Four basic points on deficits


I'm (probably) going on Scotland 2015 later, to talk about Paul Krugman's views on deficits—i.e. 'do we really need to reduce the deficit?' Now there's no real reason why my economic views and arguments should be trusted over those of a Nobel prizewinner (it's a red herring that his Nobel prize was in the economics of trade; he has a widely-respected macro textbook and a number of widely-cited macro papers). But I do think my points hold water anyway. 1. Krugman is right that we didn't and don't have a debt crisis in the UK. When it comes to debt—like with many other things—I trust the markets. Markets aren't stupid; they aggregate the preferences and information of billions of people.

Look at Greece: it can only sell new debt at a high yield because markets are worried about the existing 200% of GDP they owe. The UK can sell debt very cheaply because the UK's debt level is more or less manageable and the UK has always repaid debts it's incurred, for hundreds of years.

2. Krugman is right that (extra) deficit spending can sometimes raise growth. Cutting taxes or raising productive government spending in a recession will raise growth, but only if the central bank is incompetent and (a) has let monetary-macro conditions fall below where they were expected to be; and (b) is unwilling to correct its mistake. Cutting taxes will also enhance efficiency and give the economy a supply-side boost.

3. Krugman is wrong that the UK is and has been suffering from a massive insufficiency of demand and needed to do more expansive fiscal policy. Firstly, fiscal policy is unnecessary or counterproductive when the central bank keeps the nominal economy stable with no monetary spurts or crashes.

The Bank of England lowered its policy rate to 0.5% and kept it there for over six years; it still rests there. It did a £375bn QE programme. Consumer price inflation hit 5.2% twice and stayed above target for five years. Do we really think it was willing to see inflation go even higher, but only if it came from extra fiscal policy?

In New Keynesian models a demand-driven slump is typically identified when you have low or negative growth and low or negative inflation. But we saw high inflation and low or negative growth. This suggests that there was a big supply-side problem—the 'productivity puzzle'—and that demand was not necessarily massively deficient.

4. There are reasons to reduce the deficit other than a possible debt crisis. At the zero lower bound—as Keynesians endlessly tell us—interest rates cannot fall further to induce extra borrowing to invest and consume. In fact, the zero lower bound may or may not exist (lots of European government bonds currently have negative yields). But even if it does exist, 99%+ of assets are not yet at the zero lower bound! This especially includes private firms' debts and equities, which are exactly where private investment comes from. And remember that private investment is how societies get richer.

By all means the government should borrow to fund investment projects that will produce above-market positive returns (although NB that these almost never exist except where the government has effectively outlawed private firms from investing in a given area). But bear in mind that borrowing to funding general government spending comes out of funds that could otherwise be used for private investment. It comes at a cost, even when Bank of England policy rates are near-zero and even when gilt yields are near zero.

So Krugman is right that we don't have a debt crisis (look at markets!); he's right that deficit spending can work (in weird circumstances); but he's wrong that the UK has suffered a massive demand deficit (look at inflation!); and borrowing comes at the expense of private investment (nearly no assets are at the zero lower bound & the zero lower bound may not even exist!)

Well done to The Guardian for joining the dots here


It is, of course, possible that we're all being mugged by the retailers and supermarkets. In the absence of sufficient market competition that's actually what we'd expect in fact, for capitalists are greedy for profit. That's why we like markets. It's also possible that the retailing business has intensive competition meaning that vast pressure is being put upon those suppliers and retailers to deliver the lowest possible prices to us, the consumers. Either story is possible but it's really most unlikely that both are true. So, well done to The Guardian here:

The competition regulator is to scrutinise allegations that UK supermarkets have duped shoppers out of hundreds of millions of pounds through misleading pricing tactics.

Which? has lodged the first ever super-complaint against the grocery sector after compiling a dossier of “dodgy multi-buys, shrinking products and baffling sales offers” and sending it to the Competition and Markets Authority.

That's a version of the first story. That there's insufficient competition, we cannot take our trade elsewhere and so we're being rooked by the capitalists.

