Why won't the environmentalists learn any economics?

Today's example comes from Canada but I get hugely and vastly irritated by very much the same thing over here. Quite simply the blind refusal of many in the environmentalist movement to understand what it is that economists are trying to tell them. Mike Moffatt (both an economist and a Green, so something of an unusual mixture) tells of his experience here. Taking David Suzuki to task for his illiteracy here.

“But if you ask the economists, in that equation where do you put the ozone layer? Where do you put the deep underground aquifers of fossil water? Where do you put topsoil or biodiversity? Their answer is ‘oh, those are externalities’. Well then you might as well be on Mars, that economy is not based in anything like the real world,” Dr. Suzuki goes on to say. Dr. Suzuki’s remarks on externalities were clarified in an interview given to the magazine Common Ground: “I won’t go into a long critique, but currently nature and nature’s services – cleansing, filtering water, creating the atmosphere, taking carbon out of the air, putting oxygen back in, preventing erosion, pollinating flowering plants – perform dozens of services to keep the planet happening. But economists call this an ‘externality.’ What that means is “We don’t give a shit.” It’s not economic. Because they’re so impressed with humans, human productivity and human creativity is at the heart of this economic system. Well, you can’t have an economy if you don’t have nature and nature’s services, but economics ignores that. And that’s an unbelievably egregious error.”

As Moffatt goes on to point out the idea that economists ignore externalities is a nonsense given how much attention is paid to them. Moffatt is also a lot politer with Suzuki's view than I would be or am. For Suzuki has got the point entirely bass ackwards. Economists do not say that externalities are not important because they're not included in the price system. Quite the opposite: the statement is that we've a serious problem because externalities are important things which are not included in the price system. And it's a serious problem because we do use the price system to calculate what to do and leaving important things out of such calculations is a serious problem.

Which is why all the discussion about externalities revolves around how do we get externalities included in our decision making process? We could use regulation, yes, and at times that is indeed the appropriate way to do it. See Coase's Nobel winning work for when this is so. With other such problems it might be that tweaking the price system is the appropriate solution: see Coase again, or Pigou (come on, that's from the 1920s, you'd sorta expect people to have picked up on it by now) or even M'Lord Stern and his review on climate change. Assuming it's all happening then the solution is to tweak the pricve system by imposing a carbon tax. And then we're done, dusted and problem solved.

That other people place different values upon the environment than I do worries me not in the slightest. It is precisely such differences of opinions about value that make a market. What does annoy me intensely is that almost all of the environmental problems that are currently being complained about have indeed been studied by economists. And they've found solutions to them as well. Just about any and every environmental problem is either about externalities or common access to a resource. In many ways these are just the flip side of exactly the same problem. But we do indeed know how to solve each of them and both of them. Hardin on ownership or regulation, Pigou on tax or regulation, both mediated through Coase on transactions costs (with a decent assit from Ostrom on communal ownership). There, that's it: far from economics ignoring matters environmental economics has solved the damn problems.

So why won't the environmentalists listen?

High Frequency Trading: Yes, Smith Did Say This Would Happen

It appears that all of these nefarious high speed traders are not, as all had thought, making vast profits. Rather, they've come up against a limitation to the system which is seriously reducing their profits. Meaning that regulation and action to stop HFT is really rather moot:

Now it appears the advantages of speed are starting to dissipate, and being the fastest trader isn’t worth what it once was. High-frequency trading profits are expected to fall 35 percent this year, 74 percent below their peak in 2009. In an ironic twist, high-frequency traders have gotten so fast, they seem to have outrun their own profitability.

The specific problem they face is that their systems are now faster than those of the exchanges. Thus throwing money at getting faster doesn't do you much good. Rather like building a motor car that tops out at 250 mph when the speed limit is 70. Possible as a rich man's toy but not necessarily a profitable method of business. The car maker might make money but it's only the bragging rights for the user.

But the thing is Smith, Ol' Adam, did point out that this was the sort of thing that would happen. Someone might spot a new method of making excess profits: they go off and do so. Others note those excess profits and follow. In time, those excess profits get competed away and, with many a wobble, profits decline to normal levels again. In this very manner new profit opportunities are supplied with the capital necessary to exploit them and when they're exploited our adventurous capital goes off to look for further excess opportunities. In which manner the economy becomes ever more efficient and we all collectively get richer. Hurrah!

In an example of that search for further excess profit possibilities those HFT methods appear to be moving from the stock market over to the commodities markets. At which point Hurrah! again as they will become more efficient and we'll all get collectively richer again.

