Five intriguing papers I discovered this week II

As the second in a series, here are summaries of five interesting journal articles I read in the last week. All of these ones are new, although that may not always be the case. 1. "Very Long-Run Discount Rates" by Stefano Giglio, Matteo Maggiori and Johannes Stroebel

Giglio et al. use the difference between the prices of leasehold and freehold properties in the UK and Singapore to compute long-run discount rates. They find that over 100 years, the discount rate is 2.6%—whereas properties with 700-year or longer leases trade at par with freeholds. They point out that this 2.6% discount rate may have implications for climate change policy; the famous and influential Stern Review recommended using a 0% discount rate, which may justify much more extensive anti-CO2 measures now. Some slides explaining their findings are available here.

2. "Is the stock market just a side show? Evidence from a structural reform" by Murillo Campello, Rafael P. Ribas, and Albert Wang

Campello et al. look at a 2005 reform that, in a staggered 16-month basis and after a trial, allowed $400bn worth of Chinese equity, previously untradable, to be bought and sold. Using "wrinkles" in the roll out that provide quasi-experimental tests, they find that firm profitability, productivity, investment and value all improved substantially. "Policies that ease restrictions on [capital] markets may have positive effects" runs the final line of their conclusion—quelle surprise!

3. "Social security programs and retirement around the world: Disability insurance programs and retirement" by Courtney Coile, Kevin S. Milligan and David A. Wise

These three authors add to the burgeoning literature proving that those on the edge of retirement respond to incentives just like anyone else. This shouldn't really be a surprise, but the heavy flow of publications adding evidence in this direction suggests that maybe there was once a bizarre consensus in the other direction. Coile et al. show that delaying eligibility to pensions, increasing the stringency of disability insurance programs, and other welfare reforms for older people have "very large" effects on how much labour they decide to supply. Not exactly shocking, but certainly important in ageing societies.

4. "What Happens When Employers are Free to Discriminate? Evidence from the English Barclays Premier Fantasy Football League" by Alex Bryson and Arnaud Chevalier

In this nifty and quirky paper the authors try and isolate "taste-based" racial discrimination, by looking if fantasy football players pick footballers differently based on their race, controlling for "productivity" (i.e. their expected points tally). They find no evidence of taste-based discrimination here, suggesting that much of the apparent discrimination found in other studies (e.g. studies of fake CVs where different ethnicities see different acceptance rates even when they have similar qualifications and experience) could be statistical. That is, since employers cannot directly observe productivity (unlike in fantasy football), and since different ethnicities have different productivity distributions, certain ethnicities are on average less valuable to employers. Of course, it might be that people exercise taste-based discrimination as well when they have to interact regularly with the group/race/ethnicity in question—fantasy football is much more at arms length.

5. "The Role of Publicly Provided Electricity in Economic Development: The Experience of the Tennessee Valley Authority, 1929–1955" by Carl Kitchens (ungated)

The most fun kind of research to read is one that confirms a niggling view you've had for a while, but one that nevertheless overturns a happy consensus. The Tennessee Valley Authority is a classic example of "enlightened" central planning, targeting a hard-up area with massive coordinated infrastructural investment and widely believed to have delivered substantial benefits. But if these dams and systems were really such good investments wouldn't private companies have got around all the barriers to such an investment already? There are some cases where I suppose that sort of basic argument doesn't hold, but it's a pretty good first approach to any area, and it turns out the TVA is one of them. Kitchens newly-published paper finds "that the development of the TVA during its first 30 years did not cause manufacturing, retail sales per capita or electrification to grow any faster in areas receiving TVA electricity than in other areas in the Southeast."

Ignore the doomsayers: The recovery is real

Some commentators claim that the UK’s current economic recovery is illusory. They say that the recovery is based on an artificial boom fuelled by loose money and will eventually come crashing down to earth. I think it is very likely that this view is wrong, for at least two reasons. One, the UK does not have loose money that would fuel a credit boom. Two, the best tool we have for telling if the recovery is ‘real’ or not is the market. And the market is telling us that it sees things as looking good.

