Ring-a-ring-a-fences

The Parliamentary Commission on Banking has reported this morning and, like most of the talk leading up to and since the Vickers Report, is pre-occupied by ring fencing.  Vickers, as you will recall, dealt with the demands for separating retail and investment banking by proposing that those banking groups involved in both should have separate subsidiaries for those sectors with no links between them.

Government discussions since then have been seen by some as, under pressure from the bankers, watering down the Vickers proposals.  The Parliamentary Commission, au contraire, claims that Vickers did not go far enough and the fences should be “electrified”, i.e. any infringement would lead immediately to full separation.  Sir John Vickers himself, in an email to the Today programme, quickly responded by saying that full separation would be an own goal.

What is weird about all this is that the financial crisis had little if anything to do with the lack of such separation.  Retail banks, like Northern Rock, and building societies created a bubble of huge unrepayable debts and, quite separately, banks packaged up those “assets” to conceal their true nature and then played pass the parcel with the packages.  Lehman Brothers was purely an investment bank.  The entities that created the crash were already separated and separating the other groups would do nothing to prevent a future crash.

What is even weirder is the failure to recognise that banking today is an international, if not fully global, market.  Financial solutions have to be found internationally.  The Basel group are doing their best to achieve that and we now have three “Accords”. They focus, quite sensibly, on ensuring banks are adequately capitalised for the businesses they run.  One can, and I have, criticised their proposals as an over-reaction which will penalise small businesses, but the point here is that the rest of world’s top regulators are not worrying at all about ring-fences.

Another part of the international dimension which the Parliamentary Commission fails to recognise is the EU involvement.  Uncertainty about that undoubtedly contributed to the Northern Rock crash as Professor Tim Congden and others, including Sir Mervyn King, have pointed out.  The UK is in course of handing financial regulation over to Brussels but what is for us to do and what for Brussels is unclear.  The only thing that is clear is that the EU’s interventions will damage the competitiveness of UK banks and increase the costs for taxpayers.

So, not unusually, British chattering classes are dancing around playing ring-a-ring-a-ring-fence when the rest of the world gets on with regulating the real financial market.  It is truly astonishing that this Commission should choose to focus its entire attention on the area that matters least.  The consequence of adopting their suggestions, as Vickers himself seems to be pointing out, can only be that we will hobble our own financial sector at great cost to the economy and the British taxpayer.

But, but, people invest in order to get their profits back in their own pockets!

The US has a high corporation tax rate. The US also doesn't charge that tax to profits made outside the US and kept outside the US. Therefore, obviously, US corporations keep the profits they make outside the US outside the US. You know, that first great secret of economics, incentives matter?

Back a few years a temporary solution was suggestedL bring back the profits and we'll charge you only a teensie rate: many did. Again, incentives matter. Now there's vast mountains of money sitting offshore and perhaps that low tax trick might be tried again. Mebbe: but a common argument against it is the following:

ABSTRACT: This paper analyzes the impact of the Homeland Investment Act of 2004, which provided a one-time tax holiday for the repatriation of foreign earnings and thereby reduced the cost to U.S. multinationals of accessing a source of internal capital. Lawmakers and lobbyists justified its passage by arguing that it would alleviate financial constraints. This paper’s results indicate that repatriations did not lead to an increase in domestic investment, domestic employment or R&D—even for the firms that appeared to be financially constrained or lobbied for the holiday. Instead, estimates indicate that a $1 increase in repatriations was associated with a $0.60-$0.92 increase in payouts to shareholders—despite regulations stating that such expenditures were not a permitted use of repatriations qualifying for the tax holiday. The results indicate that U.S. multinationals were not financially constrained and were reasonably well-governed. The fungibility of money appears to have undermined the effectiveness of the regulations.

Note that this is used as an argument against the tax holiday, not in favour of it. when obviously it's an argument in favour of it.

The basic error is to think that investment is something only done by companies with the money that they have internally: thus the shock at the idea that shareholders might get some of their own money back. When in fact, all the really important investment in hte economy is actually done by individuals in new businesses: not by old ones ploughing back in their profits.

