People just aren't as stupid as the bureaucrats think

It's claimed as one of the great victories for enlightened (sorry) regulation, the way that the EU and US have both banned the incandescent light bulb through bureaucratic action. The ban came about by raising the efficiency standards required: this meant that the traditional bulb could no longer be sold.

The argument in favour of doing things this way was, in public at least, that everyone's too stupid (or, in a more polite manner, subject to hyperbolic discounting) to realise that the new bulbs will actually save them money in the long term by consuming less electricity. There are also the more cynical in the industry who insist that it's actually a case of regulatory capture. The light bulb manufacturing companies managing to get us all away from using cheap as spit bulbs and onto something with a decent margin on it.

But there's an interesting new paper that puts that first explanation to rest:

It is often suggested that consumers are imperfectly informed about or inattentive to energy costs of durable goods such as cars, air conditioners, and lightbulbs. We study two randomized control experiments that provide information on energy costs and product lifetimes for energy efficient compact fluorescent lightbulbs (CFLs) vs. traditional incandescent bulbs. We then propose a general model of consumer bias in choices between energy-using durables, derive sufficient statistics for quantifying the welfare implications of such bias, and evaluate energy efficiency subsidies and standards as second best corrective policies if powerful information disclosure is infeasible. In the context of our theoretical model, the empirical results suggest that moderate CFL subsidies may be optimal, but imperfect information and inattention do not appear to justify a ban on traditional incandescent lightbulbs in the absence of other inefficiencies.

To translate that for you: people aren't as dumb as the bureaucrats think. We're all perfectly capable of working out whether the energy savings will make up for the higher initial cost.

This has a number of implications in hte larger world as well: for example, it means that bureaucratic regulation on car mileages (like CAFE in hte US) is contra-indicated. A simple tax on petrol will drive up average mpg because we're not all as thick as bricks. Assuming that climate change really is a problem that must be dealt with then a carbon tax is going to do the job. For we're not all so dim that we cannot work out the utility of using fossil fuels or not given the change in prices.

That is, we don't need to be regulated into behaviour, we can be influenced into it through hte price system. Something that really shouldn't be all that much of a surprise to us market liberals: for we're the people who already insist that people do indeed respond to price incentives in markets.

Now all we've got to do is convince our rulers of the righteousness of this point: so they can stop writing those darn regulations.

Comment: Minimum wage increase will hurt the poor

Commenting on the Chancellor's backing for an above-inflation rise in the National Minimum Wage, the Adam Smith Institute's Research Director Sam Bowman said:

"A minimum wage increase will hurt the poor, particularly young people and vulnerable groups like migrant workers. Most of the empirical economic evidence has found that increases in the minimum wage cause increases in unemployment. The evidence also suggests that minimum wage increases lead to slower job creation for low-skilled workers.

"Minimum wage work is usually a stepping-stone to something better where employees can acquire human capital. There is also evidence to suggest that minimum wages stop young workers from acquiring the skills that allow them to get better jobs in the long run, so today’s increase could have far-reaching harmful effects by keeping people in low-paid jobs.

"One way to actually help low-income workers would be to raise the income tax and National Insurance threshold to the current minimum wage level, which would give these workers a take-home pay equivalent to a minimum wage. That would require spending cuts or tax rises elsewhere, but it would be a responsible and effective way to improve the lot of the working poor that would carry none of the unemployment risks that this minimum wage increase does – in fact, it would create jobs.

"Increasing the minimum wage runs an indefensibly high risk of creating more unemployment and harming the people that supporters of the increase want to help. Even if the immediate impact is not large, this increase will lead to a long-run decline in job creation and standards for Britain's poorest workers. It will hurt the very people it is supposed to help."

For further comment please email media@old.adamsmith.org.

Why are the concepts of competition and monopoly so difficult for people to understand?

Now if someone wants to create an open source version of Google Maps then I've most certainly not got any complaints about that. What people want to do, on a voluntary basis, in association with others is just fine by me. It's just the justification that is being used that rather confuses. After noting that we all used to work on local time and only moved over to national time when the railways made it necessary, our intrepid technologist insists that:

The modern daytime dilemma is geography, and everyone is looking to be the definitive source. Google spends $1bn annually maintaining their maps, and that does not include the $1.5bn Google spent buying the navigation company Waze. Google is far from the only company trying to own everywhere, as Nokia purchased Navteq and TomTom and Tele Atlas try to merge. All of these companies want to become the definitive source of what's on the ground.

