Taking innovation seriously

Matt Ridley made an interesting proposal in his Times column last week. In the piece he discussed the idea of the Her Majesty's Government adopting the innovation principle, which he summarises as "examine every policy, plan or political strategy for the impact it could have on innovation, and if you find evidence that the policy is going to impede it, then drop, change or rethink the thing."

He suggested that the Conservatives ought to "pledge to set up an innovation commission, guided by the innovation principle, whose job is to examine policies and report on their likely impact on innovation?" The Adam Smith Institute typically recoils at the thought of creating yet another quango, but I think it's worth making an exception in this case. If there's one thing in need of more regulation the regulators themselves.

But what would actually change if politicians and regulators were forced to take innovation seriously? Ridley suggests we'd have cheaper, safer food thanks to genetically modified crops and fewer people would smoke as burdensome EU rules on vaping would never get past the innovation commission.

I think there are two other areas where taking innovation seriously would lead to fundamental regulatory changes.

1. The Gig Economy

Innovative start-ups like Uber, TaskRabbit and Deliveroo are creating an on-demand economy that enriches consumers and offers new flexible models of working. Take Uber drivers for example: they're overwhelmingly happy to trade off traditional employment rights for the ability to work when and how long they want. Yet recently an employment tribunal ruled that Uber drivers should be classified as workers and that Uber be forced to pay the minimum wage and offer sick pay. This not only disrupts Uber's entire business model, it's having a chilling effect on other gig economy start-ups who are in a sort of legal limbo.

If regulators and courts were forced to subscribe to a form of the innovation principle, then legally ambiguous innovative workplace arrangements would be be given the benefit of the doubt.

This is because there's an asymmetry between over and under regulation. In medicine, we tend to be more concerned with false negatives than false positives. Better to be over-cautious and provide unnecessary treatment than let a condition get worse. The reverse is true when it comes to regulation. Market forces tend to mitigate the effects of bad behaviour. A monopolist can only keep prices so high before inviting competition, an exploiter can only keep wages so low before they lose workers to other employment opportunities. The costs of failing to crack down on bad behaviour are static and limited.

That's not the case with false positives. Wrongly cracking down on Uber or Deliveroo doesn't simply harm Uber and Deliveroo's shareholders and customers, it also hurts consumers widely by deterring innovators from entering the market providing similar services. Consumers are not just missing out on Uber and Deliveroo but missing out on their unborn competitors. The costs of shooting first and asking questions later are dynamic and unlimited.

2. 'Tech monopolies'

If Theresa May keeps her word, Britain is set to leave the jurisdiction of the European Court of Justice. The ECJ has typically taken an over-active approach to enforcing competition, often confusing market share with market power. If Britain were to take innovation seriously we ought to take an error-cost approach to enforcing competition law.

Judge Easterbrook set out the error-cost approach in his paper 'The Limits of Antitrust'. He shared the insight that false positives were much more harmful than false negatives. Wrongly penalising pro-competitive behaviour is more harmful than failing to act against anti-competitive behaviour. Market forces tend to correct against the latter creating incentives for new entrants to disrupt monopolists.

He observed that errors of both kinds were frequent because distinguishing between pro-competitive and anti-competitive behaviour is intrinsically difficult. It's especially difficult when dealing with new products and business models. Firms often don't fully grasp the full competitive effects of their business practices in advance, rather they employ a trial and error process.

Take Google for example. In 2016 the EU made an (in my view baseless) antitrust complaint against Google relating to its android operating system. But, Google is an excellent example of a firm experimenting with different business models without a clear understanding of their effects on competition. AdSense is responsible for nearly one fifth of Google's total revenue but was famously produced during Google's '20 percent time' where employees are given free range to work on projects of their own choosing. If firms themselves often fail to understand the full implications of product innovation until much later on. How can we expect courts to understand the full competitive effects of innovative business practices?

That's especially the case when dealing with companies like Google where they produce multiple complementary products. Antitrust law expert Geoff Manne highlights the problem with the EU's complaint about Google preinstalling Android apps:

Of course, Google receives some benefit from pre-installing its apps: Doing so provides a chance for the company to realize some return on its massive investments in the Android ecosystem by promoting its own products. Although Google requires many Android device makers to pre-install Google Search and to set it as the default (but not exclusive) search provider on their phones, this is hardly a bad thing: Search helps finance the development of Google’s other (free) apps, as well as (free and open-source) Android itself.

Imagine what might happen if Google were prevented from requiring device makers to pre-install Google Search or the Chrome browser—the apps from which it actually earns substantial revenue—as a condition of pre-installing its other apps on Android devices. Google would likely then charge hardware makers licensing fees to pre-install apps like Gmail and YouTube, the cost of which would be passed along to consumers in the form of higher device prices. This would hardly be a net gain for consumers, given that they already enjoy unrestricted app choice at lower cost today.

