard.

Making a difference in communities

Part of the problem is that smaller businesses don’t attract the attention that commercial giants get, even though their contribution to the economy may be just as important. If one of the big supermarkets unveils plans for a new distribution centre, or a car manufacturer decides to build its latest model in the UK, you’re bound to see it in the news. But if a local furniture factory gradually doubles its staff from, say, 20 to 40, few people will find out. Yet the impact of those extra jobs on shops, tradesmen and support services in the area could be enormous.

That’s why Octopus Investments is so pleased to be sponsoring The Entrepreneurs Network (TEN).  We work with entrepreneurs all the time. They’re great fun, but we see at first hand exactly how much support they need. The ones we back tend to have businesses that are already established. They’re looking to take things up to the next level, and they’re invariably hungry, not just for money, but for ideas, contacts and encouragement.

Why continued support is so vital

We make a point of helping out in any we can. Completing an investment is just the start of the story. Whenever we invest in an unquoted company, someone from Octopus will sit on the board. One CEO has told us this helped him keep his eye on the big picture, without micro-managing. Another said the Octopus director offered a strategy for breaking into the US market.

We came up with the idea of hosting regular forums, such as breakfast seminars, for CEOs from our portfolio companies. These events give them a chance to swap stories and hear how other businesses are coping with challenges and capitalising on opportunities. We may focus a session on a specific sector – such as media, technology or telecoms – but it’s great if we can also create cross-fertilisation of ideas between businesses in completely different fields.

Keeping up the pressure for change

So, we’re hoping The Entrepreneurs Network will provide a bigger arena where entrepreneurs can support each other. But it’s in the area of public policy that I hope TEN can make a real difference. We desperately need a body that can lobby government and policy-makers on the many issues that affect smaller businesses. To take just one example, a major area of complaint in recent years has been the length of time it can take to get work visas for staff coming in from abroad. This is the sort of problem where we need to keep pressuring the government to take action.

As it happens, the UK isn’t such a bad place to set up a business. A report from the World Bank’s Doing Business project put us seventh out of 185 countries on the ‘ease of doing business index’ for 2013. The survey looks at everything from getting building permits and electricity connections to enforcing contracts and trading across borders.

The worrying point is that the UK has slipped a couple of places down the rankings in the past few years. And there are countries like South Korea, Georgia and Malaysia coming up fast behind us. We have to keep working to make the regulatory environment as supportive as possible for small businesses, and that’s the challenge we’re all hoping TEN can rise to.

Guy is co-founder and Managing Director at Octopus Investments.

Bank bail-ins: needed, or misguided?

Like other businesses, banks get money from shareholders. When a business fails, the shareholders are first to take the hit. And banks also raise money from bondholders – investors who give them cash in return for an IOU.  But in the recent financial crash, innocent taxpayers bailed out the banks – the bondholders were largely unscathed. So now there are moves towards a ‘bail-in’ system – where bondholders forfeit before taxpayers do.

It’s good politics, but is it good finance? I’m really not sure. If bondholders face higher risk, they will demand higher interest. Banks will have to pay more to raise money, and will pass on the higher interest charges to customers. Right now, that could tip a number of businesses and families over the edge.

There are established legal rules about who loses what when a firm gets into trouble; but the ‘bail-in’ proposals would see regulators deciding who pays what. That’s a recipe for injustice: one can easily envisage regulators discriminating in favour of domestic bondholders, for example, and against foreign ones – after all, the foreigners have no votes. And among domestic investors too, those with political clout are likely to be favoured over others.

When things are booming, of course, bail-in bonds will look safe as houses, and their value will rise. But the slightest doubts about the security of a bank will see them plummet. Like the Basel II capital rules, people will find themselves selling off other assets to raise cash – depressing the price of what they are trying to sell and forcing them to sell even more in a market spiralling downwards. Bail-in bonds might well worsen the panic and losses that go with financial crises.

When banks run out of credit and investors run out of cash, the only agency left standing is the central bank. And traditionally, central banks have been the lender of last resort to a struggling banking system. Which means taxpayers’ cash is called on. Some people argue that this is in fact far less messy than forcing bondholders and others to try to raise cash fast on a falling market – which inevitably brings real losses.

