Peer effects: they exist but they're not very big

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One reason parents try and get their kids into 'good' schools is that they have better teachers, facilities and so on. Another is that the other students are also high achievers and this is believed to feed into their own children's achievement—via less disruptiveness, an environment more conducive to scholarly activity, and so on. A paper newly published in the Oxford Bulletin of Economics and Statistics tests the size of these effects on achievement by looking at the random component of sorting that occurs when most British children transition from primary to secondary school at age 11.

"Peer Effects: Evidence from Secondary School Transition in England" (up-to-date gated version, full working paper pdf), by Stephen Gibbons and Shqiponja Telhaj, finds that although having brighter peers raises someone's grades a bit, the effect size is very small.

Our general finding is that school-level peer effects exist, but they are small in magnitude: a one standard deviation increase in the mean ks2 primary school scores of secondary schoolmates is associated with a 0.03 standard deviation increase in student achievement in secondary school ks3 achievement.

These peer effects originate in characteristics of secondary school peers that were already evident in their achievements at age 7, and family background issues such as low income and English being second language, rather than academic progression during the later years of primary schooling preceding secondary school entry.

This finding suggests a rather limited role for peer effects in amplifying the effects of educational interventions (e.g. social multiplier effects as in Glaeser Sacerdote and Scheinkman 2003), unless these interventions occur very early on in life. Our results show only limited heterogeneity across student demographic types.

But the paper does go on to say that because school has very little impact on student outcomes, we should probably see this as a relatively large effect in that context. And that peer groups might matter for lots of other things besides achievement ("physical safety, emotional security, familiarity, life-time friendship networks, or simply exclusivity") so parents aren't necessarily crazy to aim for 'better' peers for their kids.

Make Britain safer: bring back pistols

We live in peaceful times – at least compared to the past thousand-ish years. Crime, especially personal violence, has been reduced significantly since the 13th century (though not always continuously). The drop looks something like this:

 

What explains the drastic decline in violent crime, specifically between 1500 and 1900? Why has crime spiked up (moderately) from 1900 – 2010? The widely preferred explanation for the fall in crime – particularly homicide – is referred to as the “civilizing process”, which claims that criminal breaking points can be attributed to the growth of centralised power (i.e. state power), which created more structure and stability in regional areas.

The conventional wisdom…attributes the decline in personal violence to the “civilizing process” first suggested by Elias (1939) who hypothesized that the primary cause was the transformation of Europe from a large number of fiefdoms in the Middle Ages to a small number of large, centralized nation states under a single monarch. The centralised state instituted and enforced a monopoly on violence, known as the king’s peace.

To this day, the ‘civilizing process’ remains the longest-running, widely accepted theory and continues to shape crime and policing policy. But, despite its acceptance, there are some very notable flaws in the theory, including the fact that much of the evidence shapes up to disprove the thesis:

Belgium and the Netherlands were at the forefront of the decline, yet they lacked strong centralized governments. When Sweden joined the trend, it wasn’t on the heels of an expansion in state power either. Conversely, the Italian states were in the rearguard of the decline in violence, yet their governments wielded an enormous bureaucracy and police force...

...the civilizing process theory is not consistent with the rise in violence between 1200 and 1500, it does not explain the sudden and precipitous decline and reversal of trend that occurred in the 16th and 17th centuries, and it is not consistent with the 1793 reversal of trend.

A new paper from Carlisle E. Moody published last month provides an alternative theory last century’s decline in violence. The paper, “Firearms and the Decline of Violence in Europe: 1200-2010”, finds that the sudden historical drops in crime are consistent with the “invention and proliferation of compact, concealable, ready-to-use firearms” which “caused potential assailants to recalculate the probability of a successful assault and seek alternatives to violence.”

And unlike the civilizing process theory, Moody's firearms theory remains consistent with the evidence and breaks in violence. As concealed weapons became more available historically, crime rate dropped radically. (Bolded mine.)

Homicide was increasing before the invention of concealable firearms and decreasing after. While there may be many other theories, the sudden and spectacular decline in violence around 1505 and again around 1610-1621 is consistent with the theory that the invention and proliferation of concealable firearms was responsible, at least in part, for the decline in homicide. The landscape of personal violence was suddenly and permanently altered by the introduction of a new technology. The handgun was the ultimate equalizer. The physically strong could no longer feel confident of domination over the weak.

Some of these arguments may sound familiar; they're the ones those crazies over the States tend to go on about - guns 'equalize' the playing field regardless of physical strength and 'psyche out' violent perpetrators who might be more willing to attack their victims if they knew they were unarmed.