The idea that we have loose money is extremely common. It is based on the assumption that a Bank of England base rate of 0.5%, historically very low, must mean that money is loose. This is what Milton Friedman referred to as the ‘interest rate fallacy’. It is a fallacy because it fails to ask the key question: ‘compared to what?’

That ‘what’ is, or ought to be, the ‘neutral rate of interest’ – the interest rate where, in David Beckworth’s words, “monetary policy is neither too simulative nor too contractionary and is pushing the economy toward its full potential.” The tightness of money is determined by the central bank rate relative to the neutral rate. If the neutral rate of interest is lower than the base rate, then money is tight.

Is the neutral rate of interest in the UK currently above or below 0.5%? It's hard to say. Milton Friedman pointed out that usually low rates were a sign of tight, not easy money. This is because low rates almost always coincide with very low inflation, nominal GDP growth and money growth—which Friedman pointed out were much better ways of assessing the stance of policy.

It’s possible to infer from things like NGDP growth (well-below trend until recently) that money has been unusually tight. NGDP growth seems to be returning to the trend rate, if not the trend level, that it was before the crisis. People calling ‘easy money’ may disagree, but if they are simply pointing to low interest rates without trying to compare them to the neutral rate, they’re not proving anything at all.

But even if it’s not down to easy money, maybe the recovery really does sit upon a throne of lies that will inevitably collapse. How could we tell?

Since the world is very, very complex, it is unlikely that one individual expert or panel of experts will be able to possess all the information they would need to make reliable predictions about the future.

Where possible, we should prefer the ‘wisdom of crowds’. And we have something that can do so very effectively: the market. And the market seems pretty optimistic: the FTSE 100 is growing strongly; firms are taking on new staff; gilt yields are extremely low.

Second-guessing the market is particularly unusual for people on the right of the political spectrum. As Josh Barro put it recently, “A conservative is somebody who thinks every market is efficient — except the Treasury bond market.” (A point worth remembering next time you read about the UK's "looming debt crisis".)

Of course markets can get things wrong. There is a high degree of uncertainty involved in all predictions like this. But, given a choice between the aggregated judgement of millions of market participants, all bringing their local knowledge to bear, and the judgment of a few experts, I’ll go with the market.

In summary, there’s no reason to think that either we have excessively loose money or that the recovery is illusory. Note that mine is an entirely negative argument – I am not claiming that money is too tight, or just right, nor am I claiming that markets are correct. I'm saying that, given the information we have available to us, we should resist the urge to doomsay. In short: don't worry, be happy.

Gary Becker was right, part six: The family

Becker introduced the family into economic thinking and economic calculation into family life.  He spotted that a family is a miniature economic system like a small factory.  The basic goods it produces are things such as meals, residence, and entertainment.  The costs of these goods are compounded not only of the costs of their input, but include the time spent on producing them.  Since the family interacts with the wider economy including the place of work, there will be trade-offs between the two.

As real wages at work increase, it becomes relatively less attractive to spend time producing some of the family goods.  Some of these will be outsourced, buying in what was once done at home in order to free time for more valuable activity.  Examples include buying home-delivered pizzas or paying tailors to repair garments that used to be mended at home.  Sometimes people turn to outside institutions such as nurseries and schools to take over some of the activity that was once performed within the household.

Sometimes domestic production will become more capital intensive as work wages rise, with people buying labour-saving machines such as vacuum cleaners, washing machines and dishwashers.  The rise in the value of time at work has made domestic time relatively less efficient without them.  In place of the traditional dichotomy between work and leisure, Becker looked at the switch from more to less time-intensive production of home goods.

Becker noted some of the consequences of the large-scale entry of women into the workforce.  The wages they could earn at work made them less ready to spend as much time on domestic activity such as child rearing and childcare.  This provides an economic interpretation of the widely-observed decline in the fertility of societies as their economies develop.  Becker also thought it lay behind rising divorce rates in advanced societies.

