The Ruling Class

Last night, I watched a debate on Danish television in which they discussed something rarely talked about in Denmark - and when it’s discussed, things often get heated. The theme was public sector employment.

In the wake of the recently concluded negotiations on fiscal policies, the liberal government have had to shy away from some of the “historical big tax cuts” they promised at the end of last year. However, that’s not the only area where they’ve had to notch down the expectations. They’ve promised to cut spending and even reduce the size of the public sector. Yet they’ve been unable to gather support in the current coalition or elsewhere in parliament, which has led them to downgrade their goals for public spending.

Under the previous social democratic government the public sector grew with an average of 0.5% a year. The goal for the current liberal government is to reduce this growth to 0.3%. They have failed. So far this parliament average growth has been 0.75% and things aren’t looking to brighten up in 2018 when 1.1% growth is expected.

The incumbent Danish government has made several attempts at reforming key areas in the Danish welfare model but has failed time after time, making negligible progress. Why is it so difficult to reform the public sector? Danish politics is often characterised by consensus but on this specific topic the agreement stops. This is what they discussed, among other things, last night:

Part of the explanation, it is suggested, might date back to the 1970’s and the Danish Marxist (although I’m sure other Marxists would argue not in its purest form – splitter!) Jørgen S. Dich. Dich was an economist, a seldom voice of reason (to some degree) on the left, and author of the book, the Ruling Class (Danish: Den Herskende Klasse), a critical assessment of the Danish welfare state.

As the title suggest, Dich uses Marxist class theory to scrutinise the public sector. In his analysis, he reaches the conclusion that the capitalists aren’t the ones exploiting the workers, the new ruling class of public employees are. Dich argues that, while public employees nurture their own interest on the pretext that they are improving everyone's welfare and at the same time are securing themselves high wages and good labour relations, the workers are kept in the illusion that the only conceivable alternative to the enormous public sector is social uncertainty and sickness. Meanwhile, the public sector grows ever larger. Dich’s book was - and still is today - highly relevant. You’ll hear many critical voices of the welfare state in Denmark who agree with Dich but none of them are from the left.

Another possible explanation is that politicians increase their commitment to sunk costs because they’ve invested a lot of time and money into their projects and don’t want to see their projects fail (as explained in this study). The problem with the public sector in Denmark is the epitome of that exact study.

The public sector is the raison d’être of the Social Democratic Party and the left. With time the public sector has become the 'pride' of the Danish people, much like the NHS has for the British people. The key difference is that a larger number of Danish politicians recognise the problem. However, the political willingness to break the alliance of politicians and the public sector, or even try to raise productivity, is simply non-existent. Understandably perhaps, since there’s an emerging pattern that public sector employees lean more to the left than the rest of the population. Any party on the right suggesting they would cut spending would be accused of treason and any party on the left suggesting the same would be accused of political heresy.

Try pointing out some of the problems in a debate and you’ll instantly be blamed for defaming all public workers even though the Danish Productivity Commission has stated that there are critical problems with the Danish productivity - in the public and private sector alike. The same Productivity Commission states that part of the reason for this are the disruptive taxes imposed on businesses. Given the small size of Denmark, the Danes are reliant on the rest of the global economy doing well, which leaves less room for increased taxation. Businesses, and the taxes they generate, are the foundation of the public sector and they are currently hurting because of increasing demands for more spending due to changes in the demographic and living conditions.

The fact that public employees are voters as well as employed by the state creates a circle of incentives that might help answer the question I asked earlier: Why is it so difficult to reform the public sector? Ludwig von Mises noticed in 1944 in his book Bureaucracy that the public employee is in a peculiar situation. Not only is he an employee, he is also an employer. Mises continues:

And his pecuniary interest as employee towers above his interest as employer, as he gets much more from the public funds than he contributes to them.

This double relationship becomes more important as the people on the government's payroll increase. The bureaucrat as voter is more eager to get a raise than to keep the budget balanced. His main concern is to swell the payroll.

Coincidentally, public sector employees in the lower quartile of earnings earn 10% more than employees in the private sector. Additionally, the public sector grew from 382,000 in 1970 to 835,000 in 2012 - over 40 years the public sector has more than doubled. In the same period the private sector has shrunk by 7%. Overall, ⅓ of the workforce is employed by the state.