Meanwhile, new research suggests that more than 1,400 suppliers to Britain’s supermarkets are facing collapse as the cut-throat price war takes its toll on the industry.

The number of food and beverage makers in significant financial distress has nearly doubled to 1,414 in the last year, according to insolvency practitioner Begbies Traynor.

That's a version of the second story, that there's intensive competition to the benefit of us consumers. And it is entirely contradictory to the tale of the first story.

We really cannot have both happening in he same market at the same time. But according to The Guardian we do because both examples are from the same article. Without their being able to connect the dots between the two that show that one or other of the stories must be wrong.

Universal healthcare and market-based systems aren't mutually exclusive


An op-ed published last week in the New York Times laments Americans' decline in support for government involvement in the redistribution of wealth - or, as the Times author Thomas Edsall calls it, ‘sharing’. Edsall analyses a bunch of polls throughout the article, but what he finds troubling I find to be good common sense. For example, most Americans aren't incredibly trusting of their government:

Even worse for Democrats, the Saez paper found that “information about inequality also makes respondents trust government less,” decreasing “by nearly twenty percent the share of respondents who ‘trust government’ most of the time:”

Smart thinking.

Furthermore, most Americans aren’t convinced that Obamacare is going to be the shining, efficient, cheaper, all-inclusive beacon of hope it was promised to be:

An earlier New York Times poll, conducted in December 2013, found that 52 percent of those surveyed believed that the Affordable Care Act would increase their medical costs; 14 percent said it would reduce costs. Thirty-six percent believed that Obamacare would worsen the quality of health care compared to 17 percent who thought it would improve it.

Also probably wise.

On the whole Edsall appears to understand people’s perceptions of government care (to my relief and his dismay) quite well – except for in one area.

Esdall claims the “most dramatic” change in public opinion has been people’s perception of the ‘right’ to healthcare. He cites the two Gallup polls in an attempt to claim that majority support for guaranteed access to health coverage has dropped radically over the past six years:

The erosion of the belief in health care as a government-protected right is perhaps the most dramatic reflection of these trends. In 2006, by a margin of more than two to one, 69-28, those surveyed by Gallup said that the federal government should guarantee health care coverage for all citizens of the United States. By late 2014, however, Gallup found that this percentage had fallen 24 points to 45 percent, while the percentage of respondents who said health care is not a federal responsibility nearly doubled to 52 percent.

But Esdall isn’t comparing apples with apples. The belief that in a developed society everyone should have access to basic healthcare provisions is not the same as believing that healthcare is a federal responsibility – especially in the United States.

The debate is not – and has not been for a long time – whether or not people should have access to healthcare, but rather how that care should be provided. What kind of delivery of healthcare will create the cheapest prices and best outcomes, and what safety net for those at the bottom will provide the most comprehensive care?

There is huge demand in the States for healthcare reform, and most people want this reform to focus on cheaper access to care. But that can be achieved without fully handing healthcare provision over to the federal government or adopting something that resembles the NHS.

Both the US and the UK should be looking to countries that rank highest for healthcare provisions internationally, which have almost all settled on systems where the central government funds healthcare but does not directly provide healthcare.  The Netherlands, Denmark, Switzerland, and Germany all have healthy relationships with private companies, ranging from insurance companies and charities, that provide better outcomes than those in the UK and in a cheaper, more efficient manner than in the US.

Support for universal access to healthcare and support for market mechanisms in healthcare are not mutually exclusive; there's plenty of evidence to suggest a combination of the two creates the best healthcare systems in the world.

Don't campaign against tax havens: they are good for us


Thanks to faulty headline-grabbing propaganda, most people think tax havens are outrageous places in which tens of billions of pounds are being stored offshore, denying UK citizens valuable tax revenue that could be used on public services like schools, health care and roads. Nice idea. But like many nice ideas, it veers far from the truth. First off, what of the complaint that if the money stays in the private sector in tax havens then UK citizens are being robbed of vital tax revenue? To answer this, consider if the money stays in the private sector in a tax haven, who else benefits from that apart from the person with the money? On the one hand that money is invested, which generates plenty of jobs and lots of economic growth. On the other, if a British billionaire keeps £500 million in a tax haven then all the time he's not spending it he makes everyone else in the UK better off in terms of more resources and lower prices. This is because money earned but not spent is like conferring a gift to the UK taxpayers. Moreover, it's important to remember that the primary contribution high earners make to society is not in the taxes they pay, it is in the goods and services they produce.