Becker made a major contribution to our understanding of how families allocate time and assign tasks to the various members, so much so that we now routinely attempt to estimate the likely social and domestic impact of ongoing economic developments.

Err, yes, yes, this is the point

There's a very strange comment in the British Medical Journal. One that makes me worry for the ability of some of these doctoring types to quite grasp the point and purpose of the world we live in. They're talking about e-cigarettes, vaping, all that sort of thing, as an alternative to actually lighting up the cancer sticks directly:

However, Gerard Hastings and Marisa de Andrade have a different take on the issue. They dispute e-cigarettes’ effectiveness in smoking cessation, urge caution, and suggest that NICE’s revised guidance may give these untested products implicit approval. They present long term use of nicotine products marketed by big tobacco as commercial exploitation of smokers attempting to quit. Calling for a broader view of smoking than nicotine dependency, they say, “When the only obstacle to progress on preventing the harms of smoking is the user’s dependence, e-cigarettes offer the beguiling prospect of addicted smokers migrating painlessly to safer mechanisms of nicotine delivery.” But without evidence that e-cigarettes work, they conclude, “The tobacco multinationals have leapt enthusiastically into this market; all now have major e-cigarette interests. This is not a consumer movement but the full onslaught of corporate capital in hot pursuit of a profitable opportunity.”

Err, yes, yes, that's the point and purpose of the system. This capitalist/free market hybrid that we have. If consumers decide they quite like something, perhaps it's getting a regular hit of nicotine without hacking one's lungs out 30 years later, then the point and purpose of the free market part is that the consumers get to choose among possible suppliers of those products. And the successful producers get to make a profit out of supplying those things that the consumers would quite like to have. Because, you know, over the past few millennia we've worked out that this is the best manner of encouraging people to produce the things that consumers would quite like to have.

So, a bit of invention, some innovation, sparks off a bit of consumer desire and suddenly potential producers are rushing to market, salivating at the prospect of the hot and cold running Ferrari's that the profits of their efforts will being them.

This isn't an aberration in the system, this isn't something to be decried, this is the whole damn point of it all in the first place.

I'm sure that someone once told me that you've got to be bright to be even accepted into medical training. Is this no longer true?

What's a neutral monetary policy?

The Federal Reserve Bank of Richmond alerted me to a newish paper from one of my favourite economists, Robert Hetzel, entitled "The Monetarist-Keynesian Debate and the Phillips Curve: Lessons from the Great Inflation"—needless to say it's highly interesting and informative. One bit in particular prompted me to write this screed on neutrality in central banking and monetary policy.

In the Keynesian tradition, cyclical fluctuations arise from real shocks in the form of discrete shifts in the degree of investor optimism and pessimism about the future large enough to overwhelm the stabilising properties of the price system and, by extension, to overwhelm the monetary stimulus evidenced by cyclically low interest rates.

In the quantity theory [monetarist] tradition, cyclical fluctations rise from central bank behaviour that frustrates the working of the price system through monetary shocks that require changes in individual relative prices to reach, on average, a new price level in a way uncoordinated by a common set of expectations.

In the real-business-cycle [new classical] tradition, cyclical fluctuations arise from productivity shocks passed on to the real economy through a well-functioning price system devoid of monetary non-neutralities and nominal price stickiness.

From each of these perspectives, we can derive some sort of definition of monetary/central bank neutrality, as well as an idea of what policy the central bank should operate. It strikes me that only one view is plausible, but before I make the case for that view, I will make the case for a particular theory of "meta-neutrality", i.e. a way that we should think about neutrality, whatever our perspective. I think this is something that everyone should be able to agree on, but I think that once we've agreed on it one view becomes inescapable.

Nothing is neutral with respect to everything. In one of my favourite ever essays, Scott Alexander makes a very similar point about "safe spaces" (nothing can be a safe space for everything—safe spaces for, e.g. a safe space for a disadvantaged group cannot also be a safe space for no-holds-barred rational discussion). In the same way, a monetary policy that is neutral with respect to real interest rates might conceivably have to achieve this by non-neutrality with respect to say, exchange rates. So the interesting question is what economic variables monetary policy must be neutral with respect to for us to call it "neutral" with no qualifiers.