This leads to a number of implications. Demand for workers in the private sector is rising, and with lower wages, so the private sector might not be able to compete with the public sector. If Denmark wants to maintain the public sector without raising taxes and hurting businesses, it ought to raise the public sector’s productivity. This seems to be difficult, however, because of the public sector’s centralised collective agreement system. Contrarily, the private sector provides a framework for companies to work under but it is highly decentralised and companies are able to induce productivity by offering things like better salaries and working hours, providing an opportunity for more effective use of resources. The private sector used to have a centralised agreement system but it was changed in the 1970s due to its inefficiency – something the public sector should consider doing as well.

Although I don’t agree with Dich on most areas, it’s remarkable that an economist on that side of the spectrum noticed these problems back in 1973, when the amount of public employees was half of what it is today, and when no politician on the left today is willing to admit to these issues. They’ve been thoroughly explained by the Danish Productivity Commission over several years, yet political stubbornness dominates the debate. The foundation of the public sector is shaking and it will eventually collapse if the Liberal Party doesn’t find the political courage to force change.

Regulators tend not to think about consumers

An interesting little example of why regulation isn't quite the way to promote the consumer interest:

Rail bosses have blamed fire safety and anti-vandalism rules after passengers complained new uncomfortable seats feel like "solid metal".

Govia Thameslink admits the seats on the new Class 700 trains are considerably firmer than older designs. The seats have limited padding, because cushioning is deemed as a fire hazard by the Department for Transport (DfT), according to the rail operator.

They also have to be made from graffiti-proof material, which the DfT said has a "firm feel".

Travellers have complained the seats are hard and narrow,

We have no view on how hard and narrow train seats should be. Nor, in fact, about how flammable or graffiti resistant they should be. But then that's rather our point. That we don't know leads us to a reasonable conviction that the regulators don't either.

For said regulators are going to regulate to fit their sole aim. Those commissioned with preventing fire alone will insist upon something that just doesn't burn, those against teenage scribbling ditto. Rather lost in such concerns will be the purpose of the enterprise, producing something which passengers desire to sit upon. The complexity, the balance between differing desires, will be lost in a purely regulatory world.

Which is what is happening here. The provider of the service, varied places for posteriors, isn't allowed to make that trade off which they are best placed to make, between their needs and desires and those of their customers. Someone, even many people, from outside that knowledgeable group are able to insist upon their own designs. Which is why we end up with seats which don't burn but which aren't worth sitting upon.

Which is where our own view comes back into play. We do have a vision of regulation and one which does work. Owing very much more to the Common Law principles than this sort of level of detail. General principles - don't kill the customers, don't poison them etc - using post facto enforcement and design revision. And let the people who know, that interface of consumer and producer, then get on with things. 

We thoroughly approve of Westminster's voluntary tax idea

Westminster council has decided to ask the richer among its residents to provide a voluntary top up to the tax revenue:

Officially, it’s not a guilt tax. Westminster council prefers the term “community contribution” to describe the idea that its millionaire residents might like to make a voluntary donation on top of council tax. It is, they say, merely a chance for the wealthiest to “invest in their neighbourhood”.

We thoroughly approve for it aids us in working out who is prepared to really walk the walk.

For it's really not difficult to find those who will talk about the desire, even necessity, for more taxes. It's rather less common to find people who will cough up. It was one of us, back in 2005, who first got the numbers out of the Treasury for those who had voluntarily paid extra tax in the previous year. 5 - and 4 of those were dead. Those numbers haven't changed greatly in the intervening years.

This is the difference between expressed preferences and revealed. What people really think is found in what they do, not what they say. And as we have found, and as we expect this new initiative to find, there are very many fewer people willing to pay more than the number who will call for more to be paid.

After all, even those who call for very much higher tax rates do still fill out tax forms to work out how much they must pay, rather than scribbling a cheque for some randomly large amount, don't they?

Paternity leave and the gender pay gap

We've no particular institutional view on paternity leave. We are after all liberals so how people wish to order their lives is up to them. We'll not therefore insist that people should, or should not, follow any particular form or fashion in familial life.

We will though comment upon claims which are obviously untrue. Such as this:

The first thing to understand is that fathers and mothers want the same thing.

Of course both desire many of the same things, a healthy child and all that. But in terms of work and time off, career development and so on we know that this isn't true. For we know about the gender pay gap.

It's taken a long time, as all such socially awkward revelations do, but it is now generally agreed - among those who have thought at least - that the gender pay gap stems from different, on average, reactions to the arrival of children across the genders.