How about that, eh? Free markets lead to capital being optimally allocated. Who would have thought it? The chase for excess profit leads to it being competed away and in the process we all get richer.

Twenty-two crisis meetings and no solutions

So, 22 crisis summits on since the eurozone crisis erupted, are the problems now solved? Hardly. France was very keen to push towards much deeper economic integration of the eurozone. Germany, which will end up paying for it, wasn't so sure. What we have ended up with is an agreement to create a single eurozone bank regulator, sometime in the summer.

The problem isn't just that summer may be well too late. Record numbers of Spanish households and businesses have been defaulting on their debts, the Greek government needs more cash to stay afloat, and southern Europeans have been putting their spare cash into bank accounts in the north or property in the UK. Nothing seems to have changed since 22 summits ago.

Being British, I find it hard to be objective about the French, but their idea is actually basically right. A monetary union can only hold together if you have a fiscal union as well. That is, a centralised tax and welfare policy. That is because in a monetary union, states cannot devalue. A country that produces its own currency can respond to economic problems by devaluing – much as happened in the UK during the years after 2007. That makes its good cheaper abroad, boosting exports, and at the same time makes imports costlier, so people economise on them. Eventually, the country starts to recover. But states such as Greece and Spain cannot devalue. When crisis hits them, they really suffer.

The US has a monetary union between its 50 states – they don't all produce their own currency – but it is also a fiscal union. If there is a problem in one state, such as a devastating hurricane, federal funds go out from Washington. That buys the breathing space for the local economy to recover. The eurozone could in theory become such a monetary and fiscal union, and the problems of the Club Med countries could be alleviated – but only by turning the eurozone into an effective superstate, like the US federal union. The trouble is that Americans think they have a lot more in common with other Americans than, say, the Germans think they have in common with the Greeks. So few countries would submit willingly to that central control.

The compromise thrashed out this week is that there will be no all-out fiscal union, but a step towards it – a banking union with a single bank regulator, namely the European Central Bank. The idea is that the ECB can prop up failing banks in the troubled states, and so avert a financial crisis, without anyone going so far as to say tax, welfare and spending policy should be completely centralised.

The argument is that the ECB can exert some discipline on hopeless banks like those in Spain, or cash-starved banks like those in Greece. And maybe a touch of discipline like that would be useful. However, to put all the eurozone's banks in one regulatory basket is asking for trouble. Central banks have not proved themselves to be good regulators. The Federal Reserve, set up to end bank crises and closures, managed to close down the entire US banking system itself in the early 1930s. The Bank of England managed to turn a drama into a crisis by squeezing down on UK banks in 2008, just as they were running out of money – hardly fulfilling its role as 'lender of last resort'. It might well do a better job of regulating banks than the Financial Services Authority, which didn't even see the crisis coming, but it is hardly a shining example.

And this is the snag in the eurozone. A one-size-fits-all banking regulator will not actually fit everyone. And when it does make a mistake, the mistake will be catastrophic because it will affect the entire eurozone, not just a single country. It is asking for real trouble.

Rethinking the role of government

I post LearnLiberty videos on the blog a lot, but there's a reason for it: they're really good. The above video is no exception, and makes a mockery of the public debate around the US election, which has focused on trivial areas like PBS funding (0.012% of the federal budget; or three F-22 fighter jets). I'd love to do an equivalent for the UK, where the mandatory spending areas, particularly "entitlements" like health and pensions spending, are the vast majority of expenditure.

Prof Davies's point is critically important. Simple, straightforward cuts will not do -- we need a fundamental change in the government's role that removes it from provision of all but the most basic income support, and even then in the form of direct cash transfers, not government-run schools and hospitals. For this reason, I'm a little tired of the focus on specific, media-friendly spending cuts, which usually amount to a drop in the ocean but suit the nature of rolling, adversarial media coverage. I don't just want to get rid of the deficit, I want to cut nearly everything the government currently does.

Land underlies everything

The use and ownership of land has been perhaps the most important question facing societies going right back into antiquity. Arguably the biggest story in human history is the settlement of particularly fertile regions by previously nomadic people, and their attempt to protect the land they cultivate from still-itinerant tribes and those who want to settle the same patch. It lies at the heart of many armed conflicts: even today, conflicts such as Dafur are, at heart, battles between the pastoral and agricultural peoples of that region.