No, obviously, the amount of new investment is very much smaller than the amount of reinvestment. But that's not what I mean. The things that really change economies, that bring in the new disruptive technologies, are the entry and exit from the marketplace of firms. Which by definition means the creation of new firms able to do the entering (and exit of those going bust of course). And who are the people most likely to invest in a business from the outside? Clearly, those who have already shown that they will do so by virtue of the fact that they hold equity in a business or two.

At present there's some vast amount of money offshore in those corporations. $1.2 trillion, $1.7, estimates vary. Assuming that it is a good idea that this money leaves the Bahamas or wherever and gets injected into the US economy (which I think it probably is) then this argument about dividends is piffle. The very fact that it is likely to be paid out in dividends is the very reason why it's a good idea. For putting it into the hands of investors increases the chances that it will be invested in new businesses: the long run lifeblood of economic growth.

Note to the TUC: Your own opinions? Fine: but you're not allowed your own facts

Now we all know that the past 30 years has been the triumph of neoliberlaism, where we who own capital get to trample the faces of the workers into the dust. Stealing the bread from the mouths of children and cackling gleefully as we do so. Something which the TUC would like to bring to our attention in this report. Where they use this little chart.

Which is interesting, don't you think? The profit share has risen, the wage share fallen, QED, we're screwing the workers.

Except, except, those numbers don't actually look right to me. For this is something that has been looked at repeatedly in recent months. Here's a different attempt at protraying the same information:

As you can see, the decline in the labour share is the same. But instead of a rise in the profit share being the cause we've a rise in mixed income (essentially, the self-employed and as there's more of them why not) and a rise in taxes minus subsidies: that's largely I believe the rise in VAT over the time period.

It's actually quite important for us to work this out of course. If the labour share has fallen because us capitalists are stealing it all then that's one thing. Perhaps Hurrah! and perhaps Boo! depending which side you see yourself on. If it's simply a result of a rise in self-employment then it doesn't really matter either way. And if it's as a result of a rise in taxes well, the prescription will obviously be to lower taxes. So we'd really rather like to know which of these two sets of numbers is correct.

There's definitely something hinky going on between the two sets of numbers. Both do sum to 100, as they must. My problem is that the TUC's numbers just refer to "ONS figures from the Blue Book" while the second set actually tell us which specific figures are being used (The relevant series used here are CGBZ, DTWM, CGBX, CMVL and YBHA.). And I'm afraid I'm not enough of an economist (nor statistician) to work out what hinkiness is being perpetrated here.

So I throw it open to you: what is it that the TUC has done to give us this decidedly non-standard view of how income shares have changed over the decades?

A libertarian defence of 'social justice'

The economics of Christmas

George Monbiot has cannily saved himself a few quid by flagging up his intention to scrimp on Christmas presents this year. Conveniently dropping the narrative of Austerity Britain for a moment, Monbiot has gone back to his ‘Bring on the Recession’ phase, complaining that since our “every conceivable want and need has been met” we shouldn’t waste our money buying our nearest and dearest Terry the Swearing Turtle for Christmas. “Bake them a cake,” he suggests, “write them a poem, give them a kiss, tell them a joke, but for God's sake stop trashing the planet to tell someone you care.”

So it’s a satsuma in a stocking for poor Mrs Monbiot and all the little Monbiots, as they gather environmentally sustainable winter fuel for their socialist household. But perhaps the anti-consumerism miserablists have a point. Christmas is a time when resources are misallocated and unwanted tat is exchanged. According to one study, the average recipient values their gifts at ten per cent less than their market price. That may be an underestimate. Of the roughly £8.5 billion spent on yuletide gifts in Britain last year, £2.4 billion’s worth—more than a quarter—were unwanted.

In strict economic terms, the most efficient gift is cold, hard cash, but exchanging equivalent sums of money lacks festive spirit and so people take their chance on the high street. This is where the market fails. Buyers have sub-optimal information about your wants and less incentive than you to maximise utility. They cannot always be sure that you do not already have the gift they have in mind, nor do they know if someone else is planning to give you the same thing. And since the joy is in the giving, they might be more interested in eliciting a fleeting sense of amusement when the present is opened than in providing lasting satisfaction. This is where Billy Bass comes in.

