It's a double-whammy today: growth and market failure. In this video, Madsen discusses how and why an economy grows — why we are better today than Julius Caesar was in his day. Maybe the most commonly-stated goal of politicians, far too few of them realize what growth really is.
Government infrastructure spending won't stimulate growth
Next week the Chancellor will deliver a much-anticipated budget. With calls for tax cuts, tax rises and regulatory reform, the line between politics and economics will be a difficult one to tread. However, many commentators and politicians seem to be in agreement on one thing: that ‘infrastructure investment’ would be a boost to the economy, reinvigorating the construction sector and adding to the nation's productivity. Hence we have projects such as HS2 and £6 billion announced in the last year’s autumn statement for roads and other rail projects. These measures are supposed to create jobs in the short- and the long-term whilst bringing the country's transport infrastructure into the 21st century. In the US, too, President Obama has been keen to point to ‘shovel ready jobs’ available through government infrastructure spending.
We should all be worried when politicians start spouting platitudes about the highly unrealistic benefits of these projects. The great myth of the success Roosevelt’s New Deal no doubt lingers in the minds of policy makers. But the truth about government infrastructure is wildly different from the conventional wisdom.
It is a fallacy to believe that the government can allocate resources effectively to meet future economic needs, instead of entrepreneurs. What advocates of state infrastructure spending fail to grasp is that government cannot suddenly acquire the knowledge as to which parts of the UK’s infrastructure either needs repair, replacement or, indeed, which new projects should be undertaken. The economy is dynamic and never static. The government cannot predict what it will look like in 30 years time, whether there will be an increase of manufacturing jobs in the northeast or high tech in the midlands. This is simply not possible to anticipate into the next twenty or thirty years.
The argument commonly made for infrastructure spending is that it will have a kind of Keynesian multiplier effect. Private construction firms will be employed, idle resources will be put to use and money will start to circulate through the economy as people spend their newly earned wages. But this, again, is untrue. Government infrastructure drains the economy of resources and, even in the short term, stops resources from being used elsewhere. These decisions are difficult even for the private sector, which relies on price signals. Sometimes the private sector fails, sometimes it succeeds, but because it is the investor's money that is on the line it has a reason to act rationally. Government lacks the information to act wisely, and the incentives to act prudently.
In Japan, large government infrastructure projects have failed to lift the country out if its low growth high debt slump. In the UK, many cities have built tramlines, which have almost universally turned out to be loss makers and failed to promote growth.
Entrepreneurs, not state bureaucrats, will be best to judge whether a particular project is worth the risk. The history of white elephant infrastructure projects is one that seems to repeat itself with each new administration. Let us hope that the politicians fail to match their rhetoric with our money.
Running for liberty
This weekend, our friend Hunter DuBose (pictured left) ran the Bath Half Marathon in support of the Adam Smith Institute. Love the t-shirt, Hunter!
That's right, dear readers, we inspire such devotion and enthusiasm that people are prepared to run for 13 miles just to help fund our efforts to advance free markets and individual liberty.
It is worth reminding readers that even though we give almost all of our work away for free – whether it's this blog, our reports, our student programmes, or admission to our events – it does cost money. In some cases, quite a lot of it.
We don't take government funding. And contrary to popular myth, we don't get very much from big corporates either. So, ultimately, we depend on the generosity of individuals who share our ideals to make everything we do possible.
If you like the work we do, and you want to see us become a bigger, better force for liberty, please consider lending us your support. It's easy – all you need is a credit card!
If you'd like to know more, get in touch with me (tom@old.adamsmith.org) or Sally (sally@old.adamsmith.org). And don't worry – we won't make you run a half marathon unless you really want to!
Every little helps
David Henderson quotes Robert Guest's new book Borderless Economics:
When people try to think of ways to ease global poverty, they seldom mention migration. They tend to instead think of things like microcredit. There is nothing wrong with microcredit (the lending of small sums of money to poor entrepreneurs). It has lifted many people out of poverty, which is why Mohammed Yunus, whose Grameen Bank pioneered this approach in Bangladesh, won the Nobel Peace Prize in 2006. Yet, as Mr. Pritchett points out, the average gain from a lifetime of microcredit in Bangladesh is about the same as the gain from eight weeks working in the United States. After doing a quick calculation of the total benefit that Grameen Bank confers on its clients, he asks, mischievously: “If I get 3,000 Bangladeshi workers into the US, do I get the Nobel Peace Prize?