That's because what's on the ground has become big business. With GPSes in every car, and a smartphone in every pocket, the market for telling you where you are and where to go has become fierce. With all these companies, why do we need a project like OpenStreetMap? The answer is simply that as a society, no one company should have a monopoly on place, just as no one company had a monopoly on time in the 1800s.

Place is a shared resource, and when you give all that power to a single entity, you are giving them the power not only to tell you about your location, but to shape it. In summary, there are three concerns: who decides what gets shown on the map, who decides where you are and where you should go, and personal privacy.

Facepalm.

I can see that monopoly ownership of online mapping could conceivably be a bad idea. But the actual complaint here is that because there are many companies competing with each other therefore we must prevent monopoly by introducing a new supplier. Which is ludicrous of course: we don't have monopoly, the amount of money being spent (he could have mentioned Apple Maps and several others too) means that we're most unlikely to have monopoly anytime soon and therefore the argument falls flat on its face.

Seriously, why are these concepts so hard for people to understand? Perhaps open source mapping is indeed a good idea. Perhaps we don't want a monopoly in online mapping. But to point to the existence of fierce competition in online mapping as the very reason that we should fear monopoly in it is absurd.

Planning and living costs

Interesting piece in newgeography.com about Britain's antiquated planning policies. Public opinion on them seems to be changing, driven largely by rising price houses. People figure that maybe it's time to build more houses. That was, of course, the conclusion reached by Kate Barker's study on housing a decade or more ago.

And planning restrictions impose other costs too. Not just our homes but our shops and other facilities become more squashed and crowded, and food and other essentials become more expensive – planning rules mean they have to be transported long distances, and planning delays put up suppliers' costs.

And yet, says the American author, England and Wales are less crowded than Ohio, with its rolling hills and famland. Only 9.6% of England and Wales is urban, compared to 10.8% of Ohio.

An average house in the UK cost about three times the median income in the 1990s. In the London green belt it is now seven times that. Our houses are now 30% smaller than they were in the 1920s, before the planning laws; with the obvious exception of Hong Kong, our new homes are some of the smallest in the world - 'rabbit hutch homes' as Communities Secretary Eric Pickles described them. It is indeed time to have this debate.

Low rates doesn't mean low rates

I got called up last Wednesday to ask if anyone at the Adam Smith Institute would go on the Daily Politics to explain why the Bank of England should raise its base rate (not exactly in those words). The producer was familiar with common free market ideas that argue that artificially low interest rates are blowing up a housing bubble which will later burst. I had to try to explain to the producer why I both agree and disagree with these sentiments: low interest rates do underlie economic limbo, but raising the base rate is not a solution and may produce yet lower real interest rates where it matters—throughout the economy.

The problem comes from the dual use, in the popular economic press, and even by top economists, of the term "interest rates" to mean both the stance of monetary policy and the cost of borrowing. This is understandable because during the Great Moderation of 1992-2008 all the world's most important macroeconomic authorities attempted to control the overall economy through adjusting one or a small number of key interest rates to achieve a consumer price inflation (CPI) target. At the same time, we are familiar with interest rates through our normal life: on loans, mortgages, savings, credit cards and so on. But acting as though the Bank of England directly controls these rates when it adjusts policy seriously obfuscates how the macroeconomy works and contributes to a lot of sloppy thinking.

Whereas the Federal Reserve has always used a form of quantitative easing (QE) to adjust a market interest rate—the Federal Funds Rate—the Bank of England has typically adjusted its base rate, which it calls Bank Rate, instead (updated). Bank Rate is the flat (nominal) interest rate it charges commercial banks for short term funding, and pays on their excess reserves. This sets a lower bound on overnight commercial lending, since it is always an option to lend or borrow money at Bank Rate, and therefore it is included in some market contracts, like tracker variable rate mortgages. The current UK base rate is 0.5%, a nominal number which translates to a negative real rate, but secured loans charge more like 3% in nominal terms, unsecured loans 8%, and credit cards 10%.