But note the reason for this inefficient spending. Resources are misallocated because one person has to decide what someone else wants without having the knowledge or incentive to spend as carefully as they would if buying for themselves. The market failure of Christmas is therefore an example of what happens when other people spend money on our behalf. The best person to buy things for you is you. Your friends and family might make a decent stab at it. Distant bureaucrats who have never met us - and who are spending other people’s money - perhaps can’t.

So when you open your presents next week and find yourself with another garish tie or an awful bottle of perfume, consider this: If your loved ones don’t know you well enough to make spending choices for you, what chance does the government have?

The Benefit-Industrial Complex

Anyone following the progress of the government's “Universal Credit” welfare reform program will know that (1) its signature provision is the creation of the so-called Benefit Cap limiting the amount of benefits that any one person or family can claim in a given week to £350 or £500, respectively.

Lesser known is (2) that “under Universal Credit, the default position will be that all housing costs for both social and private sector tenants” – currently paid out as a single, discrete benefit but soon to be subsumed within the benefit cap – are to be paid directly to claimants, whereas previously it was paid directly to claimants' landlords.

That the second of these proposals should be controversial is a little surprising, considering the fact that paying one's rent is the sort of thing most people will do for a substantial majority of their working lives. So I was puzzled to see Mark Easton, BBC News' Home Editor, excoriating the government, and accusing it of being “secretive*... on a matter that affects the lives of hundreds of thousands of the most vulnerable people in Britain”: the proposal to, in his words, “force social housing tenants to pay their own rent”.

Easton's objections followed three lines. First, he argued, social landlords' business plans rely on suffering only 2% aggregate arrears; such plans would be thrown into disarray if Housing Benefit claimants are given responsibility for managing their own affairs (which, he argues, would increase monthly arrears to as much as 30%). Second, he continued, existing social tenants have “little or no experience of monthly budgets,” get their benefit in cash weekly, and therefore are not predisposed to – or capable of – managing their own finances. Finally, he concluded, many have not chosen to access banking facilities or do not have regular access to the internet, both of which are necessary to use the new Universal Credit regime.

The capacity argument has been invoked frequently in relation to the Universal Credit – Shelter, for example, made representation during the public consultations preceding the 24 November Report of Session on Universal Credit that there is “considerable apprehension as to how many social tenants will manage their incomes”.

This argument is probably honestly made out of concern for humanity and backed by evidence. That it also makes it morally appropriate to burden the taxpayer for the market risk of landlords in the Housing Benefit tenant market arising from failure on the part of welfare beneficiaries to manage their finances is another question, especially when we consider the practical character of the libertarian reply.

Human beings have paid rent with reassuring frequency for millennia and statutory frameworks have regulated these payments since 1772 – 1772 B.C.E., that is (cf: the Code of Hammurabi, sections 50 and 51). Furthermore, the internet access required by Universal Credit is available free of charge at public libraries and for a small fee on mobile phones and at internet cafes around the country. The internet is used daily by billions of people of all ages, creeds and nations, and with highly variable degrees of intelligence. It is no stretch to say that able-bodied adult British claimaints of sound mind should be able to combine these two competencies and pay their bills.

Politically, Easton's concern for social landlords and their businesses is more interesting. Trials of the beneficiary-pays system have shown that the increase in arrears has made letting to DWP tenants uneconomic, and the reform means that private sector landlords “will pull out” of the benefit claimant housing market (at page 93) – a problem amplified from the perspective of local authorities who are duty-bound to find housing for these persons and “increasingly... have to advise people to look for housing in the private sector.”

