Baumol's Cost Disease isn't quite what everyone thinks it is

William Baumol has just died and we must insist that the part of his economics we like the best is his investigation of entrepreneurship and technological advance. For his result gives us the background and theory as to why the empirical observation that it is freedom and markets Wot Does It is true.

But then we all know that.. It's the part of his work that all too many don't quite get which is our concern, the Cost Disease argument. The result is that services will become more expensive relative to manufactures as a society gets richer. The cause is that a richer society means higher labour wages - this is obvious, higher wages is the same thing as saying a richer society. Manufactures have some amount of labour embedded in them as do services.

But one of the ways that a society becomes richer is that we automate more of that manufacturing, thus having less labour embedded in our manufactures, while services don't undergo quite the same transformation. Thus, as labour becomes more expensive, the manufactures with ever less labour in them become cheaper relative to the services which retain about that same labour contribution. Agreed that's not quite the way it is usually presented but it's an explanation we find easy to understand ourselves.

The classic example of this, from Baumol himself, is that it still takes a string quartet exactly the same amount of time to play a piece as it did when Mozart wrote it. We can't make them more efficient by speeding it up. But we've automated much of farming so food is cheaper relative to string quartets than it used to be.

This is then used to go on to show why government will take an ever larger part of the economy, akin to Wagner's Law. Because we get a lot of our services, like health care and education, through government, services become relatively more expensive as we get generally richer et voila, cough up more tax you peasants!

Except there's a piece of Baumol missing from that latter idea. Which is that the true statement of Baumol's Cost Disease is that services will become more expensive relative to manufactures unless we automate services and so turn them into manufactures.

With the string quartet the obvious example is recording them once and then replaying the recording. This does hugely increase the productivity of producing music, even if not of live music. Similarly with health care. Time was when the treatment for a headache was a darkened room and a comely virgin to cool the brow with a damp cloth. This was an extremely low productivity activity for the young maid. We are now very much more efficient in our treatment of headaches for we have invented aspirin. Which is really a mechanisation of the darkened room etc and as a mechanisation something we can increase the productivity of.

Wagner's Law is not thus an inevitability, it's rather a measure of how good, or bad, we are at automating services. It isn't true therefore that government must become an ever larger part of our or any other economy. It could even be that we want it to be, but it isn't inevitable. It depends upon the technological advance of, for medicine say, pill making, for education of video and distance learning. And isn't that just where we think we are? On the cusp of new technologies making those things vastly more efficient and productive?

Brexit allows us to make West Africa richer

So here's a little proposal. Brexit means that we will be free of the European Union's insistence upon imposing tariffs on products from outside the bloc. This makes us richer of course, we get access to more cheap imports.

And as Madsen continually insists, we can make poorer people richer by buying things made by poor people in poor countries. So, why don't we decide to have zero import duties on things made by those poor people?

Ivory Coast and Ghana will work together to improve the organisation and sale of their cocoa, Presidents Alassane Ouattara and Nana Akufo-Addo said on Friday at the end of a summit.

The West African neighbours, the world's two biggest cocoa producers, will also improve coordination between their cocoa sector regulators, the presidents said in a statement after meeting in Ivory Coast's economic capital Abidjan.

Cocoa is vital to the economies of both countries and Ivory Coast has already slashed its 2017 budget due to plummeting global cocoa prices.

The two countries are also seeking African Development Bank funding to develop industries to add value to their cocoa with products such as cocoa paste and cocoa butter, which can be made into chocolate.

The major reason those countries have never developed a processing industry, are still stuck exporting only the raw beans, is the differential tariff structure:

Cocoa producing countries limit themselves to mainly exporting beans -rather than manufactured cocoa, or chocolate products- mostly because of tariff escalation. The EU has a bound rate of 0 percent for cocoa beans, but a 7.7 percent, and 15 percent ad valorem duty on cocoa powder and chocolate crumb containing cocoa butter respectively;

Similarly, Japan applies a bound rate of 0 percent for un-processed cocoa beans, but charges a 10 percent tax for cocoa paste wholly or partly defatted, and a 29.8 percent duty on cocoa powder containing added sugar;

The US has no ad valorem on cocoa beans, but imposes a duty of 0.52 cents/Kg for cocoa powder -with no added sugar- and tariffs could go up to 52.8 cents/Kg for imported chocolate products containing cocoa butter.