Equally, I do not see why taxpayers should be called on to save any business that has got itself into a mess. Is banking any different? Perhaps it is. But only because of the fractional reserve system, the government guarantee of depositors’ funds, and the fact that the huge burden of bank regulation stifles competition in the sector. A better solution is, like Switzerland, to have much higher capital requirements on larger banks – so encouraging the banks to split themselves up, and encouraging new banks to start up. Competition is the best regulator.

The chocolate covered pickle version of why politicians get it so wrong

Don Boudreaux is of course correct here. Well, of course he is, he's Don Boudreaux:

Asymmetric information of the sort that many professional economists get worked up over might in principle be discovered and spread more widely by government regulators. But information about people’s subjective preferences can never, not even in principle, be known by government regulators. And yet much government regulation is proudly justified by politicians, regulators, and intellectuals on the grounds that people allegedly will value X by amount $Y once they actually encounter X. In private markets such guesses are harmless.

A private, unsubsidized firm that guesses that enough consumers will value, say, its new-fangled jar of chocolate-covered pickles by at least $4.00 per jar will actually find out if its guess is accurate or not because each individual has the choice of actually forking over $4.00 per jar (and getting a jar) or not forking over that sum (and not getting a jar). When government acts, in contrast, no such discovery procedure is available to test politicians’ guesses about people’s subjective preferences. People must pay for what government foists on them. And no process of knowledge discovery or information revelation is available to cure politicians’ and regulators’ inevitable ignorance of the subjective preferences of the very people that they pretend they are seeking to help.

I not only agree in theory I can tell you, as someone who has actually had a chocolate covered pickle (Don means here a gerkhin, of the type served with a hamburger) that that combination of vinegar, salt and chocolate is indeed, to a certain palate, delicious.

But, as ever, I would take this point much further. I have, in my working life, had some interaction with politicians. And bureaucrats as well. I have even sat across the table from a trio of North Korean generals trying to explain why, well, no, we didn't trust the North Korean state and yes, we really would like a letter of credit from them (one which their bank then refused to issue on the grounds that they didn't have any money).

That further point I would take it to being that the asymmetry of information is not in favour of those Godlike beings who pretend to rule us. It is in fact in favour of us, the people who know what we're doing, not in their favour. Just as with journalism (everyone who ever reads a newspaper piece on their speciality finds things wrong with it) so with politicians and bureaucrats. In my particular world of real expertise I've seen the US Congress stampeded into action by the insistience that China has 30% of the world's reserves of rare earths.

Indeed, it does, but all then thought that that meant that China had 30% of the world's potential supplies of these vital metals: not so. It means only that China has 30% of what anyone has bothered to map out, drill, test, check and prove that it could be mined at current prices and with current technology. Everyone in the world of rare earths ended up sniggering at the politicians. Couldn't they understand this very basic point about what the phrase "mineral reserves" means? Well, no, they couldn't: and so it is with anyone else with real world expertise who examines what our leaders seem to believe about things.

I accept entirely The Boudreaux's point about no one except the consumer understanding the consumer's desire or utility. But as I say, I take it further and insist that politicians and bureaucrats do not understand reality, the nuance and specialist knowledge of anything at all.

Sadly, we do need to have them as there really are things that need to be done that can only be done with the coercive force that government can bring to bear. But it is precisely that asymmetric information, that ignorance of our rulers, that means that we should and must limit their influence to only those things that both must be done and can only be done by government. For the rest of it we know more than they do so we should be left to get on with it.

Fortunately there's really not that much slavery in the UK

Having even one person in slavery here in the UK would be one person too many of course. Having anyone anywhere in slavery would be entirely terrible but we are rich enough and liberal enough that we should have none at all. Fortunately, there's a new report out that shows us that while the problem is real it's small.

United Kingdom Estimated number enslaved 4,200 – 4,600

That puts us as rank 160: no, the higher the number the better the rank and we scrape into the top 10 of the nations they've studied here.

But this of course creates a problem. For who can forget Dennis MacShane telling the House of Commons that there are 25,000 slaves just in the sex industry? Or Harperson alleging much the same thing? Julie Bindel and her friends at the Poppy Project insisting that there are vast tribes of women held as sex slaves, there only to be repeatedly raped for the benefit of others?