What is left unsaid by Easton is the scale of the private sector's involvement in welfare provision relating to housing. It is vast. In Northern Ireland alone, the Select Committee's report notes, “we think ['think?'] there are 60,000 private landlords who currently receive payment of Housing Benefit direct – about £250,000,000 a year” – £4,100 per landlord, or £148.00 for every man, woman and child in Northern Ireland. While I do not have exact figures to hand, if this were extrapolated on a per-capita basis nationally, the level of private sector benefit realised would rise to nearly £10 billion – roughly 45% of the total Housing Benefit bill, and nearly 1% of GDP, roughly equal in heft to the 2012 Olympic Games.

Viewed thus Housing Benefit is less a welfare program than a national industry, operating on the scale of value-added giants like automobile manufacturing (£54bn) or defence (£45bn) and capable of distorting the market to the detriment of the working taxpayer. As a component of income allocated towards housing, Housing Benefit has long outstripped private wages. As a subsidy it disrupts the supply of property for private renters, providing what is in effect a national minimum rent while driving up rents for non-beneficiaries in the process, thus striking the propertyless taxpayer from three directions.

And as a safety net it fails too – while senior editors of the BBC and Labour MPs invoke in the system's defence the inability of its beneficiaries to demonstrate the financial acumen of a Bronze Age Babylonian tenant farmer, the Commons Work and Pensions Committee report on the subject states, matter-of-factly, that “many benefit claimants will never be able to take up or return to work.” When the question of whether Britain can continue to afford its welfare state is an open one, this is clearly the wrong approach.

Quite irrespective of the relative merits of welfare provision, the existing system is ripe for reform. The government's efforts to date are a welcome first step.

*  So secret, in fact, that his article was published a full two days (24 November) after a report published by the House of Commons Work and Pensions Committee on the subject (22 November), and after months of public consultations with interested parties. But I digress.

The Benefit-Industrial Complex

Housing benefit is a national industry, says Preston Byrne. In this article he argues that it sustains a national minimum rent and drives up rental costs for everyone.

Anyone following the progress of the government's “Universal Credit” welfare reform program will know that (1) its signature provision is the creation of the so-called Benefit Cap limiting the amount of benefits that any one person or family can claim in a given week to £350 or £500, respectively.

Lesser known is (2) that “under Universal Credit, the default position will be that all housing costs for both social and private sector tenants” – currently paid out as a single, discrete benefit but soon to be subsumed within the benefit cap – are to be paid directly to claimants, whereas previously it was paid directly to claimants' landlords.

That the second of these proposals should be controversial is a little surprising, considering the fact that paying one's rent is the sort of thing most people will do for a substantial majority of their working lives. So I was puzzled to see Mark Easton, BBC News' Home Editor, excoriating the government, and accusing it of being “secretive*... on a matter that affects the lives of hundreds of thousands of the most vulnerable people in Britain”: the proposal to, in his words, “force social housing tenants to pay their own rent”.

Read this article.

We really do need to lower UK corporation tax rates you know: They're the highest in Europe

There's a rather sad misunderstanding about corporation tax in the UK at the moment. Everyone seems to think that we've got a low corporation tax here. When we don't in fact: we've got rather a high one. Oh, sure, we've a low headline rate: but that's very much the smallest part of corporation tax. The much more important part is what are the reliefs, the allowances, what can you claim back, what is actually taxable. Which gives us the effective rate:

It's very difficult indeed to describe the highest EU corporation tax rate as "low". The difference is, while we've a low headline rate, we also allow many fewer exemptions from having to pay that low rate (largely Nigel Lawson's work I believe).

And the importance of this is this:

This isn't just a theory: It appears to be true for that most economistic of organizations, the multinational corporation.  When multinationals are deciding which country to invest in, they don't pay that much attention to marginal tax rates.  According to Glenn Hubbard, 

 

...investment location decisions are more closely related to average rather than marginal tax rates. 

 

When making the go/no-go decision, corporations care more about their long run tax bill.  That's because the marginal decision is the go/no-go decision.

 

Yes, average and effective tax rates are the same thing.

 

It's not good enough our just having a low or competitive headline corporation tax rate. We also need to have a low effective rate. Good grief, at the moment we're twice Ireland's rate.