We can't tell everyone else what to do of course but why don't we make both ourselves and West Africa better off by abolishing these duties so that they can move up the processing chain?

Paul Mason still isn't understanding the Laffer Curve, is he?

That the Laffer Curve is obviously true at some level of taxation still escapes all too many people. 100% taxation of everything would leave no activity to be taxed and zero taxation of anything would raise no revenue. At some point inbetween there's a maximum amount of revenue that can be extracted from the system, quite obviously and quite clearly.

But even among those who manage to get that there are still all too many who fail to realise that each form of taxation has its own curve. We generally think - we think it's a bit high, true, others a bit low - that something like 40% on incomes is a rate which most people will cough up for. There are very few indeed who believe that a 40% VAT would have the same sort of effect. And no one at all who thinks that a 40% transactions tax, say stamp duty on housing or shares, would be an optimal level of anything at all let alone a tax rate.

Different taxes thus have different peaks of their respective Laffer Curves. Something which Paul Mason seems not to know: 

Windfall taxes on bank profits and on bankers’ bonuses, and a crackdown on offshore tax avoidance could – if Labour is prepared to be aggressive enough – collect serious amounts of money. So could a financial transaction tax. Touted for more than 20 years by economists on the centre left, the sums raised by a so-called Tobin tax may not be spectacular, because many of its benefits come in the form of financial markets reducing risk and suppressing speculation, thereby lowering any potential tax take.

But in February, former JP Morgan economist Avinash Persaud proposed a plan to extend the UK’s existing tax on share-dealing to bonds and derivatives. Even this modest proposal would generate £5bn a year. In the form advocated by the Trades Union Congress, it could raise at least £20bn.

That TUC version is from the egregious Richard Murphy so we know that that's going to be wrong. The only question, as ever, is in working out why it's wrong. Fortunately, one of us has already done that. The EU's own calculations of even a 0.1% FTT were that that was well above the peak of the Laffer Curve.

And it was truly above the peak too. We are not talking about people avoiding or evading the charge, leaving the country or anything like that. Such an FTT would lower share prices, make capital more expensive, thus lead to less investment and a smaller overall economy. A smaller overall economy from which the rest of the taxation system would be able to extract less revenue, even after we take into account the direct revenue from the FTT. And recall, this was the EU's own analysis of their own proposal.

An FTT loses tax revenue, not gains it, because an FTT at any rate is higher than the Laffer Curve peak for that particular type of tax.

Which is our message to Paul Mason and others who think there is some vast pot of tax money out there that can be gained. Kings and Parliaments have been trying to extract money from us for at least a millennium now. There are no pots someone hasn't tried to tax as yet, there is no miracle to extract more from us without our noticing. And yes, Art Laffer was in fact right at a certain level of tax rate, that rate dependent upon which tax we're talking about.

This word "liberal" is getting rather abused

The word liberal being so abused as to make near no sense in this from Giles Fraser:

The EU debate, now breaking out all over Europe, has flushed out the extent to which the so-called left, now overrun by liberalism, has largely abandoned this historical position. In this country, the liberal left now believes that support for the single market and economic free trade is the very thing that distinguishes them from a so-called hard Tory Brexit. This is an astonishing change of position. It used to be obvious to democratic socialists that the terms of international trade should be set not by the market alone but also by democratically elected governments subject to the will of their electorates. But the liberal left, perhaps not trusting how ordinary people (as opposed to more enlightened economic “experts”) might vote, thinks that trade should be free of the irritating interventions of democratic accountability. They want it to be frictionless – an irritating euphemism that ultimately means: not subject to will of the people.

The liberal project, from its inception (whether you want to start that with Smith, or Hume earlier, or Cobden later) has always been most insistent on the subject of trade.

It isn't nations that trade with nations, it isn't political entities which trade with political entities. It is individuals and associations of individuals - perhaps companies, perhaps cooperatives, but just groups of people - who then trade with individuals and associations of individuals.