But what we really want to be neutral to is the microeconomic working of the price system and markets generally, which is a bit more complex than any particular macroeconomic variable we could point to. One way around the question is by thinking about what might be non-neutral to the workings of the price system. One answer is: menu and shoe-leather costs, typically associated with high inflation, but more accurately linked to high aggregate demand (nominal GDP) growth.

Both impose restrictions on price adjustment, especially if they are unexpected and hence not "priced in".Menu costs will stop firms re-pricing things as often as would be optimal, impeding price adjustment, whileshoe-leather costs (from the high nominal interest rates associated with high inflation and high NGDP growth) will stop people from holding as much cash as they otherwise would, distorting their consumption decisions.

On the other side, unexpectedly low NGDP growth, combined with "money illusion" in borrowers ("sticky debts") and workers ("sticky wages"), could cause other microeconomic problems—markets won't clear until people's information, expectations and plans have adjusted, i.e. until people realise that the fall in prices/wages is not a relative price adjustment but a fall in overall prices/NGDP.

Overall this suggests we should call a policy neutral without qualifiers not when it is perfectly neutral (which is impossible) but when it is the "neutrality maximising policy". In the words of David Beckworth "neither too stimulative nor too contractionary and is pushing the economy toward its full potential" or in the words of Alan Greenspan one that "would keep the economy at its production potential over time".

That is, one that balances the distortionary costs of high (particularly unexpectedly high) NGDP growth with the costs of low (particularly unexpectedly low) NGDP growth. Empirically, menu cost and shoe leather problems have never been large in the USA and UK when NGDP is ticking along at about 5%. By contrast, NGDP growth less than 2.5% is almost always consonant with stagnation, while NGDP growth of less than zero always means a recession—much bigger costs. This suggests policy, far from being unprecedentedly easy in the lacklustre post-recession recovery, was if anything on the tight side of neutral.

Two crucial final points:

1. Identifying the conditions that we'd want to see in the macroeconomy for a (relatively) undistorted microeconomy does not mean endorsing a particular monetary arrangement or regime. Whether we have a central bank or not, we'd want stable NGDP growth.

2. This 5% level is contingent on society-wide expectations. If long-term expectations held by borrowers, lenders, firms, consumers and workers were for 0% NGDP growth (e.g. the 19th Century), then 0% NGDP growth would be more likely to be the neutrality-maximising monetary policy.

How to fix the NHS: privatisation

So it appears that we do know how to sort out the NHS then. Privatise it:

Last week, Hinchingbrooke Health Care NHS Trust was named the top hospital in England, based on 12 indicators for ‘outstanding performance in high quality care to patients’. Hinchingbrooke, in Cambridgeshire, had been the only small hospital even to make it onto the shortlist in the 25th year of the annual CHKS Top Hospitals Awards. Yet the expert panel awarded it the coveted first prize ahead of such leading NHS foundation trusts as Guy’s and St Thomas’ and Chelsea and Westminster. But Hinchingbrooke is unique: it is the only NHS district general hospital to have been put under the control of a private company — the Circle Partnership, which is co-owned and run by doctors and nurses. In 2011, Hinchingbrooke was failing, having had three notices served because of ‘inadequate’ results in accident and emergency, colorectal and breast cancer treatment. But when the Conservative-led Government approved Circle’s bid to take over its running, there were dire warnings and howls of fury from the unions and the Labour Party. Unison declared: ‘This is a disgrace, an accident waiting to happen, putting patients at risk.’ Andy Burnham, the shadow health secretary, protested: ‘This is not what patients, public or NHS staff want.’

From possibly the worst hospital in the country, so bad that not even the State wanted to try and keep running it, to the best hospital in the country. Sounds like we'd do well to do more of this then. You know, more of what works?