The private ownership of land is hugely beneficial, as it has been conclusively shown that private ownership is the only way of guaranteeing either resilience, sustainability and efficient land-use. This was the core of Garrett Hardin's seminal article The Tragedy of the Commons, published in Science in 1968 (interestingly, in a peer-reviewed natural science journal rather than an economics journal). It is also the subject of the work of the late Nobel laureate Elinor Ostrum, whose Hayek Lecture (delivered shortly before her death) will be published by the IEA in the autumn. Basically, if "everybody" owns something (e.g. fisheries), nobody husbands the resource and it is not used optimally; if we look to government to regulate this (e.g. again with fisheries) the results are invariably driven by political objectives, which rarely if ever align with sustainability.

On the specifics of land - and indeed all questions of "sustainability" - there is too often considered to be a trade-off between the present and future generations, with the future always presented as the victims of current greed. In fact, future generations are invariably better off than past generations, so to sacrifice the current for the future is doubly unjust. It is the temporal equivalent of denying improved living standards to the Third World because it might hurt citizens in the First World (in chronological terms, the 2010s are the Third World of the C21st).

The other advantage with a proper market in land is that it ensures that the choice of land for development is optimal - which means that it incorporates the desires of all concerned parties. To take the example of converting farms into housing, it is extremely unlikely that in a free market, an efficient and productive farm would be closed and converted into housing. Rather, it would be the marginal farms - those barely getting by, making a loss or surviving only on subsidies - that would be converted. This would not affect food security (which anyway is better addressed in the UK by opening up international trade and looking to improve yields) – it  might even free up capital which an enthusiastic farmer could invest in a new, more productive farm elsewhere. It would improve biodiversity, however, because farms are extremely bad environmentally – what I describe elsewhere as a " man-made monoculture of dubious environmental merit, that is for the most part closed to the public". The average back garden has more diverse plant and animal life than the average farmer's field.

Ultimately, land underlies everything, and not just literally. In the next couple of weeks, the IEA will publish a monograph on road privatisation, but (the authors frankly admit) road markets require entrepreneurs to be able to build new roads. Present planning laws make this very difficult. All parties agree that more homes need to be built in Britain, but planning laws are the major impediment to this. Food prices are too high in Britain because we have substantially less retail space than our continental neighbours, again as a result of planning laws. New school capacity, new hospitals, new airports… land, land, land.

Until we repeal our planning laws and free land owners and local communities to make informed choices about land-use, with the costs and benefits accruing to the owners and decision-makers, present and future prosperity will be a hostage of an ill-conceived nationalisation of land use that took place 65 years ago.

Independent Seminar on the Open Society - October 2012

The Adam Smith Institute’s Sixth Form conference - The Independent Seminar on the Open Society - was attended by over 280 students this October. The event focused on economics, offering students an insight into some aspects of the discipline which are not covered by the A-Level syllabus.

Dr Madsen Pirie began proceedings by speaking on the importance of economics. He debunked concepts such as the Marxist Labour Theory of Value and explained the impotency of mathematics in explaining human action. Those interested in such arguments should watch Madsen’s series ‘Economics is Fun’ which now has over 113,000 views.

Steve Baker MP put the case for markets as promoters of moral actions. While any moral code we know (including the secular portions of the commandments) have not been able to make all act morally, neither can markets make us moral. However, market institutions do promote and encourage moral behaviours.

Emily Skarbek introduced her research on the Chicago fire of 1871, a fascinating existence proof for community responses to natural disasters. The ability of local people with particular knowledge of the needs they faced calls into question the commonly held view that governments are best placed to deal with such tragedies.

Tim Evans reminded students that we do not have a free market in the United Kingdom. In fact, even the money we use is controlled in a distinctly soviet fashion. Indeed, the Berlin Wall of today is in our pockets. It is this state control of money that Tim argued will be responsible for the next financial crisis.

Chris Snowdon and Tam Fry debated the need for a fat tax to combat obesity in the United Kingdom. While Tam argued that obesity posed a coming crisis for the NHS, Chris argued that a tax would be ineffective and against the paternalistic tones of such a measure. The students voted against a fat tax.

The event attracted students from around 30 schools, with most rating the day as Good or Excellent. Teachers and students should note that our next ISOS event is planned for the Spring of 2013, and they can e-mail pete@old.adamsmith.org if they wish to receive further details.

High alcohol taxes are self-defeating

Not too long ago I wrote about the HMRC's 'most wanted' tax evaders list. As I pointed out, most of the criminals concerned were being given an opportunity to exploit high rates of duty and VAT on alcohol and cigarettes by smuggling. Similarly, this very revealing programme by BBC's File on 4 traces some of the types of and scales of frauds carried out in the alcohol trade. Unfortunately, the programme focuses on the types of frauds conducted and ignores some rather more important issues.