But according to the report, those crazies have some strong points. The report cites several studies which found that the possibility that a victim might be armed deters criminals from acting:

Even in the United States today, criminals are reluctant to encounter armed victims. In 1981 Wright and Rossi interviewed 1874 incarcerated felons in ten states. Eighty-one percent agreed with the statement, “A smart criminal always tries to find out if his potential victim is armed.” Thirty-four percent report being, “scared off, shot at, wounded or captured by an armed victim. (Wright and Rossi 1986, pp. 132-155) Using the same data, Kleck found that, among criminals who had committed violent crimes or burglaries, 42 percent had been deterred during an attack by an armed victim and 56 percent agreed that, “most criminals are more worried about meeting an armed victim than they are about running into the police.”(Kleck 1997, p. 180)

Perhaps, then, we might admit (based on evidence, consistency and lack of other credible theories) that firearms reduced violence historically; but in the modern era, guns cause more violence than they deter. But that's not the case either:

The government in England has been placing increasingly stringent controls on guns especially handguns, since 1920, reducing both the actual and the effective supply of firearms. (Malcolm 2002) The homicide rate in England in 1920 was 0.84 and the assault rate was 2.39. In 1999, the corresponding rates were 1.44 and 419.29. Thus both the homicide and assault rates increased as the effective supply of handguns declined.

That's a 17,544% increase in England's assault crime over the past 100 years. In truth, there is no explicit correlation between gun control laws and murder rates between countries (Switzerland and Israel “have rates of homicide that are low despite rates of home firearm ownership that are at least as high as those in the United States.”) It is the case that handguns used in crimes in the UK have doubled since they were banned in 1997. Guns can't account fully for the drop in crime throughout the 20th century, nor can they account fully for the rise in violent crime over the past 100 years, but there is no doubt that accessibility to firearms has worked as a successful deterrence against criminals in progressive societies and that bans have ensured that any handguns in England are only falling into criminal hands.

Should we proliferate handguns around England tomorrow? Probably not. (Obviously we should begin with firearm training sessions - safety first!)  But liberalizing gun laws should not be off the table. Historically, they've earned it.

Today's crazed loon idea

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So, we know very well that the government is spending very much more than it is raking in in taxes. There should be some solution to this at some point. At least we hope there will be. But perhaps not this solution:

What might be fairer would be to treat capital gains in houses just like any other financial asset and tax it at 28pc.

Given the turnover of the UK housing market and the gains built into it, it isn’t fanciful to think that, in a good year, the Government could raise £20bn to £30bn a year alone from this source.

For those inflamed by the inequities of the North-South divide, they will be pleased to know that the bulk of anything raised in this way would hit the south east of England hardest.

How wonderful: increase the taxation of the most successful part of the economy. And it's worth pointing out that the SE already pays much more tax: because the higher salaries earned there are taxed under national income tax rates, not regional ones. but then this is just mad:

As far as pension funds go, a simple 1pc levy on the value of schemes would be easy to administer and collect. This would raise an additional £20bn each year and given that pension fund contributions are subject to income tax relief, it doesn’t seem unreasonable to pay some of those investment gains back to the nation.

We specifically grant income tax relief because we want people to save for their old age. So now we're going to charge a wealth levy on people who save for their old age? Even knowing that wealth taxes have much larger deadweight costs than income taxes (or consumption ones)? Meaning that if you think pensions savings are undertaxed then it would be more economically efficient to simply reduce the income tax benefits of doing so rather than instituting a wealth tax.

Of course what's really interesting about the proposals is that no one at all believes that government could ever just curt back its spending to the amount of tax revenue that it has available. Sadly.

What we need to do is obvious

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This piece could equally well be titled "Interesting things we learn in The Guardian". For we find out that Britain has the longest tax code in the world:

The question is: why does the UK have the longest tax code in the world? The Hong Kong tax code, widely held by tax lawyers to be the most admirably efficient in the world, is 276 pages long. The British tax code, rapidly beginning to look like the most disingenuous in the world, is currently in excess of 17,000 pages. It has more than trebled in size since 1997.

And what was it that happened in 1997? Ah, yes, Gordon Brown.

We also find out something else very interesting:

A couple of tax lawyers eventually told me that a 276-page tax code could generate the same if not more revenue in the UK....

So, umm, given that a 276 page code would both reduce the amount wasted on dodging around the systemn and also provide the same or more revenue (in itself the primary purpose of a tax system), why don't we have a nice bonfire and get ourselves a 276 page tax system? One that might actually be comprehensible to some mere mortal? We can't really see any argument against it.