When it comes to tax havens, what is also being missed by a lot of people is that tax havens actually make us better off in another way, in that they provide vital competition to tax rates in the UK. A popular view from the left is that because of tax havens governments have to increase our taxes to make up for all the tax they are not getting from money stored in places like the Cayman Islands. In actual fact, the opposite is true – tax havens keep our UK taxes lower not higher.

To see why, suppose there is just one quite expensive Bakery in town (call it Bakery A). Along comes another Bakery in competition (Bakery B), offering townsfolk lower prices for bread. The very worst thing that Bakery A could do in response would be to raise its prices even more. Their best response would be to try to out-compete Bakery B for custom. This is the nature of competition, and how it lowers prices and improves efficiency.

Similarly, tax havens are like Bakery B: their more competitive tax rates place competitive pressures on governments that might be tempted to tax us highly. Competition for prices occurs with tax just as it does with bread, laptops and cars. Governments must be competitive with their tax rates, otherwise more and more money will be stored in places with lower tax rates. Tax competition is a key driver of economic growth in the world, as this incentivises politicians to keep taxes on savings and investments low. When tax rates are excessive, there is less economic growth. Tax havens provide the necessary competition to militate against this happening.

Finally, tax havens can claim to have some of best standards of living and economic growth in the world. That's precisely because low taxes stimulate economic growth and better standards of living, as the qualities of the free market predominate over party political interests. Instead of calling for politicians to tackle the grave injustices of tax havens, campaigners should be calling for a more fruitful tax system here, based on lower rates, reduced complexity and bureaucracy, and increased market freedom.

Well, that's markets for you


Not only is this markets for you it's rather the point of markets for you:

The Co-operative Group has told its members that it cannot make an enhanced commitment to stock Fairtrade products because of tough competition among supermarkets and its shift towards convenience stores.

The UK’s largest mutual made the remarks in response to a motion tabled ahead of the upcoming annual general meeting asking for the commitment to Fairtrade – for which the group has prided its link in the past – to be reiterated and also retain the long-term strategic objective that that if a “Co-operative product can be Fairtrade, it will be Fairtrade”.

Saying it could not back all elements of the motion, the board blamed the current financial position of the group and “the austere market climate we continue to face and the strategic direction of the business into convenience shops which naturally increases pressure on space and range”.

There are some out there who desire to purchase Fairtrade products. We don't share that view, thinking them to be counterproductive at best, but we absolutely defend the more basic idea. If your worldview means that you either desire to, or desire not to, purchase products made in a particular manner, or place, of by a certain group of people or not, then that's rather the point of having a market economy. So that you may do so. If enough people share those values of yours then you might even be lucky enough to find that supply arises to meet your desires. This is true of bread without alum, of meat that isn't rotten, of food prepared to certain religious standards and, yes, to things made by poor people in poor countries. It's wonderful, it's glorious in fact.

However, it is worth noting that perhaps not everyone shares your particular worldview. As here: the Co Op finds that while there's enough people who care about Fairtrade to make it worthwhile not enough people care about it to make it compulsory. And that's where we'd slightly argue with the description of it being "competition" that causes this. Because yes, OK, the supermarkets are in competition to sate our desires. And some of us do desire to pay higher prices to provide that outdoor relief for the dimmer children of the upper bourgeoisie that is the real result of Fairtrade. But not all of us: and therefore it's not really the competition between the supermarkets being the problem here, it's that not enough of us Britons share the initial worldview.

Which is, again, one of the great glories of this free market idea. You get to maximise your utility by purchasing things made in the manner you approve of and so do I, we, them and they. According to our different estimations of our own utility.

