When your funding sources do & don't matter

The most common response we got to our Monday ASI paper on chlorine chicken is that our view was driven by a monetary interest. It wasn't: we don't accept any funding for specific projects—everything comes out of general funds—and as far as I know none of our general donors stand to benefit from such a move either. The actual inspiration for the paper came in a facebook chat in January between ASI staff, screenshotted below. But the interesting question is: would it matter if we did get our funding that way?

There is a popular view, perhaps derived from a Marxist-materialist worldview, or more mundanely from a economicsy self interest perspective, that opinions are just outgrowths of economics. Everyone cynically supports the perspectives that stand to contribute to their narrow, mostly financial, self interest. The rich like property and the poor like redistribution. Sometimes, in a more vulgar version of the theory, the holder will argue that self interest is for thee, but not for me, and all views except theirs are a sort of false consciousness.

It's certainly one model of the world. But as Sam says very well here: political error is driven by complexity, not greed. In fact, most of the evidence on public choice suggests that people are pretty altruistic and "sociotropic" in their political behaviour. People are ignorant, and that causes great problems. But by and large they are not corrupt or atavistic. I think that jumping to motivational games suggests people are unwilling, or unable, to try and understand the question at hand, and thus need some sort of crutch to explain beliefs, rather than being open to the possibility of honest disagreement.

Look: even if I were in favour of this trade deal step due to Big Chicken or Big Chlorine payouts, how could that affect my work? Scientists working in lab studies declare conflicts of interest because their work is partly dependent on their probity. The recent massive scandals around p-hacking, publication bias, and even straight scientific fraud underline why this is important.

But when I write something I'm not asking anyone to trust me as an authority, and I use publicly available data and evidence created by people completely unrelated to me. This is by definition transparent, doesn't pose problems in the way Monsanto-funded pesticide research might. Does getting payment from corporate lobbies or interested parties make me more convincing? Does it find me better data or cleaner logic? It's hard to see how it could possibly affect the situation in any way.

Interest groups fund people who support their interests. If they didn't fund them, they'd still support those interests, but with less money. If John Stuart Mill were alive today then tobacco firms, brewers, distilleries, and Coca Cola would probably give him cash. But he would be defending the Harm Principle either way. True Believers have a comparative advantage over shills in advocacy.

The only possible reason someone could ask for my motivations is that they can't be bothered to tackle the argument. Perhaps they are even looking for reasons to dismiss evidence that conflicts with their existing worldview (we are all prone to this, because it hurts to admit you are wrong). But neither do their motivations tell me that their conclusions are wrong, just as the fact the IFS gets their funds mostly from governments doesn't tell me they're wrong, and the fact that CLASS is funded by unions doesn't tell me that they're wrong.

It's simple minded to jump to money as an explanation for all evils. Sometimes people are just wrong, because social, political, and economic questions are often hard to answer.

Fine, clobber the rich, but not with a 100% inheritance tax

Abi Wilkinson has a piece at The Guardian making the case for bolstering the UK's welfare state by raising inheritance tax to 100%. She argues that it would be good to do more redistribution, to fund more and better public services, and that unlike other taxes, it does not face objections of moral desert. Perhaps you deserve the sweat off your back, she argues, but it's hard to see how you've earned a pile of cash that simply fell into your lap through luck. And she argues that we cannot infinitely respect the wishes of the dead.

There are some small points that Wilkinson is simply wrong on: she argues that elderly folk retiring earlier and earning less would make space for younguns to fill those spots. This is the Lump of Labour Fallacy: it's wrong for the same reason that immigrants don't steal jobs off natives, and the entry of millions of women in the labour market in the 1970s didn't cause mass male unemployment. When more people work we just produce extra stuff, consume extra stuff, and invest in extra stuff. But this claim isn't crucial to her case, and there's a more important point here.

Libertarians have always been divided on inheritance. If you think that freedom is important because it lets humans express their free wills, then why respect the non-existent wills of dead people. Jim Buchanan, the public choice theorist who suffered at the hands of Nancy Maclean and supposedly ties the whole libertarian right together, advocated an 100% inheritance tax. Robert Nozick switched towards one later in his life. Thomas Jefferson thought similarly. "Even" Adam Smith was against unlimited rights of bequest.

But unlike both Wilkinson and libertarians, I think we should approach this question pragmatically, not based on moral rules. We want to raise money to fund redistribution and public goods. How can we do this at the lowest possible economic cost? Inheritance tax is an inefficient way of raising money, even if we ignore problems of enforcement and loopholes.