Duty on alcohol was substantially increased by March 2008 by the then-Chancellor Alistair Darling who introduced a four year tax escalator due to last until 2014, under which the duty rate on all alcoholic drinks was set to increase by two per cent above the rate of inflation. High taxes on alcohol must be seen as a regressive tax (of about 1.6% of disposable income) on lower income groups as it constitutes a greater percentage of their disposable income than the better off. HMRC reckon that £1.2 billion a year is being 'lost' to the Treasury due to these frauds, up from £400 million in 2001, which points to a significant and growing level of criminal activity. One of the interviewed police officers investigating these frauds, however, suggests that this may be a substantial under-estimate. 

Aside from the loss of revenue to the UK Treasury, it would be interesting to know how much the enforcement activities demonstrated in the programme are also costing the police and HMRC, not to mention the costs which they impose on legitimate businesses. Surely this suggests that rates of taxation have exceeded their revenue maximising point (to say nothing of their growth maximising point, although this is clearly a contentious issue where alcohol is concerned) and it is quite possible that a cut in duty would be self-funding, not only from a tax but also an enforcement perspective. Quite simply, lower rates of duty mean lower profits for smugglers and therefore less smuggling.

Contrastingly, the conclusions of Richard Bacon MP given on the programme are - given that rates of duty are unlikely to be reduced - that enforcement should be stricter, which would surely only increase the costs to the taxpayer. Mr Bacon believes that reduction in duty is unlikely because of the UK's parlous fiscal circumstances, but one wonders if this is supportable in view of the Laffer curve effects outlined above. He also suggests that the high rates of duty exist because of the desire to discourage alcohol consumption. This is contrary to evidence that alcohol consumption in the UK is actually declining, except among certain groups who are probably extremely price inelastic anyway or who, one suspects, are actually buying the smuggled booze itself! It is also the case that differential rates of VAT on off-premises versus on-premises sales are helping to encourage people to drink at home rather than in pubs. Availability of cheaper smuggled alcohol may also be a factor in this trend which has so seriously damaged the UK pub sector and is reckoned to have cost about 5,000 jobs here.

However, the programme also makes the point (which it does not go on to explore in depth) that the availability of illicit alcohol is actually pressurising legitimate retailers to drive down the price at which they sell. How much this is a factor in retailers' efforts to sell alcohol at below-cost prices and the resultant emergence of minimum unit pricing policies, which simply represent additional profits for retailers and smugglers, is hard to say. What is clear is that with alcohol, as with so many areas of public policy, government spends a great deal of money and resources attempting to correct the impact of problems is has created itself. It is also clear that rates of tax on alcohol, and much else besides, must come down - even the EU is arguing for that! 

The financial watchdog is barking

We are used to sabre rattling by financial regulators.  The last one told the industry to be very afraid of what the Financial Services Authority would do to them but, in the event, the only fearful thing was the FSA’s incompetence.  Martin Wheatley, CEO-to-be of the new watchdog, the Financial Conduct Authority, is barking similarly likewise.  According to the Independent on Sunday, he told the Association of British Insurers that he “will punish insurers and banks that make "excessive" profits”.

Quite how anyone, let alone a long-term financial bureaucrat, with little or no business experience, can determine what is or is not an “excessive” profit beats me and I’ve been teaching marketing for 40 years.  Perhaps RBS will be punished if it makes enough money for the government to sell off its stake.

But this is only one of the four all-seeing powers he expects to utilise.  The other three are “are making sure that firms develop new products, that they strive to offer better services than their rivals, and that the most successful banks or insurers are those that respond best to consumer demands.”

Wheatley should study the words of Adam Smith and seek greater understanding of how competitive markets work.  It would seem that he has little idea of brands or marketing or how consumers make choices and spend their money.  Wheatley’s apparent intention to tell suppliers how to do business would be ambitious if it were not ludicrous.

His insight that the most successful banks and insurers will be those that respond best to consumer demands runs the risk that they will thereby make excessive profits and need to be chastised by Headteacher Wheatley.  No doubt he will keep a cane for that purpose behind his door.

How exactly will he ensure firms develop new projects, especially when they are threatened with the cane if they succeed?