So we've established that the Bank of England sets a lower bound on interest rates with its Bank Rate. And we've also established that Bank Rate affects some other rates directly, principally tracker mortgages. We might also expect it to affect other rates in the economy—for example a cut will "ripple out" through the economy, because all other things being equal, it is now cheaper for banks to borrow from the BoE and they will thus be more willing to do so. Economists call this the liquidity effect. They will thus be more willing to lend cheaply and less willing to borrow from savers. So one effect of lowering the Bank Rate is to directly lower some rates, put a lower lower bound on others, and make others cheaper.

However there is an opposed reaction. Lowering Bank Rate doesn't just make loans cheaper, but it increases demand. It does so by injecting extra money into the economy (from the extra loans), but more importantly by signalling to markets that it intends demand to grow faster and that it is willing to take measures (such as further lowering Bank Rate or boosting the money supply through a QE programme) to make sure this happens. This is why stock markets react so strongly to a (policy) interest rate cut—all businesses are worth a bit more because they expect higher total revenues over their future.

But if firms expect higher demand in the future they will in turn demand more investment funds to put into projects to service that demand. This means that cutting the BoE's base rate puts pressure on effective market interest rates in both directions. It is an empirical question which direction the overall effect goes in—but this means that the simple coincidence of low real effective interest rates out in the economy and a low, by historical terms, Bank Rate, shows nothing. It could be that the best way to raise interest rates out there in the economy is to cut the Bank's base rate, or, since it can't go much further now, print money to raise inflation (which would ceteris paribus cut the rate in real terms). Look at the graph above for an illustration of how the Fed's changes in their QE programme (the red line) and their Federal Funds rate (the dark blue line) don't produce big shifts in (real) market interest rates like corporate bond returns and 30-year mortgages.

So my view on low interest rates is complicated. I think the Bank should get out of the business of setting rates altogether, and vary the size of the monetary base to control nominal income in the economy. But if the Bank is going to use rates as its key policy tool, it shouldn't raise them when a recovery hasn't quite taken hold—it's uncertain whether it'll raise market interest rates, but it will certainly choke off the demand we need for solid growth.

I do wish that people would make up their minds and be consistent

Yes, I know, forlon hope given the combination of politics and non-godly religion here, but I do wish that people would be consistent. Given the announcement over the taxation of fracking we're getting the usual complaints from the usual people:

The government also came forward with a proposal to turn more of the tax revenue from fracking over to the communities where the wells would be. Friends of the Earth dismissed the tax proposal as "a new low" and likened it to paying off local councils to sign off on drilling permits. But there's nothing underhanded about the idea, which would have councils retain 100% of the property tax paid by businesses to support local services.

I'm old enough to recall when business rates were indeed paid to local councils and there was great lefty hysteria when it was decided that they should be centrally allocated instead. So I'm a little confused about the same sort of people now shouting that local taxation to pay for local things is a bad idea.

There's also been outrage at the idea that fracking fields should pay lower corporation tax rates (in reality, lower royalties but they're assessed as corp tax) than North Sea fields. Yet this criticism is coming from exactly the same people who insist, very loudly and at length, that it is the duty of government to support and even subsidise nascent industries. I don't mean just renewables here either: I mean the whole encouragement, protection and coddling of infant industries. It is exactly those who support such ideas who are now screaming about the government encouraging such an infant industry merely by the expedient of not taxing the snot out of it.

Which is what brings me to my wish: that people will at least be consistent in their ideas and approaches. For we do need to have an attitude towards governmental subsidy and encouragement which is more sophisticated than merely to provide them for things I like and don't for things I don't.

Bank bonuses and bogus arguments

Here I go again, defending bankers. It's a dirty job, but someone has to do it. Well, it's more than a hobby than a job because the banks don't even pay me to do it.

It's bonus time once more, that time of year when the unpleasant politics of envy erupts after the peace and goodwill of the holiday season. This time, RBS wants to pay bonuses more than 200% of staff salaries. That of course requires the permission of its shareholders – principally, the UK Government in the form of Chancellor George Osborne. Such bonuses are "inappropriate" say many political critics, particularly when "ordinary families are struggling with the cost of living."

But bonuses are a very sensible way to pay people in a volatile sector. In an economy that is growing, as the UK's is now, banking business is great. There are company mergers and acquisitions to do, investments to be placed, and all the rest. In a stuttering economy, business is disastrous. So banks have a system that rewards key people on the basis of results. That is a lot better than scrapping bonuses, raising salaries instead (which is what would happen), and then having to lay people off (and lose their expertise) where you hit a rough patch. With a bonus system, you just pay them less and they hang on, in the hope and expectation that things will improve.