And if we were to take the Hong Kong example seriously we might want to take two more things from them. One being that there's no with holding in their system. In order to pay your taxes you've actually got to go and pay your taxes, there's no salami slicing of that wedge from each and every paycheque. This physical act of having to hand over the money obviously puts a certain pressure downwards on tax rates as people actually see how much government is costing them. And while we'd never actually reach the second defining feature of the Hong Kong system, their low rates, we would obviously get closer if that pressure were to exist.

On our little list of things not to worry about

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OK, so this is only a letter to The Guardian but it still betrays a certain mindset that we find ourselves being very confused by:

He talks about the future of businesses based on a new Companies Act, but it’s not clear how this would address the problems presented by 40% of shares in major UK companies (including utilities) being foreign owned.

We're confused because we simply cannot see why this might be a problem. The foreign capitalists are sending their lovely foreign capital into our country. This means that there is, other things being equal, more capital in this country than there would be without that lovely foreign capital. Given that it is capital added to labour that increases the productivity of labour, the average productivity of labour is what will determine the average income in the country, this means that foreigners sending their lovely capital to our rainy little island means that wages are higher here in the rain than they otherwise would be.

And we think this is a good idea.

As to why there is this concern our best bet is that old problem of the British left. All too many socialists are also quite ghastly nationalists. A combination we had rather too much of in Europe in the last century so hopefully not something that's going to become popular again.

The BBC and the Election

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It will be interesting to see how the Conservatives bear up under the relentlessly hostile BBC campaign coverage.  It is not that the BBC openly praises Labour and its policies.  What the BBC does do is to follow the Labour agenda of the stories they wish to focus upon.  One week it is continuous coverage for several days of alleged failings and deficiencies in the NHS, perceived as a Labour issue.  The next it highlights for several days allegations of "tax dodging" – a phrase they use to conceal the distinction between paying tax in accordance with the law, and criminal dishonesty in concealing earnings. Tax avoidance means organizing your affairs to lower your tax exposure in ways that the law allows and sometimes encourages.  Tax evasion means not paying the tax you are required by law to pay.  The words "tax dodging" and "tax dodgers" are used to conceal that distinction.  Multi-millionaire Margaret Hodge wants people to pay what she thinks they ought to pay, rather than what the law requires them to pay.  The BBC has given massive coverage to another area seen as a Labour issue.

The BBC also pursues a relentless anti-business campaign, highlighting what it sees as abuses by businesses, even where these, too, are within the law.  Energy companies are castigated for not passing on falling wholesale prices, with never a mention of the time lag between energy companies buying wholesale and the delivery of that energy to customers.  Stories focus not on the role of companies in creating jobs and wealth, but on their alleged abuse of their market position.  Again, since the Conservatives are perceived to be more pro-business than Labour, the BBC is following the Labour agenda.

It is unlikely that the BBC is taking orders to highlight Labour issues every day, and much more likely that the BBC programme planners and presenters think like Labour does, and regard these issues as the important ones.  There could just be some self-interest, too, with BBC planners thinking that a Labour government would probably give the BBC a more advantageous licence fee renewal deal than would a Conservative one.  It will be interesting to see how effective their campaign is.

The housing question isn't just how many, but where

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I usually like Policy Exchange’s work but its new paper on solving the housing crisis is a little disappointing. Its main argument is that “Over one million new homes could be built over the next decade if each of the 353 councils in England built just one garden village of 3,000 new houses”. The arithmetic checks out, but that still wouldn’t do much to solve the housing crisis. The problem with England’s housing market is not simply that not enough houses are being built. It’s that they’re being built in the wrong places. According to Paul Cheshire, twice as many homes were built in Doncaster and Barnsley (where there isn’t much demand for housing) as in Oxford and Cambridge (where there is) in the five years to 2013. In 2002/03, it was three times as many!

This is why national house construction numbers can often be misleading. The crisis of unaffordable houses is mostly centred on places like London, Oxford, Cambridge and the rest of the South East. People want to live where the jobs are. (As it happens, an older Policy Exchange paper recognised this, suggesting policies designed to make it easier for people to move from North to South.)

Spreading housing development around the country will hence end up doing much less than we might hope. If your problem is a housing shortage in London, building more in Hull won't help much.

A second problem is that building entirely new villages is expensive, because of the new infrastructure that needs to be built. The report suggests paying for this with levies on the new builds, which just reduces the downward pressure on prices these houses would have. Building all that extra infrastructure is needless when there is already so much empty land around existing train stations to be built on in the South East (enough for one million homes!), where there really is demand for new housing.