Wheatley’s reference to the payment protection insurance imbroglio is misleading.  Like so many disasters it was an unintended consequence of the government’s own policies.  The original concept was, and is, fine; the problems arose from the mis-selling.  The reason it became a disaster was that the regulator, then the General Insurance Standards Council, watched the mis-selling arise and did nothing about it.  Once again, the regulator either did not understand the industry or was too incompetent to move in promptly.  If the regulator had moved in swiftly, there would have been no disaster.  The FSA took over as the regulator in 1997 but 13 years passed by before, in December 2010, they addressed it with regulations for selling PPI.  The banks appealed the retrospective aspects of the new regulation to the courts.

Consumer complaints had been pouring in from 2007 so it was at least three years of FSA inattention.  In any case, there was no need to wait for the issue to be dragged into the courts as the FSA has quasi-judicial powers to discipline banks directly.

If Wheatley restricted himself to saying that the FCA would do their best to ensure fair trade in competitive financial markets, we would all cheer.  A regulator should seek to establish a culture which makes interventions unnecessary.  Consumers, if they are dissatisfied, can and do complain to the Financial Ombudsman Service.  If trends in such complaints indicate that external correction is needed, the Competition Commission and/or Office of Fair Trading (from April 2014 the Competition and Markets Authority) can wade in.

An ASI Briefing Paper to be released soon will show that we do not need the FCA at all and the unworldly barking by this new watchdog support that conclusion.

Don't believe the austerity hype

UK Chancellor of the Exchequer George Osborne has been warned by the International Monetary Fund that he risks further damaging the economy unless he slows the pace of austerity and faces up to Britain's 'growth challenge.

Er…what austerity? This graph, compiled by Veronique de Rugy of the Mercatus Centre, shows that UK public expenditure has been growing at a pretty solid pace, even in real, inflation-adjusted terms. If you or I were in debt as deep as the government's, we would aim to cut our spending and reduce it. But the government continues to increase its spending, and continues to borrow and add to its debt to finance it. Indeed, the Treasury expects that UK government debt will increase three times, from around £581bn in 2008 when the present crisis hit, to £1,500bn in 2015/16 which is as far ahead as the Treasury forecasts.

Public expenditure is, of course, notoriously difficult to cut. It involves making politically difficult and unpopular decisions. And indeed, during difficult times there are more people drawing unemployment and other social benefits, which are a very large part of the UK government budget. George Osborne's hope was that he could finesse things by hoping that the growth of people's incomes would outpace the growth of public expenditure, so that the relative burden of public spending would diminish, and less borrowing would be required. But given the general economic malaise in Western economies, and the disarray in the euro area in particular, our customers are not buying much more, even at the cheaper prices made possible by the downward slide in the value of the pound.

There is little sign of this changing in the near future. The only way to boost our earnings further is with a growth agenda of deregulation and tax cuts on business (such as a National Insurance holiday for small businesses), which would stimulate employment and investment. In the long term, however, we still need some mechanism to prevent governments simply borrowing to spend – such that they get the benefit while in office, but future government or future generations get the bill to pay. And it needs to be a mechanism that, unlike the eurozone's borrowing rules (or former Chancellor Gordon Brown's), does not fall at the first hurdle when the going gets tough.

Whether governments are ever capable of such self-restraint, however, remains a moot point. So let us start right now by looking at the things that are preventing businesses, particularly small businesses, from hiring and investing and expanding – and get government and bureaucracy out of their hair.

Ten very good things 10: Inequality

Where some look at people and wish we were more equal, I revel in the diversity of humankind, and in the different talents and skills we can make available to enrich the lives of others.  Inequality is my good thing number ten.

10.  Inequality

One of the great virtues of the human race is its variety.  We all have different tastes and different talents.  We value things differently, and through our choices, we give expression to our unique characters.  Freedom is valuable because it allows people to give effect to their own values and to live by the precepts they think are important.

It is because we are different that we co-operate in trade, with each party to an exchange preferring what the other offers.  Some of us are talented at music or sports, and have abilities that others enjoy seeing us exercise.  Some of us are creative and can think of new ideas to offer.  Some of us are risk-takers, eager to undertake new ventures in the hope of success.

This diverse and pulsating pool of different talents is what enables human beings to progress, to innovate, to strive for excellence.  People who want equality more than freedom are sacrificing the diversity that makes people strive for different goals, and they are compromising the creativity that leads humanity to improve and to progress.

Some people imagine a world in their mind in which people are equal.  This is not the real world with its rich diversity, so they often try to make that real world behave like the imagined one.  In doing so they sacrifice the freedom that enables people to live by their own values, and the variety that provides examples we might choose to emulate if we can.

It is not equality we should value, but opportunity.  An equal, but static society is less likely to provide people with the chances of fulfillment than one that allows them to advance towards the goals they think worthwhile.