It should not be up to MPs – and MEPs in Brussels, Strasbourg, or wherever they have decanted to this week – to decide how much bankers should be paid. They are hardly icons of virtue on the pay and expenses front themselves. Most of them don't even understand the sector. If bonus caps are to "reduce risk taking", then why did MEPs cap fund managers, who don't take anything like the risks that bankers do.

Bank bonuses are already heavily restricted. Rules introduced in 2010 cut the amount that could be paid in cash, and spread the pay-out time over 3-5 years. So people today get more of their bonus in shares - which means that the long-term health of their company is dearer to their hearts than any one-off "quick profit."

Let us not forget that after New York, London is the world's leading services centre. The sector brings in about £60bn in tax every year, more than 10% of the government's entire budget. We need it to succeed, and retain talent – which means paying them world market rates. That's what we do with footballers – John Terry is paid £6.7m a year, Wayne Rooney is on £15.1m and Steven Gerrard picks up £7.2m and got an MBE too. But football clubs are very small businesses compared to banks. Though a world footballing brand, Manchester United's capitalization is just £2.47bn; the market capitalization of RBS is seventeen times bigger, at £41.8bn. Should we be surprised if star performers in RBS are paid seventeen times what Rooney earns? But in fact we baulk when they are paid fifteen times less.

There is a problem with banking, but it is not bonuses. It is the lack of competition. The main UK banks can literally be counted on one hand: HSBC, Lloyds (which includes Bank of Scotland), RBS (which inlcudes NatWest), Barclays and Standard Chartered - though the latter operates mainly overseas. Lack of competition means customers get a worse service at a higher price, and providers can indeed overpay themselves. In a competitive market, anyone over-rewarding their staff would go out of business. So let's not try to guess what the "right" remuneration is for bankers. Let's open the sector to competition – which means scaling back the regulation on new entrants – and let the market do the job for us.

In a gift economy we'll all still be getting richer even as GDP stays the same

It's a fairly standard observation these days that economic growth isn't as fast today as it was in the decades immediately post WWII. Quite why is always a bit of a puzzle: obviously, immediately post WWII Europe was nowhere near the technology limit so catch up growth was possible. And as China is showing us today catch up growth can indeed be faster than when you are trying to figure out how to invent the new stuff not just copy the old. There are myriad other speculations as to cause as well but one that is obviously in part responsible is that we've had a rise in the non-payment part of the economy more recently. All that open source and collaborative stuff being done in software for example.

This is an interesting paper that tries to put some numbers on the value of just one of those projects, the Apache server suite:

Is that a lot of Apache? Standard principles of GDP measurement compare a free good to the pricing for its closest substitute, which comes from Microsoft’s server products. Using this approach, Frank and I estimate that use of Apache potentially accounts for somewhere between $2 billion and $12 billion in the United States. Apache’s advanced functionality provides reasons to think the estimate tends toward the higher number, but, as yet, standard methods can’t settle on a single number. Is that a lot? That equates to between 1.3 percent and 8.7 percent of the stock of prepackaged software in private fixed investment in the United States. That looks like a lot to me, especially for one piece of software.

In comparison to a $15 trillion economy that's not much: but it is indeed something all the same. And there are many such projects as well where we're all getting good use out of things that we're not having to pay for.

And those numbers are also a gross underestimate. For what they've done is valued Apache at what it would cost to get the same services from the paid for alternative (one of Microsoft's bits of kit). But of course that alternative is made cheaper by the fact that there is this free competition to it. And that's not all either: we're still grossly undervaluing the contribution being made.

For the true addition to the wealth of nations is in fact the use value that we get out of whatever it is: as with Smith's definition of the labour theory of value of course. And I think that's where our economic statistics are misleading us: I think there's far more wealth being enjoyed these days than is actually being counted in the cash transactions that flow around the economy. Apache, MySQL, Google's search engine, these are part of it yes. But think of the fall in telecoms prices in recent decades: the effect of these is that the economy is shrinking but does anyone really think that we are poorer as a result of being able to make a transatlantic phone call without requiring a second mortgage?