Indeed. I give to Kiva.org regularly and I'm very happy to support the good work they do. Nevertheless, information like this makes me think about how much more effective my money might be. That, and how much richer the world would be if we were more open to foreign people working in our countries.
So: what charity can I give to that smuggles poor people into rich countries?
The cost of ‘fair access' will be higher fees
Last time I posted here, I attacked Professor Les Ebdon’s plan to poison the well of British higher education by subjugating the admission criteria of our best universities to ‘progressive’ political priorities.
However, before and after that article I’ve found that ‘merciless meritocracy’ is insufficient to sway some of my progressively-minded student friends. Equalising university access chances between high-achievers and the rest is ‘fair’. So entrenched is their opposition to selective and private education, or even the ‘internal market’ of parent choice, that the argument that it is schools that have failed similarly go nowhere.
So we who support the continued excellence of our top-flight universities need a new argument. One less vested in meritocratic principle not shared by our opponents, and grounded in something that both sides understand. Something like money, for example.
The case is fairly simple. Since Tony Blair engorged it, higher education in this country has become very expensive for the government to provide. As a result, governments have had to introduce fees, which have not been popular with students. Yet the fees for enfranchised domestic students have been held down by the much higher fees charged to international students.
International students are one of the financial keystones of UK higher education, worth “billions” of pounds per annum. The Guardian figures from 2009 show that foreign students were facing fees of up to £20,000 a year.
International students are willing to pay such fees, for now, because the UK’s best universities rank amongst the best on earth. With access criteria designed to ensure global competitiveness and attract the best and brightest from around the world, universities like Oxford, Cambridge, Imperial College et al are maintaining their global position despite the slump in the UK’s relative performance in secondary education exams.
However, if we start channelling less capable students into these institutions in the name of ‘fairness’, what do we think will happen?
For a start, the universities will have to expend ever more time and resources bringing their entry-level students up to the standards required for rigorous undergraduate study. It is also probable that the standards of attainment by graduates will fall as people who weren’t ready pass through the system.
Sure, in domestic terms the government can undoubtedly nobble these results: we will doubtless start seeing ‘value added’ degrees to maintain the illusion of attainment if the likes of Ebdon have their way. But in international terms, our comparative results will slump.
Much more directly than secondary education results, this will matter. If our universities are not internationally competitive, they won’t attract the same quality or volume of international students. The cost in global connexions and revenue could be astronomical.
Once the universities lose this lucrative source of funding, the only ways to make up the shortfall will be higher fees for students or higher taxes on the general population. Poorer students will find themselves taking on more debt for degrees whose value is decaying.
All in the name of ‘fair access’.
The Coalition’s new home loan scheme: just a carrot for floating voters?
Taxpayers will guarantee deposits for new houses up to £500,000 under the government's New Buy Guarantee scheme. Many buyers find it difficult to raise 20% (or more) deposits and this scheme will allow them to buy houses with as little as 5% deposit.
Home ownership is certainly a plus for society as a whole – it gives people a stake which encourages responsibility. It is also a form of saving, which reduces the risk of ending up on welfare; and it builds up a lever to finance future entrepreneurship (most entrepreneurs self-finance their venture). Home ownership is in decline and is becoming increasingly difficult for first-time buyers.
So is this New Buy Guarantee scheme the right way to encourage home ownership? I don’t think so, for a number of reasons:
1. Taxpayers will be forced to take the risk for people who may not be able to repay their mortgage. Arguably, requiring a 20% deposit is a pretty good indicator as to whether a buyer risks defaulting. Why should people who are prudent with their money have to pay for risks taken by others?