Alternatively, Google could vertically integrate like Apple, exercising tighter control over the Android ecosystem. This would be no boon for competing app developers, who are attracted to Android’s openness—just ask Spotify what it thinks of Apple.

A hypothetical innovation commission ought to force regulators to give businesses in markets with high levels of innovation the leeway to experiment with new business models. One way to do that would be to require direct proof of an anticompetitive effect and not merely rely on theoretical harms. Another would be to grant legality per se to new product introductions to remove regulatory uncertainty for innovators.

Innovation massively matters, but often regulations can have chilling effects and deter welfare-enhancing changes. An innovation commission could tip the scales in favour of innovation and prevent employment courts and competition regulators from keeping new products from the market.

Congratulations to the CMA here, congratulations indeed

As we all know bureaucracy is the application of rules to things. Not the application of good sense, logic or even being sensible, but the application of rules. At which point we really do have to say congratulations to the Competition and Markets Authority. For they have decided that it would be better that one small part of the emergency services infrastructure should close down rather than be acquired by a competitor. One the grounds that acquisition would create a monopoly.

No, really, we do not jest:

Vodafone is to shut down its pager business after failing to receive backing from the competition watchdog to sell the dwindling division that relies on old technology popular in the 1980s.

The telecoms group said it was ditching plans to sells the business to Capita’s PageOne, and would instead close it after the Competition and Markets Authority announced plans to launch an in-depth investigation into the deal.

There's no more than a 1,000 or so users of this old system but those include the likes of lifeboat men etc. Pagers have better coverage and are more reliable it appears. And the argument from the CMA is that as PageOne is the only other supplier of such services then of course, on anti-monopoly grounds, it cannot buy its only competitor.

You know, rules is rules and the hell with good sense.

One of the reasons we dislike monopoly in the first place is that we're entirely sure that competition means that people must take account of reality. That they cannot be insulated from the effects of their own stupidity as others will take advantage of it.

So, why is there only the one Competition and Markets Authority?  

Where house prices come from

In the UK, housing is mostly provided by the market.* But supply and demand are not the only concepts you need if you want to understand why London house prices are so high, and indeed why they have been rising. You also need to think about expectations and about interest rates.

When you rent housing, you're just consuming the value of the housing: you get a spot to live somewhere. But property also has an investment value: if you buy it, then it will provide you housing services every year until you sell it. A house is very durable, so the value of the services it provides may change large amounts over the period of its life. Its rent—or rental value, if it's not rented out—will go up and down, both because the owner improves or worsens the property, and because the rest of the world changes so that anything located where it is worth more.

House prices move much more rapidly than rents—both up and down—because of this investment value. The money that you put into the house can be put to other uses: you always have the option of renting, and either investing the cash elsewhere, or not borrowing the money in the first place. So house prices are affected by interest rates, as well as the rates of return on equities and bonds; the cost of borrowing and the return to lending or investing. When interest rates fall, house prices go up even when rents don't rise; when interest rates rise, house prices go down even though rents don't fall.

It is market rates that matter. Before the crisis many banks and building societies offered tracker mortgages that were linked to Bank Rate, and this is still true to a lesser extent. But they linked their actual market rates to Bank Rate because the BoE shifted its headline policy rate exactly when they'd want to shift their rates—in response to market conditions. When this rule broke down, during the crisis, many lenders simply dropped or altered their link. The link between the BoE base rate and house prices is weak, for this reason, but the link between market rates and house prices is very strong.

However, it's not just today's interest rate that matters: homebuyers do not repay their mortgage at today's rate forever; rates typically vary with the times. The unprecedented boom in London prices we are seeing today comes from the unprecedented fall in long-term interest rate expectations—the very same fall that many economists associate with "secular stagnation", the much-hyped idea that productivity growth is falling and can't be raised. And an infinitesimal fraction of private bank funding comes from the Bank of England, borrowed at its base rate: there is little reason to expect that future Bank Rate rises will change this. Instead, it is real market factors, like increasing supplies of savings coming onto the world market from developing countries, and/or poor alternative investment options, driving this expectation of low rates well into the future.

Interest rates—and expected future interest rates—combine with the supply situation—and the expected future supply situation—like two blades of a scissor. If planning rules are loose then a shock to the path of interest rates has little effect on prices: builders just build more to accommodate demand. House prices didn't fluctuate with interest rate trends before British planning rules became much stricter with the 1947 Town and Country Planning Act, and they don't fluctuate much in Houston or Japan, countries with much more liberal regulation on construction. But since we made building hard to do, we've seen large swings in UK house prices with market conditions and rates.