As so often occurs to me I think at least part of what we're observing is a function of our not measuring what's happening very well.

It's not exactly news that Will Hutton is wrong now, is it?

I do so like it when two stories turn up on the same day illustrating an important point for us. In the first one Will Hutton is telling us all how regulation is just essential for the economy to thrive:

The low regulation lobby is in effect creating high-return, low-risk business fiefdoms largely free of social and public obligations. Worse, shareholders and investors set these returns against what they might expect investing in frontier technologies and innovation. Why do that when you can make more certain and higher profits in pay-day lending, bookmaking or the drinks business? The Cameron-Osborne-Hunt-Paterson mantra leads straight to a low innovation economy and a high-stress, low-wellbeing society, while offering unnecessarily high returns to those at the top.

Reality is very different. Business is part of the society in which it trades. Regulation and legislation, far from burdens, are crucial grit in the capitalist oyster. They are proposed in our democracy because they will reduce public and social costs that otherwise society has to bear. By obliging business to accept the costs it creates, it raises genuine innovation. It is time to call time. We don't want ministers acting as surrogate corporate lobbyists. We need them to fashion a new compact between business and society.

And then we have the head of Intercontinental Hotels telling us that there must be more regulation:

Fast-growing internet companies such as Airbnb should be subject to the same regulations as traditional firms, the chief executive of InterContinental Hotels Group has said. Richard Solomons claimed there is a “slight naivety” about online businesses and governments should treat internet firms – many of which are developing into global powerhouses – in “exactly the same way” as traditional companies. Traditional hotel firms, which are often far bigger employers than internet ventures, are currently at a “disadvantage”, he said. The hotels chief cited the accommodation website Airbnb, whose financial backers include the Hollywood actor Ashton Kutcher, as one example where online firms were subject to different rules.

The website, which allows people to rent out spare rooms to visitors, was “an interesting concept”, he said. “But what about fire and life safety, what about food safety, what about security issues, what about cleanliness – all those things that we [hoteliers] are required to keep to a standard? What about paying tax? “If you are paying somebody for a service and that service is sold as a major operation, it’s becoming a big business then why would different standards apply? “Governance and regulation needs to treat online businesses the same way as existing businesses so that existing businesses are not put at a disadvantage.”

Or as we might put that, you've got to impose regulation on those upstart internet firms in order to protect my business.

And contrary to what Hutton says (look, that's obvious, reality is always contrary to what Hutton says) that's what most regulation does do. It's why it's so welcomed by incumbent businesses: it means that those changes in technology, rises in productiivty, growth in the economy in short, have a much harder time killing off those incumbents. And we as consumers would very much like there to be less of that regulation so that those upstarts can succeed.

As to the larger issue, once again Hutton is showing us that there's nothing quite so conservative as the British Left. But we already knew that, didn't we?

Adam Smith and the solution to the Easterlin Paradox

We have yet another attempt to solve the Easterlin Paradox. This one telling us that actually, it's not just that everyone getting richer doesn't make us all more happy, it's that everyone getting richer makes us all more unhappy. It's really not something that I find all that persuasive.

Those with long memories will recall that I have touched upon this subject before. And I've claimed that the mistake that is being made here is that people are looking at levels of incomes. Whereas, given what we know of human psychology (things like loss aversion and so on) what we actually ought to be looking at is changes in incomes. Rising incomes make people happier: falling incomes make them less happy. The link to levels of wealth is simply that the currently rich countries have had rising incomes for a couple of centuries or so. What's slightly confused me as I make this point is that I can't find anyone else making it and I didn't understand why.

Until, of course, I opened the good book for a bit of a reread:

It deserves to be remarked, perhaps, that it is in the progressive state, while the society is advancing to the further acquisition, rather than when it has acquired its full complement of riches, that the condition of the labouring poor, of the great body of the people, seems to be the happiest and the most comfortable. It is hard in the stationary, and miserable in the declining state. The progressive state is in reality the cheerful and the hearty state to all the different orders of the society. The stationary is dull; the declining melancholy.

Adam Smith got there a couple of centuries before either I or Easterlin. It is the changes in incomes that produce the happiness, not the levels.

Ah well, worth being reminded in 2014, as I have been in previous years, that I am capable of coming up with good ideas just as I am of coming up with original ones. We're still on the hunt for that one that is both of them at the same time of course.