Do patent-owners 'hold up' further innovation?


One of the standard arguments of the anti-patent crowd is that patents hinder follow-on innovation by making it risky or costly to build on other people's breakthroughs. There is some evidence for this (see this post from my colleague Charlotte).

However, a new paper challenges this general thesis by looking at whether the outcomes it predicts happen in the real world. If it is true that owners of standard-essential patents (SEPs)—those ones that set up a whole standard used across the marketplace and essential for a large number of follow-on innovators—charge over-the-odds fees and prevent follow-on innovation, then it must also be true that:

  1. Industries where SEPs predominate are ones with relatively stagnant (quality-adjusted) prices, because new entrant innovators have less chance to bid them down through competition
  2. Court decisions that reduce the power of SEP holders will lead to more innovation in those sectors

The paper, "An Empirical Examination of Patent Hold-Up" (pdf) finds neither of these to be true:

A large literature asserts that standard essential patents (SEPs) allow their owners to “hold up” innovation by charging fees that exceed their incremental contribution to a final product.

We evaluate two central, interrelated predictions of this SEP hold-up hypothesis: (1) SEP-reliant industries should experience more stagnant quality-adjusted prices than similar non-SEP-reliant industries; and (2) court decisions that reduce the excessive power of SEP holders should accelerate innovation in SEP-reliant industries.

We find no empirical support for either prediction. Indeed, SEP-reliant industries have the fastest quality-adjusted price declines in the U.S. economy.

The principle is nicely illustrated in a few charts.

Screen Shot 2015-04-20 at 15.53.51

Screen Shot 2015-04-20 at 15.54.01

At one point there was more or less of a consensus among libertarians that intellectual property was a good kind of property rights. Nowadays you are more likely to see a proto-consensus against copyright at the very least and often patents as well. I think that emerging evidence means we should keep our minds open.

Markets are actually quite good at regulation


The ASI blog reader may not be surprised to discover that some regulations have unintended consequences that, instead of solving a given problem, make the situation worse. This isn't necessarily always true—though it might be, it's an empirical question—but it seems that regulatory fair disclosure laws, intended to make executives disclose more bad info about their firms, are another one of these. A new paper "What Induces CEOs to Provide Timely Disclosure of Bad News: Regulation or Contracting?" (pdf) by Stephen P. Baginski, John L. Campbell, Lisa A. Hinson & David S. Koo finds that regulatory fair disclosure laws lead to executives systematically guessing more pessimistically about the future. But the laws fail to stop executives delaying the release of bad news.

By contrast, they find that contracts including provisions for 'golden parachute' payments get rid of the career concerns which incentivise repressing bad news, and get around the asymmetric information problem that would exist in their absence.

Prior research finds that career concerns encourage managers to withhold bad news in the hopes that subsequent events will turn in their favor, and that government regulation (i.e., Regulation Fair Disclosure, or “Reg FD”) eliminates this problem.

In this study, we re-examine the effectiveness of government regulation at mitigating the delay of bad news, and consider the effectiveness of a contracting mechanism that accomplishes the same goal. We provide two main findings.

First, recent studies show that Reg FD changed the way managers provide forecasts in two fundamental ways: (1) managers are more likely to issue a range forecast that is pessimistically biased rather than a neutral point estimate, and (2) managers are more likely to issue forecasts at the same time as earnings announcements.

We show that when design choices do not reflect these changes in manager behavior, the extent to which regulation induces timely disclosure of bad news is overstated.

Second, we identify a compensation contract (i.e., ex-ante severance pay agreements) that firms use to explicitly reduce their CEO’s career concerns, and thus should encourage more timely disclosure of bad news. We find that if managers are promised a sufficiently large payment in the event of a dismissal, they no longer delay the disclosure of bad news relative to good news.

Overall, we find that managers continue to delay the disclosure of bad news after Reg FD, and that if firms provide compensation contracts to reduce their managers’ career concerns, this asymmetric release of information is eliminated.