Thus who should be able to trade, and how, with whom, is something to be left to individuals and associations of individuals. It is precisely by it being the people who trade who decide what and how to trade that trade is subject to the will of the people.

Instead of being run through the nation state, the thing which does not trade, and thereby be subject to hijacking in favour of special interests.

Perhaps not many people would be interested in Norwegian beef. But it's not the voice of the people that has placed a 344% import tariff upon it, is it? It's the concentrated interest of Europe's farmers that has led to that, and the 200% on such from Morocco, the 80% from Colombia.

The point of free trade is precisely that it is liberal, that it is the expression of the voice of the people.

But then in this diminished modern age we have rather fallen, haven't we? Time was when it was Bishops of the Church of England who mangled morality on our behalf, now we have to make do with mere Canons. Eheu fugaces, where is Spacely-Trellis these days?

We would not say that this surprises us

The House of Lords tells us that farming exports are hugely reliant upon access to the market of the remnant European Union:

Leaving the European Union without a trade deal in place could put up to 97% of British food and drink exports at risk, according to a House of Lords report that lays bare the agricultural industry’s overwhelming reliance on local markets.

As negotiations between the EU and British government appear to take a turn for worse, concerns are growing that failure to reach an exit deal could leave many industries facing steep tariff barriers in future – something government ministers hope could be offset by opportunities in other international export markets.

The latest Lords report on the implications of Brexit exposes particularly high dependency on the single market and associated EU trade deals among British farmers and food manufacturers.

We just cannot say that this surprises us. For as they also say:

It is the impact on farmers that is giving peers most cause for concern, and the report warns of a possible quadruple whammy from Brexit as they lose access to EU farm subsidies, European export markets, access to European workers and protection from a cheap imports from outside the EU.

The entire EU system is built so as to keep small scale Northern European farming viable. That's why those barriers against cheap imports, the things which would make the average person across the country so much better off. That's why the money lifted from wallets as tax to pay the subsidies. And of course that's why exports are so reliant upon those other places which have extortionately high food prices as a result of trying to keep small scale Northern European farming viable.

And, of course, the great promise of Brexit, that we can reconsider this and other such arrangements and decide whether they're worth it.

We think not of course. Subsidies these days are the single farm payment and that's just, as David Ricardo pointed out 200 years ago last fortnight, going to act as an increase in rental value and thus push up the capital value of land. Abolishing the system as a whole will thus reduce the capital requirement for anyone desiring to go into farming and thus, well, you know, make it cheaper to be a farmer? Plus, also, make food cheaper for all us consumers as the repeal of the Corn Laws showed that 150 odd years ago.

And it really is true that we're supposed to be doing our economic management for consumers, not producers. Abolish the entire system of agricultural subsidies and we'll all, in aggregate, be better off. Thus we should abolish all agricultural subsidies.

As we've been saying, nothing so conservative as a modern lefty

George Monbiot reiterates something we've been saying for some time now:

Conservatism takes three main forms. Inclusive conservatism seeks to protect objects of value for the benefit of everyone. These might include great urban vistas, or national parks, or wildlife, or works of art, or great institutions, such as the NHS and the BBC. This is the conservatism governments invoke when a nation goes to war.

For of course those are all the things that our current left scream are the national treasures and which must never be changed in any manner. That is, there's nothing quite so conservative as a modern lefty.

After that burst of truth we do find the main nub of his argument to be terribly, terribly, amusing:

In converting European law into UK law through the so-called great repeal bill, the government will grant itself the power, as its white paper states, “to correct the statute book where necessary”. “Correcting the statute book” will come to be seen as one of the great political euphemisms of our time.

The corrections will take the form of secondary legislation, which means using something called a statutory instrument. The government estimates that 800 to 1,000 of these instruments will be required – on top of the usual total – and their impact will be profound, as they are dealing with huge issues. In practice, there is almost nothing parliament can do to challenge them. As the Brexit analyst Ian Dunt points out, the bill is “shaping up to be the single biggest executive power grab in Britain’s postwar history”.