2. Mortgages to uncreditworthy borrowers triggered the crash of 2008. In America, Freddie Mac and Fannie Mae were set up to expand the mortgage market: they bought mortgages from lenders which allowed the lenders to issue new mortgages. Freddie and Fannie were implicitly guaranteed by the government and thus the taxpayer. George Bush Sr and Bill Clinton forced Freddie and Fannie to take on ever greater shares of mortgages to the poor, thereby encouraging banks to give mortgages to uncreditworthy borrowers. This was the root cause of the crash. Who receives a mortgage should be the private sector’s responsibility (for both profit and loss); not the state’s.
3. It is true that it is more difficult than ever for first-time buyers to get onto the housing ladder. But this scheme is not limited to first-time buyers. Claiming that its aim it to help first-time buyers is misleading.
4. Whose fault is it that first-time buyers find it so difficult to raise a deposit? The government’s. Inflation has been pushed up by quantitative easing and artificially low interest rates, which make saving unattractive and raises the price of housing. (It is naïve to suggest that the Bank of England is independent in this matter.)
5. Property prices have shot up through a shortage in housing supply. Planning regulations create a stranglehold on new developments.
6. The measure is specifically aimed at the construction industry. There is a whiff of “picking winners” to this. The market is much better placed to allocate its resources as to maximise return and growth. Governments tend to pick losers because they lack the information dispersed among millions of individuals in the market – Hayek’s “knowledge problem”.
For politicians, schemes like this are love at first sight. They allow them to claim credit for “results” they can boast about come polling day. An ordinary tax cut won't convince specific categories of floating voters such as first-time buyers to vote for them. The figure of 50,000 jobs has already been plucked out of thin air. No doubt this new scheme will allow politicians to claim credit for any uplift in the construction industry, irrespective of whether it's related to this scheme or not.
There is a better solution:
- Reduce taxes to make it easier for people to save so they can take care of themselves – including saving for a mortgage.
- Extend the stamp duty holiday for first time buyers. It runs out on 24th March.
- End the artificially low interest rates and stop money printing to encourage saving, reduce inflation, and reduce asset bubbles.
- Continue the reform of planning law to make house building easier. [ed — see our recent paper Planning in a Free Society for ideas] Take some of the heat off by introducing private compensation legislation to operate between developers and individual neighbours to compensate them for loss to their property’s value resulting from development.
Weekend notes
Detlev Schlichter is on typically forceful (and, yes, depressing) form over at Paper Money Collapse.
We should accept that deleveraging is ultimately unavoidable. If it comes with a period of deflation – so be it. But we will get neither. The system will be sustained at this stage of arrested collapse for as long as policymakers can get away with it. My outlook is that we will get even bigger central bank balance sheets (forget exit strategies! There is no exit!), we will get no sustained growth but inflation will creep higher.
The noisy advocates of easy money and of government stimulus always pretend to care for Europe’s unemployed youth. It is today’s youth that would have most to gain from a cleansing correction now, and it is those who already made their money and who sit on inflated assets and overstretched balance sheets that have most to gain from the central bank’s policy of extend and pretend. That is, until the whole thing goes pop anyway. Which won’t take too long.
In the meantime, the debasement of paper money continues.
Have you read his book yet? If not, get your copy here.
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Charles Murray's new book 'Coming Apart: The State of White America, 1960-2010' seems to be stirring up a lot of debate. His thesis, as I understand it, is that the gap between a new upper class and new lower class of Americans is growing, but that it has far more to do with diverging values, cultures and behaviours than economics. I haven't read it yet, but David Brooks says he'll be "shocked if there’s another book this year as important". For now, I just like Murray's comment to the FT on the race for the Republican nomination:
I am really unhappy with Obama. I really think he's terrible, but Romney and Santorum as the alternatives? Don't even think about Newt… I'm in despair. I mean, I'm a libertarian. I will take Romney over Santorum. And both of them over Newt. That's not a ringing endorsement, I know, but what can you say about such a field?
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On the other hand, for all his flaws (and they are many) Mitt Romney has at least said something exciting about tax - he plans to cut marginal rates by 20 percent across the board. As Fraser Nelson wrote in the Telegraph last week, Britain's Conservatives should take note. They won't win the next election by chasing opinion polls and running scared from the Left's renewed class warfare. They need to craft an aspirational agenda that is worth getting out of bed to vote for. As it is, all the Tory leadership is talking about is which taxes to raise to provide cover for scrapping the 50p tax rate (which isn't actually raising money anyway). They blame the Liberal Democrats, of course, but the real problem is that they are themselves completely unprincipled.