Men and women aren't paid different sums, mothers and fathers earn different amounts, the differences coming from their own choices about how they wish to order their lives once that exalted status has been reached. As we say, took a long time to get here but we are all now acknowledging reality.

But given that this is reality then it cannot be true that mothers and fathers - on average, always on average across those populations - desire the same things concerning children, work, time off and leave.  

We really do think that it's worth having a shufti at reality before trying to design policy you know....

Skateboards and why we overstate inflation

One of the little problems of modern life is that we can see, with our own very eyes, that the society around us is getting richer. We can do more things, faster, better, than our forefathers. Yet when we try to look at real wages it seems that we're not advancing at all, or only marginally. A goodly part of the answer is that we're calculating the real part of wages wrongly. At which point, skateboards:

If I flip to the back, there are mail-order ads for skateboard decks. The going price, depending on brand, is around $42. All of this is to say that while some things in skateboarding have changed a lot over the past 28 years, the cost of boards has essentially stayed the same.

Or if we measure that in real prices, adjusting for inflation (and guessing here, not actually doing the calculation) then skateboards have halved in price. This is roughly what we would use to compare to wages. The more general inflation rate is made up of all of the things we buy, weighted by how much of each of them we buy. There will be some things going down in real price, some in nominal, some rising in both and so on. "Inflation" is the sum of all of them, times those weights.

And yet we've an obvious problem here.  Today's skateboard is better in quality than that of 30 years ago. So, has the price really been static in nominal terms? Well, no, it hasn't. And the process of adjusting for that change in quality is "hedonic" adjustment.

This is obviously important when discussing, say, computing power. And great effort is expended to try to account for it. With a measure of success too. But our problem is that such adjustments really should apply to just about everything we use and or purchase. Even the humble skateboard.

Inflation these past few decades really has been overstated as a result of our not properly accounting for increases in quality. The usual guesstimate is 1 to 2% a year or so. Which makes a heck of a difference summed over a generation to real living standards - those things we're told haven't been improving.

This is one of those times when with a choice between an economic statistic and your own lying eyes go for the oculars. Living standards simply have been improving, whatever the estimates of real wages. 

Happy New Year, Happy New China

We wish a very happy Year of the Dog to all our Chinese friends and followers, both in mainland China and across the world. It is, of course, an appropriate animal after China has disproved the adage that “you can’t teach an old dog new tricks.” China is a very old country, yet over the past forty years it has shown a commendable readiness to experiment with, and to adapt to, new ideas.

Communism under Mao Zedong failed to deliver the goods. Prosperity was all around them, yet the Chinese people had to struggle with barely adequate food, poor housing, rationed clothing and woeful services. The system of central planning and collective farms had let China fall far behind not only the Western nations, but also Asian states like Japan, Singapore, South Korea, Hong Kong and Taiwan.

After Mao and his Gang of Four had gone, the Party leaders decided in 1978 to embark on a programme of systematic reform, cutting back on central planning and bringing in market reforms. Peasants were allowed to work their own land for profit and to sell surpluses in town markets. Communist-controlled enterprises saw authority devolve down to managers, given the right to hire and fire. People were allowed to move to where there was work. Free enterprise businesses were permitted, and sprang up in their thousands.

China’s Paramount Leader, Deng Xiaoping, opened up China to large-scale foreign investment, and accelerated a massive programme of foreign trade. The Communist Party retained a monopoly of power, as Communist governments do, but capitalism was allowed to flourish in China. Unlike Communists who slavishly follow the ideology, Deng opened it up to empiricism, and did what worked. We might be entering the Year of the Dog, but it was Deng who told us about cats. We don’t ask if it is black or white; we ask if it catches mice. Deng’s free enterprise cat caught the mice. 

China prospered as never before, rapidly becoming a net exporter of food instead of an importer, and achieved 3 decades with economic growth ranging between 7% and 10%. China still has too much state in its economy by our standards, and still closes off some freedoms taken for granted in the West. But China has stepped onto the world stage as its second major economy, and most Chinese are happy and proud that it is prosperous and respected.

We hope the Year of the Dog will be one of prosperity and achievement for our Chinese friends. Every dog has its day, and long may yours continue.
 

The NGDP Targeting Reader

You might have seen our new paper Monetary Policy After The Crash: Lessons learned? call for the Bank of England’s 2% CPI Inflation mandate to be scrapped and replaced with a Nominal GDP target.