Statutory instruments cannot be amended. Due to a combination of government control over the parliamentary timetable and a number of arcane and archaic procedures, hardly any have been blocked in the 70 years of their existence. Already their power is freely abused. They are supposed to be reserved for technical matters: straightening out laws in ways that don’t alter our relationship to the state. Increasingly, they are used to sneak more significant changes through parliament. As the journalist Jane Fae reports, 1,900 a year were used, on average, by the last Labour government (a high enough number, which probably incorporated plenty of abuses); under the Conservatives this has risen to more than 3,000.

Unpicking EU legislation will be done by SI, which isn't a greatly democratic method, that's the argument. Which does rather miss the point that almost all of the EU legislation was imposed by SI without Parliament being able to reject it even if it roused itself sufficiently to do so.

That is, it seems just fine to use this method to impose the Brussels Terror but not to get out from under it.

We would, harsh though it might seem. categorise that argument as being a hypocritical one.

Polly has what she wants and yet still isn't happy

Not that we think this is odd, for we don't think Polly will be happy until we all do what we're damn well told and tug that forelock while you're doing it boy. But still, the internal dissonance in her own piece is quite wondrous:

 He is waiting to see whether in her election manifesto, Theresa May will turn out to have meant what she said in her “sacred text”, her single speech pitching for the leadership. She said back then that though the FTSE traded at the same level as 18 years ago, “executive pay has almost trebled” with “an irrational, unhealthy and growing gap” between bosses and workers. She pledged “to make shareholders’ votes on pay not just advisory but binding” with full transparency of “the ratio between the CEO’s pay and the average company worker’s pay”.

We entirely agree, shareholders are the owners of a company. The CEO and other executives are their employees. And employers should indeed decide what to pay their employees. Which is of course exactly what happens today:

This is the comical charade of governance, a half day’s embarrassment. When it comes to voting on top executives’ remuneration, those in the room press little buttons, then up on the screen comes the total of all institutional shareholders: result – 8,885,701,000 votes, or 96%, gifting Gulliver his £8m. It was never in doubt.

Quite why shareholders being able to do what Polly insists shareholders must be able to is a comical charade is beyond us bears of little brain.

But Polly does want us all to know that she's very unhappy about us all doing what she insists we must do, determine the pay of our employees. And don't you forget it.

Larry Elliott on Macron's problem

An interesting little example of how entirely sensible commentators can fail to see the implications of their own observations. Larry Elliott observes that Emmanuel Macron should be thinking about more than just supply side reforms of France's labour market. He's right, of course:

And that’s because the assumption is that all France’s problems stem from structural rigidity and the lack of labour market flexibility rather than from inadequate demand. The classic neo-liberal diagnosis is that the French state is too big and needs to be pared back through significant cuts in spending. Likewise, the French unions are too powerful and the unemployed need to price themselves into jobs by working harder for lower wages.

This has been the standard explanation of France’s economic woes ever since the abandonment of Keynesianism in the early 1980s. The abiding economic orthodoxy has held that low inflation should be the sole aim of macro-economic policy and should be achieved through control of the money supply; that fiscal policy - changes to tax and spending - is ineffective; and that the economy is a self-adjusting mechanism that will revert to full employment provided prices and wages are flexible.

France, in other words, was not giving up anything of real value when it joined the single currency because all that was required was for the European Central Bank to keep inflation low and for politicians in Paris to embark on meaningful structural reform.

The Keynesian take on France, by contrast, would be that adjustment to shocks tends not to be automatic but comes through the use of all the main economic levers: interest rates, the exchange rate and fiscal policy. The failure to deploy all these weapons explains why growth in the 12 original members of the eurozone averaged 3.4% a year in the 1970s and 0.1% between 2009 and 2015.

That is, rather, to assume that economic policy which I think is good policy is therefore Keynesian policy. Using the exchange rate, for example, is a standard part of any IMF program to pull a country out of the doldrums. And it was Milton Friedman's entirely correct critique of the euro before it even started, that the design did not allow the use of the exchange rate to cushion change. He didn't predict Greece or Finland or Italy specifically, but did point out the general point that when an asymmetric shock hit then not being able to use the exchange rate meant that the only solution would be that internal devaluation.

Or as we can also put it, only supply side policy.