When economists analyse taxes they typically use the visors of incidence and behavioural responses. Behavioural responses are what they say on the tin: how households and families adjust their economic behaviour in response to a tax change.

Incidence is who is made worse off by a tax. Money is there for consumption. If you save it or invest it, it is only to spend it in the future, to insure against an unexpected consumption need you might have, or to give it to others to consume later. A tax's statutory burden falls on whoever hands it over, but a tax's incidence is on who eventually has lower consumption in order to fund it. An example is VAT: shops hand it over to the government, but consumers end up paying most of it through higher prices. Similarly, buyers hand over Stamp Duty Land Tax, but sellers are also made worse off by it: about half of it is paid in the form of lower house prices.

Wilkinson's piece implicitly assumes a higher inheritance tax falls entirely on the deceased and their benefactors. But it only falls on the deceased if their behaviour doesn't change in response, and they generate estates of an equal size in their lifetime even given the tax. This is questionable under a 40% tax, but dubious in the extreme under an 100% tax.

The higher the inheritance tax, the higher the implicit income tax, and the more unbalanced the tradeoff between your consumption and your kids'. At 100%, it is infinite: no matter what you do, you cannot make your kids' lives better off after you die. Your incentive, again heroically assuming we are able to deal with all the practical difficulties, is both to generate less wealth, and to consume any you do generate before you die. Why not live out your days at the Ritz like Thatcher?

Less income created means less for public goods and redistribution, not to mention less for their kids, and less for them. And while more holidays and nicer houses for older people is all well and good, more consumption means we have to switch land, labour, and capital towards producing those things, and away from the things the savings of the old were buying. Nearly all of these savings aren't hidden under beds, but are being put to work: lent out by banks, and invested in equities through pension funds. This investment is what funds productivity growth—and productivity growth is what underlies higher wages.

So an 100% inheritance tax would barely make rich old people worse off, but it would clobber workers with no chance of inheriting. This is why I disagree with Wilkinson and a bunch of smart libertarian scholars, including the namesake of my very own think tank. There are very good reasons to tax the rich to improve the well being of the badly-off. But we should do that through consumption taxes that are guaranteed to reduce their Maserati and private jet purchases, not taxes that destroy their incentive to invest in society.

How onerous are Basel III's constraints on bank leverage?

It is generally acknowledged that high bank leverage was a key factor contributing to the severity of the Global Financial Crisis. For the UK, Bank of England data suggest that UK banks’ average simple leverage – the ratio of banks’ total assets to their shareholder equity – was 24.4 over 2006.[1]

Basel III then sought to counter high leverage by imposing a minimum required leverage ratio on regulated banks.[2] The ‘leverage ratio’ is the inverse of the leverage.

So how onerous are Basel III’s constraints on bank leverage? More precisely, what is the maximum permitted leverage under Basel III?

A clear expression of the Basel rules on this point is the following from the 2015 Prudential Regulatory Authority (PRA) Rulebook in the UK:

3 MINIMUM LEVERAGE RATIO

3.1 A firm must hold sufficient tier 1 capital to maintain, at all times, a minimum leverage ratio of 3%.[3]

3.2 For the purposes of complying with 3.1, at least 75% of the firm’s tier 1 capital must consist of common equity tier 1 capital [CET1].[4]

This minimum required leverage ratio is expressed in terms of the ratio of Tier 1 capital to the leverage exposure. Section 3.1 of the PRA Rulebook would suggest that the maximum permitted leverage is then 1/3 percent = 33.33.

Section 3.2 of the PRA Rulebook then states that at least 75 percent of the firm’s Tier 1 capital should consist of CET1 capital.

Now 25 percent of the 3 percent minimum Tier 1 leverage ratio is 0.75 percent, so the minimum required leverage ratio expressed in terms of CET1 capital = 3 percent minus 0.75 percent = 2.25 percent.

This implies that the maximum permitted CET1 leverage = 1/0.0225 = 44.44.

However, Basel III also allows banks to include a ‘sin bucket’ of non-CET1 capital items as part of their reported CET1.

So let’s distinguish between ‘reported’ CET1 (or CET1 including the sin bucket) and ‘clean’ CET1 (or CET1 purged of the sin bucket).

Under Basel III rules, the clean CET1 can be as low as 85 percent of reported CET1.[5]

Let’s also assume that bankers make maximum use of the sin bucket so the clean CET1 = 85 percent reported CET1.