The report’s author Prof Anthony J. Evans persuasively sets out the problems with the Bank of England’s current mandate and explains why we need to adopt a new target and reform the Bank’s Open Market Operations.

It’s an idea with a strong intellectual pedigree. The Bank’s current Governor Mark Carney has flirted with the idea. Michael Woodford, considered by many to be the world’s leading monetary economist, also backs the proposal. Christina Romer, who served as Obama’s Chief Economic Adviser endorsed it. And Greg Mankiw, Dubya’s Chief Economic Adviser and author of the best selling economics textbook, has shown that Nominal GDP targeting performs well compared to other monetary policy rules. Other supporters include Nobel Laureate Bob Lucas, Cato’s George Selgin and perhaps even F.A Hayek.

Rather than explain the idea here (I’ve done that in CapX today). I thought I’d share what I thought were the best introductions to the idea out there.

Scott Sumner’s excellent blog The Money Illusion is probably the best place to start. We’ve published two papers by him The real problem was nominal and The Case for Nominal GDP Targeting. They’re both great papers but for my money, the former is a better introduction to the ideas of market monetarism, while the latter is better at highlighting the specific advantages of Nominal GDP over inflation targeting.

Our former Executive Director Sam Bowman’s Nominal GDP Targeting for Dummies is the best explanation of the ‘musical chairs’ model of why recessions happen.

And our former Head of Research Ben Southwood did an excellent job at skewering common misconceptions around monetary policy, including:

• It’s bad if QE increases asset prices. And for that matter that QE only increased asset prices.

• That central banks “control” interest rates

• That higher inflation hurts savers or investors

• That raising interest rates will make house prices affordable

• That QE works by stimulating lending

It’s also worth reading Anthony’s other Adam Smith Institute report Sound Money: An Austrian proposal for free banking, NGDP targets, and OMO reforms.

Enjoy!

To introduce Oliver Kamm to the concept of markets

The point of a market - any market, in anything - is to swap one thing for another. The desirability of doing so can stem from all sorts of sources. Could be just that someone is better at something than another. Could be that government action is making such so. Could be a different method of organisation, natural endowments, prodnoses banning something, but the secret to the market part is the swap and nothing else.

Mr Johnson’s big idea is that Remain and Leave voters should unite to ensure that Britain takes advantage of regulatory divergence from the EU and creates a prosperous future. It’s a preposterous notion. Mr Johnson appears unaware that regulation in tradable goods and services exists for reasons entirely unrelated to bureaucratic meddling by Brussels. Standards in food safety, product safety and financial services are there to protect consumers.

British commerce is currently able to sell to EU countries unhindered by tariffs or non-tariff barriers. The EU is not just a free trade area but a single market. If you make a virtue of not adhering to common standards with Britain’s closest trading partners, you’d better have a good idea of what will replace that relationship.

We've regularly pointed out around here that markets in forms of organisation are just as important as any other. We're entirely fine with the idea that cooperatives, or other forms of communal, even socialist, organisation will outperform, in certain circumstances or sectors, more capitalist forms. Even that the State does some things better than non-state actors. Our point always being that we've got to have a market in such things so that we can see which is doing it better.

Exactly and entirely the same is true of regulation and standards. Once we get past the basics already there in common law - don't poison the consumers sort of things, possibly harms to third parties - then we positively don't want the one set of rules. We want the competition to see which actually is better, we need the market.

To take just the one example, current EU law states that a vacuum cleaner with an engine (hmm, technical things aren't quite our bag, motor?) over a certain power may not be sold. We'll never know whether people want one such unless they're allowed to express that preference by buying one, will we? That is, without competing regulatory systems, one which allows and another which does not, we'll never know which system works - "work" being, as always, defined as what makes the consumers as rich as it is possible for them to be?

Far from UK regulation diverging from EU being a problem with Brexit it's actually one of the major points and purposes of the process.  

In defence of library fines

A recent article in the i presented the results of a freedom of information request regarding the total overdue book fines collected by university libraries – the article states that 130 university libraries collected fines totalling around £3.5 million in the academic year 2016/2017. The article’s slant towards university libraries charging fines for overdue books being somehow ‘unjust’ is clear – see, for example, the article’s use of Bath and Chichester as universities that have abolished such fines for students, as well as the quoting of the shadow Education Secretary (for some reason) thinking this is related to Vice-Chancellor’s pay.