I also wonder how much people want to live in villages which really would be very small. At the UK average household size of 2.4, we’re talking about villages of 7,200 people, far enough from existing towns that those residents won’t object to them. As someone who grew up outside an Irish town with a population of 6,666 (seriously), take it from me – these places can be a little dull.

There are 138 authorities in London and the home counties. Building new homes there – even if they had to be in new villages – would be better than nothing, although I don’t know how you’d go about building new villages in central London. Building new homes in places like Scunthorpe and rural Cornwall would be a lot less good, and policies that do not recognise that will distract us from what we really need to do.

Maybe there’s no such thing as a bad policy that results in more housing, but is it too much to ask that they also be houses that people want to live in, in places they want to live?

Central banks don't control interest rates

Apologies for going on and on and on when it comes to this topic, but I think it's important. Central banks set macroeconomic policy, partly through setting a policy rate, and this affects the environment in which the yields on securities, i.e. interest rates, are set. But they do not directly control much except for their own policy rates (in the UK, a discount rate at which it lends to banks and pays on reserves they hold with it; in the US and Eurozone other rates are used in preference to or as well as a discount rate).

I have made various logical and empirical arguments for this claim in the posts I link in the first line; this post was spurred by my discovery of a 2013 paper from Eugene Fama (joint winner of 2013's economics Nobel) making the case yet more rigorously. Entitled "Does the Fed Control Interest Rates?" it answers 'probably not':

To what extent does TF, the target Federal funds rate set by the Fed, influence other rates? There is lots of variation in rates unrelated to TF, and any effects of TF on rates dissipate quickly for longer maturities. For short rates, all the tests have interpretations in terms of: (i) a Fed that has the power to control rates and uses it, and (ii) a Fed that has little power over rates or chooses not to exercise its power. In the end, there is no conclusive evidence (here or elsewhere) on the role of the Fed versus market forces in the long-term path of interest rates.

A key piece of evidence is the fact that large spreads often emerge between private securities like commercial paper and the Fed-driven rate (i.e. Banks do not lend at the rate the Fed is targeting, despite its best efforts):

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Fama argues that the evidence should be a cautionary tale for those who believe the Fed to have great powers of controlling the economy, making the case instead the market forces are usually the key driver, and I agree with him as far as it goes. But I think that monetary policy doesn't work necessarily by affecting real yields but by devaluing money to clear markets.

I think the central bank's control of the monetary base is what gives it power: it can vary the supply of money elastically (like free banks would) to stop money demand shocks from interacting with sticky wages and causing recessions. What it cannot do is produce any extra prosperity above the amount you get from monetary stability and neutrality.

Economic Nonsense: 5. Taxes should be increased to fund necessary spending

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Taxation changes behaviour.  Taxes on goods and services makes them more expensive, and in most cases people buy fewer of them as a result.  Taxation on incomes makes work less attractive, motivating some people to do less of it.  Taxes on business usually fall on those who buy the products of those businesses, often reducing demand to below the level it would reach without taxation.  Taxes that people regard as unfair or oppressive will often lead people to take steps to avoid their burden.  Taxes on inheritance lead people to dissipate their wealth early, or they break up the capital pools that enable heirs to invest. Dynamic models of the economy try to take account of this.  Doubling the tax on tobacco products, for example, does not yield twice the revenue.  It might lead to twice the smuggling, though.  Vast increases in the duty on alcohol does not raise revenue in proportion, thought it does lead some drinkers to move down to cheaper booze.  Some tax increases actually yield less revenue because of the behavioural responses they trigger.

Arthur Laffer famously noted that a 0% tax on incomes yields no revenue, as does a 100% tax.  The graph line that links those two zeros is the Laffer Curve, and it has a peak somewhere whose rate yields the most revenue.  Even this moves as people adjust to the new status quo.  If a 50% rate of income tax is lowered to 40%, it is highly likely that it will soon bring in more revenue.  The rate reduction makes work more attractive, so people do more of it.  It also makes complex and expensive avoidance schemes less necessary, as people opt just to pay the lower rate tax instead.

When the economy in question had adjusted to the 40% top rate, however, more revenue might then be raised by lowering it to 35%.  The optimum revenue-raising rate depends on the status quo to begin with.  In many cases it might be appropriate to lower taxes to raise more revenue, rather than to hike them.  It is never likely that higher rates will yield more revenue in proportion to the increase.