This means that the Leverage Ratio using clean CET1 can be as low as 85 percent  2.25 percent = 1.9125 percent and still comply with the Basel III minimum required leverage ratio. Inverting this number gives the maximum permitted leverage using clean CET1, i.e., 1/1.9125 percent = 52.29.[6]

A loss of 2 percent of the leverage exposure would then be more than enough to wipe out a bank’s CET1 capital.

In plain English, the Basel III capital rules allow banks to maintain remarkably high leverage and still be Basel III-compliant. Indeed, the Basel capital rules would appear to allow banks to maintain considerably higher leverage than they had on the eve of the financial crisis!

I should also note some qualifications, which will serve to further loosen the impact of the Basel III maximum leverage constraint:

1. The first is that these calculations ignore sources of hidden leverage such as accounting standards that cause capital to be over-reported or the additional leverage in off-balance sheet positions.
2. The second is that the above calculations relate to book values, not to market values, and market-value leverage these days will typically be higher than book-value leverage.

In fact, since Basel III does not impose any restriction on market-value leverage, the maximum permitted market-value leverage under Basel III is theoretically unbounded.

 End Notes

* I thank Anat Admati, Tim Bush, Gordon Kerr and Sir John Vickers for helpful discussions on the subject covered in this blog posting.

[1] Obtained from the Bank of England’s Financial Stability Report for November 2016, p. 58, where the 2006 average simple leverage ratio is reported as 4.1 percent. The simple leverage is then 1 ÷ 4.1 percent = 24.4.

[2] Critics however have argued that such requirements are onerous. These include many leading bankers (e.g., Jamie Dimon and former Deutsche Bank chairman Josef Ackermann) and even central bankers (e.g., Alan Greenspan), the American Bankers Association, and the British Bankers Association (see, e.g., the citations in A. Admati and M. Hellwig, The Bankers’ New Clothes: What’s Wrong with Banking and What to Do About it, Princeton University Press, 2013).

[3] As an aside, it is disappointing to see that the PRA’s own rulebook explicitly endorses the ‘capital is a rainy day fund’ fallacy by stating that banks “hold” capital. Banks do not “hold” capital. To suggest that they do is to suggest that capital is an asset to a bank and it is not. Read Admati and Hellwig.

[4] Prudential Regulation Authority (2015) PRA Rulebook: CRR Firms: Leverage Ratio Instrument 2015. London: PRA, p. 5.

[5] For more on the ‘sin bucket’ see T. F. Huertas (2014) Safe to Fail: How Resolution will Revolutionise Banking, Basingstoke: Palgrave Macmillan, p. 23, or Basel Committee on Banking Supervision (June 2011) “Basel III: A global regulatory framework for more resilient banks and banking systems,” pp. 21-6 and 65. 

[6] If one took account of systemic or countercyclical buffers, however, the maximum permitted leverage would be somewhat lower, but not much.

What terrors The Guardian reveals to us, eh?

We do think it must be terribly stressful being a member of the aggrieved left these days. So may of the world's basic problems are on the way to being solved, capitalism and free markets doing that solving. As this excellent chart from Max Roser shows. Given this there must be the most terrible angst suffered as something else to complain about is searched for.

As an example of this we offer the latest from The G:

Revealed: the insidious creep of pseudo-public space in London

Pseudo-public space – squares and parks that seem public but are actually owned by corporations – has quietly spread across cities worldwide.

If there were some epidemic of private economic actors taking over the publicly owned green spaces of our cities then we too might start to get a little uppity. This is not what they are complaining about.

The current publicly owned spaces are remaining as just that, publicly owned spaces. However, developers of varied private sector projects are realising that we humans like a bit of space around, a colonnade to house the cafe tables perhaps, a fountain or two, stretch of green grass to sooth the eye, this sort of stuff, possibly even just some cobbley bit to wander around in. Shrug, OK, this is the private sector, it ends up through trial and error in offering what people actually want.

These bits of open space, meeting places and all that, are additional to the publicly provided and extant ones.

At which point The Guardian is complaining. No, really, this is an outrage! The rich bastards who own so much of the world's most expensive real estate are allowing just anyone, you, me, the hoi polloi, to use that vast wealth pretty much as we wish. For free!

How! Very! Dare! They!

Clearly the law must be changed immediately to prevent anything so outrageously liberal from happening. Really, where would we all be if people were able to just decide to allow others to walk upon their hallowed flagstones?