However, the article fails to take into account the fact that charging fines for overdue books is actually a good thing – specifically, it allows what economists call the ‘(partial) internalisation of an externality’.

An ‘externality’ arises when someone undertakes an activity but does not incur the full societal cost of such an activity. For example, suppose that a pristine hill view is enjoyed by a large group of people, but now a factory has started producing widgets nearby and as a result also releases copious amounts of black smoke that spoils that view. Although the factory would be paying for things such as the energy and raw materials required to produce its widgets, it would not be paying anything to account for the fact that it was spoiling what was once a lovely view. Hence, the factory’s production imposes an externality on those that used to enjoy the view.

In the same way, someone holding an overdue library book imposes an externality on others that want to borrow that book. It is free for a person to borrow the book, and in the absence of fines for keeping it for too long, it is free for the person to keep hold of the book. This means that other people that would want to borrow the book but cannot do so now incur a cost in terms of a delay in when they are able to borrow it.

Returning to the factory example, now suppose that the factory was required to pay a sum to the local council in order to take account of the amount of pollution it creates when it is producing – in this scenario, the factory will realise that the more it produces, the more it pollutes and the more it will have to pay the council. In this way, the factory would now take into account the costs it creates for society as well as the costs it incurs itself – hence, the factory now ‘internalises’ the externality.

Likewise, charging people for keeping books overdue means that they now realise that they take into the cost to society of doing so. In other words, charging for keeping books overdue is an improvement for society as other students can also borrow the books that they need in a timely manner.

Although one could claim that the size of fines charged by university libraries is too high, from what I can recall they are set at a level lower than those charged by ‘normal’ public libraries (it would be interesting to see if there was much variation in the size of fine charged across the type of library, its location etc).

Moreover, there is an argument to be made that university libraries should charge higher fines than those charged by normal libraries. In particular, there are likely to be between 50-150 people on the same university course, with a sizeable proportion of them wanting to read the same book at the same time, whereas a public library is highly unlikely to have such large contemporaneous demands for a specific book.  Hence, the size of the externality resulting from an overdue book in a university library is likely to be higher than it is in a public library, meaning that the fine levied by the university library should be higher than that charged by other libraries.

Nevertheless, the thinly-veiled slant of the article that ‘university library fines are another way that universities are out to get money from students unjustly’ is not supported by simple economic theory. Indeed, it is highly likely that students actually benefit from the charging of fines for overdue books.

Introducing John Vidal to the environmental Kuznets curve

It's not that people disagree with us, we've been known to disagree with ourselves. And not just among ourselves, but within each. Nor is it that people don't know things - we're ignorant on many a subject. It's that all too often the people who would tell us all what to do believe things which just ain't true. As with John Vidal:

A eureka moment for the planet: we’re finally planting trees again

John Vidal

That the forests are coming back is just fine of course. It's this idea that there's anything new, or even anything that's just happened, which is wrong. Simon Kuznets pointed to an observation, that environmental curve. When the task of life is to do anything to make today's dinner the environment gets the short end of the stick. Once food, clothing, shelter and so on are roughly enough dealt with we devote some portion of our rising incomes to doing things in slightly more expensive ways - ways that don't harm that environment, moving on with yet greater incomes to things which restore its near pristine nature. The Thames has salmon in it again after a several hundred year gap of it containing not much more than sewage.

As to forests - the low point of US tree cover was in the 1920s. Note that the environmental curve is an observation, not a theoretical construct. So when the peak (or trough) occurs is not something to be calculated but seen. We can also always find specific reasons other than just general wealth. That US reversal largely coming from abandoning the hard scrabble farms of New England and their gradual reversion to forest over the intervening century. Yet we do have a good guide from this and other episodes to give us an idea of the level of economic development at which it happens. A rough sketch being a little before where China is now, a little after where India is today.

Note that nothing was actually done other than not doing anything to the land. Those sweeping vistas of colour so enjoyed in the Fall as the leaves change and fall are modern, the result of simply not farming that land for 100 years. 

That is, the environment is a luxury good. No, this is a technical definition, it's something we spend more of our income upon as incomes rise.

Now, we don't expect everyone to know this although it would be nice if they did. But John Vidal was environmental correspondent of The Guardian for many years. He doesn't think this is all true. And surely he should know and understand it?