Well, the solution to this problem is that this report is actually defining slavery properly:

1 Recruitment, transportation, transfer, harboring or receipt of persons. 2 By means of threat or use of force or other forms of coercion, of abduction, of fraud, of deception, of the abuse of power or of a position of vulnerability or of the giving or receiving of payments or benefits to achieve the consent of a person having control over another person (these means are not required in the case of children). 3 With the intent of exploiting that person through: Prostitution of others; Sexual exploitation; Forced labour; Slavery (or similar practices); Servitude; and Removal of organs. (UN Trafficking Protocol, 2000).

Note that trafficking requires all three. For example, transportation, with their consent, of people into the sex industry does not count as trafficking nor as slavery. And odd as it may sound there are indeed people entirely willing to offer up a short term rental of their bodies for the sexual gratification of others. And, unsurprisingly, they'd rather like to do this in a high wage country like the UK than in the perhaps low wage countries of their origin. Thus they migrate for the work.

There is indeed a small problem with slavery in the modern UK. One that we should indeed be doing out best to combat. But the larger numbers bandied about are the result of either hysteria or political manipulation. As Operation Pentameter showed us there's no perceivable instances of sex slavery going on: why on earth would there be given the willingness of some to do the work anyway?

The ideological drift of Nobel laureates in economics

The new issue of Econ Journal Watch is online. It is a bit different from most issues, being devoted to a survey of the ideological stances of 71 Nobel economists – with profile of all of them.The aim is to assess how their opinion changes, and whether Nobel economists tend to become more or less classical liberal throughout their lives.

George Mason economist Daniel Klein led the project, a very substantial piece of work. Twelve of the laureates replied to a questionnaire seeking to identify their ideological outlooks at different times in their lives. Klein discusses the results in an audio podcast. The bottom line? Most of the Nobel economists (51 of them) did not noticeably change their views. Of those that did, a larger number grew more classical liberal over their lives than grew less classical liberal.

On Russell Brand's misunderstanding of profit

The former Mr. Katy Perry took to Newsnight this week to display to all of us his ignorance of economics.

And after a few textbook political dodging of the question, Brand, 38, finally laid down his revolutionary manifesto which would create: 'a socialist egalitarian system based on the massive redistribution of wealth, heavy taxation of corporations and massive responsibilities for energy companies exploiting the environment.'

Hmm. I wonder whether we can manage it without starving 8 million Ukrainians this time. The fallacy at the heart of his prejudices though is this:

'David Cameron says profit isn't a dirty word, well I say profit is a filthy word,' the comedian passionately declared. 'I think the very concept of profit should be very much reduced because wherever there is profit there is also deficit. This system currently doesn't address these ideas.'

Ah, no. Entirely misunderstanding what is going on here.

Profit is simply the proof that value is being created. Leave aside for a moment who is getting that profit and consider what it actually is. We have the costs of our doing something: whatever those costs might be in labour, wages (no, not the same thing), raw materials, other inputs and for purists, the opportunity costs of doing something else with all of these things. We also have the income from having done this thing, whatever it is. All profit is is the acknowledgement that the income is higher than hte costs of having done it. Thus value has been created.

And we like people creating value: it's really rather the point of having an economy at all, creating value. For if no value was being created then there wouldn't be any value for us human beings to consume.

Indeed, we can go further. The opposite of profits is losses: they being an acknowledgement that  value is being destroyed. What is being produced from our process is less valuable than the things we are using to do the production. There is therefore less wealth to share around: people are all poorer therefore.

Losses are the destruction of economic wealth, profits the creation of that wealth.

Now, we can indeed mumble to ourselves over who gets these profits. We can even note that the consumer surplus (which is the profit accruing to consumers from that production with profit normally being defined as the value created flowing to the producers) is usually vastly higher than those "profits".  But even as we shout about the distribution of profits we must all recall the most important point here. Which is that we very much desire that profits be made. For they are, by definition, the proof that economic value is being created, that the value of output is higher than the value of inputs.

And that really is what we want in an economy, an increase in value creation.

Is economics a science?

There should be no Nobel Prize in Economic Science, says economist Liam Halligan, because economics is not a science. It was, of course, only added (by the Swedish central bank) some 75 years after Alfred Nobel's death; but recipients get the same grand medal and scroll, get to shake hands with the King, and give a lecture.

Halligan cites this year's award to Eugene Fama and Lars Hansen of Chicago University, and Robert Shiller of Yale, jointly honoured for "laying the foundations for the current understanding of asset prices". Understanding? As Halligan says, "You may be forgiven for thinking that no one truly understands asset prices. The global stock market turmoil of recent years is surely testament to that."