Alternatively we might suggest a more adult reaction. A cooling glass of something frothing and a reflection, as Dr. Roser is pointing out, that we've sweated most of the difficult stuff and that the good old days are in fact now. At which point it's not actually necessary to find something to be aggrieved about.

Don't cry fowl play

“Global Britain. A nimble independent Britain, freed from the regulatory shackles of the EU, was supposed to be able to rapidly sign trade deals where European efforts have stalled endlessly. And we can, but trade deals require concessions. If we want a quick and profitable deal with the USA, we need to put chlorine-washed chicken on the table.

The EU’s attempt at a better trade deal with the US has gone through 15 rounds. But post-Brexit Britain will have more latitude to make, and gain, concessions. One such concession is dropping our prohibition on chlorine-washing broiler chickens, which has frequently proved a stumbling block in EU-US deals since its 1997 introduction.”

I have a piece in the Telegraph, albeit behind a paywall, explaining the findings of our new paper, written by Pete Spence, on chlorinated chicken washing and trade deals with the US. Read the whole thing, and check out the author's own case in City A.M.

Look how well we're dealing with the problem

Evidence that a problem is being solved is not evidence that we need to find a solution to that problem:

The number of homeless children living in temporary accommodation has soared by almost 40 per cent in the past three years, new figures reveal, compounding fears Britain is facing a “catastrophic” housing crisis.

Councils are housing 120,540 children with their families in temporary shelter, an increase of 32,650 extra children since 2014.

Labour’s shadow housing minister John Healey said ministers should "hang their heads in shame" over the "shocking" figures.

1210,540 children are at risk of sleeping rough. Precisely zero children are sleeping rough. That's rather good evidence that we've got a pretty good solution to the risk of children sleeping rough.

Do note that we don't therefore think that everything's just hunky dory with British housing. We've been insisting for some years now that we can make the system massively better by blowing up the Town and Country Planning Act 1947 and successors.

Evidence that millions of children are learning to read and write is not evidence of some literacy crisis. As with temporary accommodation, it's evidence that we're solving that problem.

The difference between taste discrimination and rational discrimination is an important one

That difference being that taste discrimination is doing something because of some prejudice or belief which is not rational, rational being doing that same thing for sensible reasons. The NBA is overwhelmingly black but not because those who hire the players desire higher melanin contents, but because that's just how it works when you select for the ability and desire to play basketball at the highest levels. 

Baseball provides us with another example, as that most definitely was subject to taste discrimination years back. One major reason it ended being that it wasn't rational - teams realised they were potentially losing games, series, because they were not tapping into that talent in the Negro League.

As Gary Becker famously pointed out taste discrimination is costly to those who do it and a free market is one of the best ways of getting rid of it. One of his examples being the Jim Crow laws, they existed because of this very market process. They had to be encoded into the law otherwise the market would indeed compete the discrimination away.

At which point the story about the security tags on ackee:

An angry shopper has accused Sainsbury's of racism after he found £3.80 tins of Jamaican fruit security tagged in a south London store. 

Toby Taylor, 31, said he bet the chain 'wouldn't tag hummus' and slammed it as 'corporate racism'. 

He was shopping in his local supermarket in Penge, Bromley this afternoon when he noticed a whole shelf of the delicacy had been placed in security boxes - despite being reduced and only worth £3.80. 

Supermarkets have excellent information on what walks out the door, that's what all the barcodes, scanning and computer equipment is all about. They also know, as a result, what walks out the door having been paid for and what leaves rather more lightly. Those security boxes are put onto things which tend to leave without paying tribute. They are costly, therefore it is only done to those products where it is worthwhile.

That ackee is more likely to be stolen than lychees  could be a horrible example of all things in our society. But it's not racism on the part of the supermarket. 

This BBC gender pay row makes them all appear more than a touch dim

We're watching this row at the BBC over the gender pay gap with more than just a touch of amusement. For the correct, in our minds, lesson to take from this is that most of those complaining are more than just a little dim.

Please note that we're not saying that the pay structure itself is correct, nor that that of society itself is. Those are value judgments and we'll not impose ours on you nor the real world. But the shock and horror being expressed is most odd, for the gaps being presented are little different from those across society. Indeed, the BBC seems to be doing its job of being as society, reflecting society, rather well:

Women working at the BBC have spoken of the anger and frustration that has emerged across all levels of the institution after the disparity in pay between the male and female top earners was revealed.

What is the gender pay gap does depend rather upon how one measures it. But the figure that varied feminists often use is the mean gap, uncorrected for anything like age or qualifications. They have also been told (Harriet Harman specifically in fact) not to use this as it is highly misleading.