But leave that niggle aside and consider what is really being said here. France has problems different and specific to that country, not entirely shared with other eurozone members. The solutions lie in being able to vary the interest rate, the exchange rate and fiscal policy - quite possibly with some supply side work as well. But interest and exchange rates are specifically blocked off by euro membership in its very essence, while the surrounding rules strictly limit fiscal policy.

Thus it is the rules of the euro itself which limit the room for action, leaving only that supply side policy available. Which is where we get to the implications of the observations. If that is the diagnosis, as Elliott thinks it is, then the solution is for France to leave the euro.

Or, of course, as Friedman said it was and some of us have been shouting for two decades, the euro is a bad idea and it should never have been started. The solution is therefore for everyone to leave it.

Clean energy

Environmentalism has a bad rap. It’s associated with hippies in hemp shirts, with pungently medicinal smelling beard wax and salt in place of deodorant. The reality is that a shift to clean energy helps everyone. It will improve living conditions, drive down prices and free up human capital for choice-creating innovation. And the shift does not need to be subsidised or blackmailed into existence, it is coming. It makes sense both to the markets, and to the people who make them up and want to see the coral reefs survive. Oil and gas get more expensive as they get more scarce, and as finite resources they are getting more scare, this makes the opportunity cost of prioritizing finite resources over clean energy greater. Geopolitically, many oil and gas resources are held by volatile state powers such as Russia and Saudi Arabia, meaning they are subject to price fluctuation and the stable prices of clean energy are more appealing to risk averse markets. As well as solely economic reasons, there are a lot of rich people like Bill Gates and Elon Musk who value a continually healthy planet and fund research into things that preserve this.

After initial research costs, clean energy is astronomically cheaper than the dirty energy of old. It can be largely automated, no permits are needed to dig for it, and even a judge on their first case wouldn’t award a payout to a solar worker claiming black lung. These reductions in costs can be passed on to consumers, in the form not only of cheaper energy for the home, but of cheaper consumer goods created using clean energy, and cheaper services provided in energy intensive places like office buildings and sports facilities.

Secondly, many public pressures to resist international trade are reduced, freeing up cross border trade. Agreements like the Paris Accords, which instruct members to sanction heavy polluters are a tricky issue, with politicians often made to demand lower emissions and less industry on threat of losing valuable, earth conscious voting blocs. If China and India moved to cleaner energy, such as solar panels which could generate plenty affixed to the roof of a Mumbai factory, these pressures would be reduced. This would allow greater free trade with these countries and their cheap, loose labour markets, and this would push down the prices of many goods for consumers as well as offering a wider range.

Finally, in a long-term point, human capital would expand. Pollution is not only bad for your lungs, it’s bad for your brain. Many pollutants inhibit the development of brain tissue, making people exposed to it in infancy less intelligent and capable of innovation. Additionally, a lot of intelligent, qualified people are tied up in projects such as making mines safe, or flood defences from global warming, or trying to develop mouth guards that prevent carcinogenic particles entering the human body. A move to clean energy could free up this human capital, and allow more to be created, which facilitates greater innovation and development. Pollution could be stopping us from perfecting self-driving cars and space travel, if that’s not a reason to curb it, nothing is. 

When did social mobility become the only aim of the education system?

We can imagine that social mobility might be one of the things that you think about concerning a school system. But to set it as the one and only over-riding measure seems to us to be going very much too far:

Heads are being urged to "vigorously" oppose the expansion of grammar schools in England.

The National Association of Head Teachers will debate calls to reject a new wave of grammars in the absence of evidence that it aids social mobility.

If grammars can only exist if they aid social mobility then that is indeed insisting that social mobility is the only measure of the design of the education system. Which does look like, to us, an error.

It's entirely true that there's not a great deal of social mobility around. But as Greg Clark has shown, that's also true in places like Sweden that don't have grammars. And there's also that long insisted upon point that grammars increase social mobility by providing the bright from any background with an academic education.

But we would still insist that the basic contention here is wrong. It cannot be true that social mobility or its furtherance is the only measure of a school system. We really do think that we want to consider other matters too, like the costs of the system, what it's teaching perhaps, possibly even whether the system is teaching anyone anything at all. That last being something we're really not all that sure about for at least some British schools.