Just like obscure traditions, market practices that look arbitrary, weird, or irrational are often one of the ways market institutions create a successful and rational economic order. Regulators need to be very careful before tinkering with them.

Finnish politics just got interesting


We think it's fairly obvious that over the past decade the most successful economy in the eurozone has been that of Germany. And we also think it's fairly obvious why this has been so, the so-called Hartz IV reforms. Which appears to be very much what the new Finnish likely Prime Minister believes in:

A millionaire former telecoms executive touted as a technocrat capable of rescuing Finland from economic slump won Sunday's parliamentary election, but he will likely need coalition support from a second-placed eurosceptic party critical of any more Greek bailouts.

Opposition Centre Party leader Juha Sipila, who advocates a wage freeze and spending cuts to regain Finland's competitiveness, beat pro-EU and pro-NATO Prime Minister Alexander Stubb after four years of policy stagnation and a bickering coalition.

Hartz IV looked at Germany's labour costs and concluded that they were too high for the productivity levels in the country. This therefore meant unemployment for some, low economic growth for all. The answer to this was to change the relationship between the costs of labour and the production from that labour.

It's worth nothing that this is one area of economics where there is no difference between the different schools. All will agree that involuntary unemployment is the result of wages being higher than the market clearing level. The arguments all start with why this is so (a supply or demand shock? Capitalist plutocrats screwing everyone? The banks have fallen over?) and then continue on into what should be done about it (raise demand in the economy? Increase educational levels? Lower wages?).

Dependent on the details of what is happening, something which is an empirical, not theoretical, question one of all of them could be happening, could be the right solution, at any one time. Germany then and apparently Finland now mapped it out and decided that it really was simply the general wage level that was too high. That was managed down in Germany and a decade of comparative success has followed (yes, we do have to limit ourselves to the eurozone economies in that comparison, given the burdens of the single currency). Here's hoping that the Finns have the analysis right this time and that the same solution works again.

There is no such thing as tax avoidance


You don't have to go far through the public prints to find all sorts of blood curdling tales about how the Treasury is being ripped off by varied forms of tax avoidance and even aggressive tax avoidance. And yet the truth is that as a thing tax avoidance doesn't actually exist. So it isn't as we're told in the Telegraph, that tax avoidance is actually a good thing, it's that it just doesn't happen:

Successive governments have left us with a tax regime so complex it verges on chaotic.

Which is exactly why we should be suspicious of politicians who talk imprecisely about “tax avoidance” and “tax evasion” – or who muddle the two terms, or use them interchangeably.

There is nothing wrong with tax avoidance.

Tax avoidance is what everyone does, not just the wealthy. It’s what we do when we save in Isas and pensions, or in Junior Isas for our children.

There's no doubt at all that there are attempts to avoid tax. Sticking your money in an ISA or simply not declaring millions in income are both attempts to avoid tax. But we have a system which decides which of those plans is successful in doing so. That system being HMRC in the first line, the various tax tribunals in the second and then on and up to the European Court of Justice as both Vodafone and Cadbury found out. The end result of this system of adjudicating upon attempts is that there's no room left for tax avoidance to actually happen in. For, obviously, once the courts have had their say either whatever is going on is obeying the law of the land or it isn't. And when it is decided that it isn't that's tax evasion. And when it's decided that it is according to said law that's not actually avoiding anything, is it? It's paying, in full, one's dues as Parliament has decided you ought to.

There really isn't anything called tax avoidance. There's only obeying the law and not obeying it.

So, could the public health people please shut up?


Vaping, smoking, the great question is, is one a complement to the other (complement, meaning that more of one leads to more of the other) or a substitute (more of one leads to less of the other)? Evidence:

Electronic cigarette use among U.S. middle and high school students tripled in 2014 while cigarette use fell to record lows, according to provocative new data that is likely to intensify debate over whether e-cigarettes are a boon or bane to public health.

No, that's not provocative data, that's conclusive data. A substitute not a complement.

Every public health advocate should now be pushing vaping. Anyone who claims to be such and is not is simply a Puritan.

By their actions shall ye know them.