Why so? Because if you have a distribution where the bottom anchor is zero but there is no obvious upper limit then the mean will over state the reality, the median is a better figure to use. So says that Statistics Authority.

But why is that mean misleading about the gender pay gap? Because in near all pay distributions there are many fewer women in that upper stratosphere than there are men. Yes, we do know why, motherhood, primary child carers, career breaks and so on, just do mean that the average experience of womens' working life leads to less grasping of that brass ring of a very high income. Again ,we do not say this should be so but we do insist that it is so.

It is also well known that this is so. There just always are fewer women in the upper reaches of any pay distribution, we know this so well that we've official warnings not to use misleading statistics about it all. 

At which point the amusement. The BBC is that institution which is supposed to explain this complex and difficult world to us all. Yet here we have all this shock and horror over something that is indeed known, just not by those doing the shock and horror.

Hmm, perhaps dim isn't le mot juste, ignorant of what they speak perhaps?

Good to see someone getting the point of Brexit

It's not that we approve, heaven forfend, of this particular policy idea but we do insist that this is the point behind Brexit: 

All of which is significant. Corbyn and McDonnell are smart enough to understand the risks of Brexit, but they also see it as an opportunity to push through their own economic agenda. Which is why they are exploring the freedom Brexit would provide for public ownership, lower rates of VAT to help those on the lowest incomes, state aid to support sunrise industries, and fair trade agreements with developing countries.

Remainers on the left would argue that there is no need to leave the EU for this to happen, but they are wrong about that for two reasons. The first is that a radical socialist programme that included a different approach to state aid, state ownership, public procurement and managed trade would be deemed illegal under European law. The second is that without Brexit, the impetus for change would quickly dissipate.

No, we really don't think that a more socialist economy is the way Britain should be moving - but you knew that, right? The underlying idea is entirely correct though. Membership of the European Union cuts us off from the possibility of a number of useful and interesting economic policies. 

We would like to see, for example, unilateral free trade. That's not something which EU membership allows. Not with that great big wide world out there that is. This is a policy different in kind from that socialism above of course - it has actually been tried and it worked, unlike socialism anywhen anywhere. We ourselves did it in 1846, that free trade thing, and we prospered mightily as a result.

Brexit allows us policy freedom which EU membership doesn't. Yes, that includes damn fool things like socialism but we are indeed all adults aren't we, capable of making up our own minds rather than having to rely upon Brussels to do it for us?

We fear Sir Michael Marmot is confused here but it's a good plan anyway

Sir Michael Marmot is famed as the academic who told us all that health inequality is caused by economic inequality. we don't doubt that this is partially true although we'd really like to insist that health inequality will produce economic as well. Becoming bedridden and incapable to work at age 40 will lead to income inequality at age 60.

His latest work tells us that life expectancy is rising more slowly in the aftermath of the recession. This could of course be true. We might even agree with Owen Jones here:

An ideologically driven programme of cuts is almost certainly robbing us of life. Consistently rising life expectancy should be something we all take for granted. The UK, after all, is one of the wealthiest societies that has ever existed in human history. There are continuing dramatic improvements in medicine and technology. And yet new research by an ex-government adviser, Sir Michael Marmot, suggests that the rise in life expectancy – a constant trend for a hundred years – has stalled since 2010. What happened that year, exactly? Was that not when David Cameron, George Osborne and their Lib Dem stooges began slashing public services with a false economic pretext?

And thus the call for revolution:

Is there any clearer evidence of how utterly bankrupt our social order is? Human and social progress is grinding to a halt in Britain. Life is getting more insecure and poorer for millions – soon, it may even be getting shorter. That’s why we don’t just need a change in government in Britain, we need a change in how we organise our society. A peaceful, democratic revolution is long overdue in Britain, for the sake of our living standards, our health – and for the sake of our very lives.

Well, OK. So, what exactly should the revolution consist of? As Marmot points to:

There is no reason why the UK could not emulate Hong Kong, where life expectancy for men is 81.1 years for men and 87.3 for women – the highest in the world – Marmot added. Hong Kong has overtaken Japan in terms of how long citizens can expect to live.

So, let's increase economic inequality up to Hong Kong levels then, cut social spending down to Hong Kong levels and slash government overall to Hong Kong levels. We're just fine with that but we do think that Professor Marmot, given his usual proclivities, is confused here. And no one at all is surprised that Young Owen is confused at all, are they?