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In happier news, I was delighted to see the Wall Street Journal's Mary Anastasia O'Grady endorse the legalisation of cannabis on Fox News. Ever so gradually, the tide of opinion is turning against America's deadly, destructive, disastrous war on drugs. There is even talk that Colorado voters will approve a ballot initiative to legalise and regulate the production, sale and consumption of cannabis this November. Now there's something I could bring myself to vote for.
Economics is fun, part 14: Opportunity cost
Today, Economics is Fun takes on that critical concept, ignored all too often in politics and the media: opportunity cost. Madsen shows that when you do anything in economics, you should always think about the next best thing you might have done instead.
If you want to drill down into the concepts discussed in these videos, Madsen's excellent book Economics Made Simple is available now.
On the Greek CDS market
To return to Felix Salmon (just because he's the one writing interestingly about a currently interesting subject) on the Greek bailout. I find it very difficult to understand the concerns he has. A CDS, a credit default swap, is a form of insurance against someone you have lent money to by purchasing a bond, defaulting on what they owe you. Greece has defaulted, this has been declared to be a credit event, the CDS will pay out and it would appear that all is well with the world.
Going forwards, then, I can’t imagine that investors will have much if any confidence that CDS will really perform the hedging function they’re designed for. My feeling is that if you look at the numbers for total single-name CDS outstanding, they’ll decline steadily from here on in. Because you ultimately can’t trust them when you really need them.
I really don't see that. The contracts have shadowed the bonds all the way down, they have been triggered and they will pay out.
But still, the whole CDS saga in Greece and elsewhere does rather feel as though ISDA is making it up as it goes along.
As I've mentioned before, I like this in a decision making system. In a legal system, as I've said. Far too many of the world's problems are caused by people trying to write rules to deal with any and every possible and impossible eventuality. I would much prefer a few basic ground rules, the accretion of precedents and then on top, the ability to look to both of those when those unthought of impossible things happen.
But it's this that really puzzles me:
The word that jumps out at me here is Restructuring. In Europe, restructuring counts as a credit event; in north America, by contrast, it doesn’t. Which means that the derivatives market was pretty lucky here. If the standard Greek CDS documentation had looked like the standard US CDS documentation, there wouldn’t have been a credit event,
I cannot see how the market was "lucky" simply because everyone has agreed to abide by the terms of the contracts they signed.
Oh, and just one more note, not about Felix. Now that the CDS have been triggered, now that we're going to see a settling of them all as a result of this "event". And given that we're not going to see the banking system of Europe fall over as a result, please, could we have a little less wittering about the evils and dangers of derivatives please?
Why drug legalisation probably won't increase drug consumption
We've long been in favour of drug legalisation around here. One obvious reason is that it's your body, you decide what you'd like to put into it, food, other people's (yes, even other peoples') body parts or interesting chemicals. A second is that legalisation cannot be worse than the current disastrous situation of gross coruption of the body politic and society.
But there is always that worry: won't legalisation increase consumption? At which point there's an interesting economic argument that no, probably, it won't:
Many people, on both the pro and con side, recognize that inelastic demand is the core problem with most drugs. Inelastic means not very sensitive to outside influences: illegal drug abusers can’t/won’t quit because their demand isn’t responsive to the usual laundry list of things that cause people to modify their other demands: price, income, and externalities like danger.
....
One of the prime tenets of economics is that demand is either elastic or inelastic, but it isn’t both (other than when we assume demand as a straight line because it allows us to use algebra). Demand can adjust, and become more elastic with the passage of time, but it’s still unlikely to go from inelastic to elastic.
The very problem we perceive with drugs is that people will do near anything to keep getting them. Which is simply another way of saying that demand is inelastic. If demand is inelastic then legalisation is unlikely to increase consumption very much.
Even I'm not sure that this is perfectly true but I do think it is generally so.