Monopolies only work if they're not contestable

A little story from the annals of my corner of the weird metals industry. You'll recall all those stories of how the Chinese had cornered the market in rare earth metals. Then the wily Orientals rather scrutably decided to, once they were 97% of the supply, restrict exports, reduce production and rub their hands with glee as they collected monopoly profits. All in all an example of how they had got it right through industrial planning and we in our free market foolishness had got it wrong.

So let me bring you up to date with what's happening:

The shares and rare earth prices plunged in 2011 as buyers pursued alternative raw materials and used stockpiles. Lanthanum oxide, a rare earth used to refine gasoline, has dropped 53 percent this year, according to Shanghai Steelhome Information data. Cerium oxide, used in glass polishing, has declined 56 percent and neodymium oxide, used in magnets, has fallen 46 percent, the data show.

Prices have indeed done that. But not particularly for the reasons mentioned, although they play a part. The real reason is this:

Molycorp and Australia's Lynas Corp (LYC.AX), some of the few rare earth producers outside of China, are ramping up production even as prices have dropped sharply since early 2011, dragging shares of other producers as well. "We remain very concerned about what will happen as new supplies from Molycorp and Lynas totaling 57k tonnes hit up against a ROW (rest of the world) demand estimated at 40k tonnes in 2011 ...," J.P. Morgan analyst Michael Gambardella said in a note to clients.

Here's what really happened. China did indeed end up with a production monopoly on rare earths. For they were willing to sell as much as anyone wanted at a price they were willing to pay. (A small personal note, the one rare earth that I really deal with I used to import into China, as it was the only one they didn't in fact produce in quantity.) Oooh! A monopoly, that's bad!

But as soon as they tried to exploit that monopoly then, given that rare earths aren't rare (nor earths), people started to contest that exercise of monopoly power. To the point that prices are falling, we're looking at over supply at current price levels. In fact, Bayan Obo, the largest Chinese mine (and the world's) was closed for November in a bid to keep prices up. There's even more. Another of the Chinese producers, Jiangxi, is largely owned by the family of the incoming Chinese President, Ji Xinping. And there's been quite a lot of rules and regulations trying to put some of the smaller operations out of business: on purely environmental grounds you understand.

And yet global prices continue to fall as global supply rises.

Which brings us to an interesting observation. Monopoly, purely and simply as monopoly, is neither a bad nor a good thing. If someone's the lowest cost producer and can supply total demand then why the heck not leave it as a monopoly? The difficulty comes if someone attempts to exercise those monopoly powers, to gouge consumers in some manner. And for many to most monopolies the exercise of such power leads to competition and the breaking of that monopoly power.

This isn't always true: and we should most certainly take action when that competition cannot, for whatever reason, arise. But as long as a monopoly is contestable then there's usually pretty much nothing wrong with the existence of said monopoly. As the Great Rare Earths Scare of the last few years shows us. As soon as anyone tried to rook consumers by exercising that monopoly the monopoly disappeared.

Free markets beat central planners once again. Oh Dear, such a shame, eh?

50,000 views for our "Economics is Fun" videos

Among the most fun things I did this year was the series of short videos about economics.  My book Economics Made Simple was published in January, so I decided to upload some YouTube videos to put across its basic ideas in a snappy way, taking only about 3 minutes for each. They were not really scripted, except that they were based on the book.

Xander stepped in, and there were just two of us.  I was presenter and he handled cameras, lights, sound, filming, cutting, editing and graphics.  We recorded them over a three-week period, doing several per day.  I picked up whatever was to hand at the last minute to use as a prop. For the first one I collected the office bell on the way up to the mezzanine overlooking the street, and rang the bell for each error.  We deliberately tried to keep them user-friendly and with an amateur look to them, instead of a slick finish. I wore a different T-shirt for each of the 20 videos.

The series took off well, and we advertised them on Guido's site to keep up the momentum.  The total views now exceed 50,000, and we've had many invitations to give talks to schools from teachers who've seen them.  We called the series "Economics is Fun," and it was.  It's much better than calling it "the dismal science."