Expectations usually bring tomorrow to today. Unless we keep being shocked by the planning situation—it either gets stricter, or it stays the same but we expected it to get more liberal—then tight supply constraints are probably not to blame for rising house prices. Unless rising demand from foreign and British migrants continually shocks us that probably isn't to blame either. Those both contribute to the level of prices, and, sure, this involves an adjustment period, but most tenancies are not that long, and there are a lot of housing transactions, so the stuff we've known for decades is most likely capitalised in.

Quantitative easing isn't a likely candidate either, except because house prices and rents are higher when we avoid massive economic depressions. Money from quantitative easing doesn't "go into" things in a special way any different from other money. Investors don't suddenly change the fraction of their portfolio they want to hold in property when the Bank of England increases the money supply (slightly). In fact, we have strong evidence of "portfolio balancing"—when gilts become more valuable because of QE, investors sell some, and buy more of other assets to keep their total portfolio held in roughly the same way.

No: QE, immigrants, and even supply constraints probably aren't to blame for recent rises. Rises since, say, 2012, are most likely down to continual surprises in financial markets—expected interest rates trending further and further down than we've expected.

*That's not to say there's a free market: we have stamp duty land tax, council tax, business rates, housing benefit, affordable housing requirements, deep thickets of regulation on what you can, can't, and must do with your property, especially if you rent it out, as well as restrictions on how you can transfer and own properties, not to mention planning restrictions, building codes, and design rules. But, within these constraints, supply and demand interact to provide houses, flats, and rooms to consumers.

The Overseas Development Institute doesn't understand what a subsidy is

Not understanding what a subsidy is, and therefore who is getting it, is a bit of a problem if you decide to write a report about subsidies and who is getting them. Yet this is exactly what the Overseas Development Institute has just pleasured us with. A report which tries to look at subsidies to the use of coal in Europe and the UK. The specifically British numbers are here.

The two major numbers they tot up are not in fact subsidies to coal at all.

One is the reduced rate of VAT on the domestic use of heat and power. We can, if we like, call this a subsidy on the use of heat and power. We would hesitate to do so on the grounds that not taxing the hell out of something doesn't strike us as a subsidy but there we go. But given that this is specifically a totting up of subsidies to coal, as against other methods of energy generation, this isn't a subsidy to coal, is it? For nuclear, solar, wind power,  natural gas, all receive exactly the same subsidy. 

And we are really very sure indeed that the reduced VAT on domestic electricity usage is never recorded as a subsidy to wind or solar installations. We know this because we've been and looked and read the reports.

The second mistake is worse. They include capacity payments as a subsidy to coal. So also the balancing reserve. Sure, the payments go to coal plants but they're not a subsidy to coal at all. They're a subsidy to solar and wind.

For the reason for the existence of the payments is that the sun does not shine all the time (there's even something called "night" to be taken into consideration) and the wind does not always blow. It's thus the technical inefficiency of these two renewables which requires that we have some rusting hulk somewhere capable of giving us electricity when we desire it. Such payments thus need to be on the other side of our ledger, these are subsidies to that Green Power, not the old fossil fuels.

So, well done to the Overseas Development Institute there.

Still, four people got to collect wages from the Oak and Hewlett Foundations while producing this pap so that's alright then, isn't it?

The strange death of Labour England

After just over 100 years, the stage might be set for the final eclipse of the Labour Party.  It could easily happen that Labour will lose heavily in the coming election, not least because of the leadership, or lack of it, of Jeremy Corbyn.  

From their current 229 seats, Labour could be down to 180 or even fewer, depending how well the polling data represents real voting intention.  Normally a party leader would resign after so catastrophic defeat, but Jeremy Corbyn is no normal leader.  If he chooses to stay on, he might be challenged for leader.  If so, he would be on the ballot as the incumbent, and would probably gain enough Momentum votes to remain leader.

At this point, since he refused to leave the party, it might well leave him.  140 Labour MPs might decide to form a separate party, perhaps called “Centre Left Labour” or something similar. Anything that included the word “Labour” might be subject to legal challenge, though.

This party would be the main opposition party.  Its leader would be Leader of the Opposition and would receive the salary and status that goes with it, plus the office space and the financial support.  He or she would face the Prime Minister at PMQs, and would receive the media attention merited by the opposition.

Jeremy Corbyn’s rump of maybe 40 MPs would be consigned to back bench obscurity, not even the third largest party, which would be the SNP.  People would draw comparisons to the Social Democratic rebellion from Labour in the 1980s, but the circumstances are vastly different.  They were not the main party of opposition, commanding the finance and attention that accompanies that.  Nor was the official Labour Party as discredited as this one is now.

The new centre left opposition party that inherited Labour’s mantle might take more than one election to become a credible alternative governing party, but the Corbynite rump on the back benches would gradually disappear from the political stage, and after a century of influence, the Labour Party itself would head into history.  It could happen.

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.