The sad thing is that economists are so keen that their subject should be thought of as a science that they have infused it with many of the tools and approaches of the physical sciences – making it look more like applied mathematics than the study of (decidedly non-mathematical) human beings that it really is. I often say that, through their intense application of mathematics, the mainstream economists of today pride themselves on a more and more precise understanding of things that the rest of us know are complete tosh.

Under all the equations and algorithms, Fama's 'rational markets' idea is quite simple: markets quickly price in all new information. And since information itself can change quickly, the short-term movement of markets can be hard to predict.

That is plainly true: people in markets would soon find themselves losing money if they did not take account of the facts. However, there is more to human life (and therefore to markets) than mere facts – as both Hayek and Keynes knew. Halligan sums up this point with a phrase that should be engraved onto the computer screen of every supposed economist:

"...it obviously makes sense that share prices reflect all available information.... But they also clearly reflect rumours, supposition, herd-instinct, prejudice, hubris, pessimism and a myriad of other immeasurable qualitative factors, including occasional madness...." That's humanity for you. Good luck trying to model that.

The govt is finally catching up with the ASI

A second day for the ASI to celebrate. It may have taken HMG four years to catch up with our policy on a bad bank, but it took just six months for our arguments on green taxes to win through. In April’s blog, “An end to Zombie politics”, we called for the government to “suspend surcharges on energy bills [and] subsidies to energy suppliers or technologies”. Yesterday Cameron told the House of Commons that he is doing just that. There has been a certain amount of backing and filling since, with today’s Times suggesting that the Government may pick up costs no longer funded from energy bills. This sort of robbing Peter to pay Paul misses the point. The most recent IPCC report altogether rejects the alarmism formerly propelling green policy. In addition, reviews of the climate change literature point to the benign effect for the next fifty years of such warming as may occur. To use the slogan of climate change campaigners, “the science is settled”, that is settled against the expensive green policies which the government seems set to abandon.

And while in self-congratulatory mood, let’s note that our call for an acceleration of shale exploration was endorsed overnight by the National Trust, also reinforced by the agony of the Grangemouth complex, unable to compete with cheap American feedstock.

Whatever next? Let’s set up our scorecard on the policies we were calling for earlier in the year.

The rediscovery of classical economics

It is appropriate that David Simpson should preface his new book The Rediscovery of Classical Economics with the famous 'road less traveled by' poem by Robert Frost. For his purpose is to put forward an alternative to the equilibrium economics that has dominated the subject for nearly a century. His alternative is classical economics, in the tradition of Adam Smith, Marshall and the Austrians. In their view, economic growth is the thing to study; they see markets as a dynamic process rather than as static; and they focus very much on human nature rather than seeing economics as a series of detached, static, mechanical models.

The reliance on equilibrium economics leads to some systematically bad policy mistakes. The mainstream economists tend to assume knowledge, such as the lowest-cost mix for production, that the classical economists point out must be, sometimes painfully, discovered. Knowledge, and how dispersed pieces of partial information are used and co-ordinated by market players, is critical, but the mainstream economists and their policymaker counterparts again assume that they can do better themselves, from the centre – a fatal conceit. And the mainstream economists again assume that people are rational in their economic behaviour – which, says Simpson, does not reflect the reality of the world that we are trying to understand.

The book shows how classical approaches provide a much better understanding of how market economies work than does equilibrium theory. All economics is about human behaviour – something often forgotten by the mathematical modellers – so Simpson starts with looking at human being, the limited information they have and their hopes and expectations, and adaptive nature. Adaptation of course means constant change, and the book looks at how markets adapt to change in an incremental, voluntary and self-organising way, another useful lesson for policymakers.

Simpson sees the process of policy formulation as another evolutionary, adaptive process, though of course the motivating factors are different. And they are much more complicated than the simple business objective of turning a profit, which is why government policy is so often confused and contradictory. Simpson concludes by extracting some key principles from the Austrian economics including some insights on the severe limitations of mathematical analysis in economics.

Readers who have that uncomfortable feeling that economic policymakers and the economists who advise them have a less than complete understanding of what they are doing will find out, from this book, why they are right to think like that. I hope both economics and policymakers read the book, as it will make them far more aware of their own limitations when it comes to managing the economy – which is not a sort of machine you can easily tinker with, but a complex, dynamic network of economic processes that is quite good at organising itself.