There is more to this than just privatisation of course. While we might like to think so markets all the time nothing but markets isn't quite the best way to run the world. It's a useful guide, certainly, that our presumption should be that markets will sort everything out but it's not a strict rule that will guide us to the optmial end state. There are those times when we need to do other things: the trick is in working out what we should be doing and where we should be doing them.

With regards to the NHS it's worth thinking back to the various WHO reports on who has the best health care systems. Note how the ranking is achieved:

The rankings are based on an index of five factors:

Health (50%) : disability-adjusted life expectancy Overall or average : 25% Distribution or equality : 25%

Responsiveness (25%) : speed of service, protection of privacy, and quality of amenities Overall or average : 12.5% Distribution or equality : 12.5%

Fair financial contribution : 25%

There's an awful lot there that deals with the equity, or "fairness" of the system. And a system that is nominally free at the point of service should beat everyone else hands down at that sort of thing. Yet the NHS was only 18th even by these, very favourable to the NHS indeed, criteria for measuring a health care service. The reason being that while the NHS is very equal, it's not all that good. Mortality amenable to health care is dreadful as is speed of service.

So, what could be done to improve matters? Well, one idea is to take a leaf from the book of what the WHO regarded as the best health care service in the world, the French. Which is, roughly speaking (the French use an insurance system but it's so tightly bound with the tax system that it's not radically different) to keep the current tax based financing system but open up provision of services to anyone who wishes to do so. Charities, for profit companies, doctors' and workers' cooperatives (Circle being a combination of those last two), the State itself: why not have a vibrant ecosystem of providers?

As it turns out this is a very good idea: for we've maintained that equity and fairness in the provision of health care but the change in the system, from a centrally planned near Stalinist monstrosity to something approaching a market, has led to those very large improvements in the quality of treatment and the speed and responsiveness with which it is delivered. The best of all worlds perhaps.

Now that we know what we should be doing the only question left is why isn't everyone trumpeting this from the rooftops? It cannot be that some people would prefer health care to remain bad simply for ideological reasons, can it? It would be quite outrageous to suggest that any in our fair land are so blinkered as to do that.

Is the City muddling into oblivion?

One of the most valuable parts of the UK economy, the City, will not be greatly affected by the UK leaving or staying in the EU.  The EU market will continue to be governed by EU regulation.  The UK market may be a bit freer but UK regulators will try to ensure it is not. The rest of the world market will not be affected.  Any greater freedom would be offset by no longer being officially part of the EU lawmaking process.  Unofficially, the UK’s position as a major net importer should secure some attention.

You might expect the City, faced by these troubled waters, to have a realistic long term vision and a strategy to get there.  You would be wrong.  The City believes it has done well muddling through the last 300 years and therefore it should carry on doing so.  Each new EU directive can simply be challenged as it heaves over the parapet.

Furthermore the government has no idea what the City should want in the longer term. And therefore it cannot help. The Chancellor has just demoted the City from the attention of the Treasury Financial Secretary to that of the Economic Secretary.

And even if the government did know, does the UK have enough influence in the EU to bring it, or most of it, about?  Business for Britain claims that the UK was outvoted on every single one of the 55 occasions it voted “no” to new EU legislation.  This is independently supported by Full Fact. Europhiles per contra claim that the UK’s vote was successful over 90% of the time but that is because the UK voted “yes” over 90% of the time.  Maybe the UK has been successful behind the scenes but there is no evidence of that.

Venice was the financial capital of the world in the 18th century just as London is today and for many of the same reasons.  Latterly it failed to see the threats from Paris and Amsterdam (in particular) just as the City is failing to recognise, still less plan to counter, its competitors today.  Future tourists floating down the Thames are likely to be listening to the same stories that those on the Grand Canal hear today.

Gary Becker was right, part five: Human capital

Human capital is generally reckoned to be the skills, knowledge, and experience possessed by an individual or population.  It represents the value of our human capacities, and is what enables us to achieve our goals individually, or collectively in organizations and nations.  It can be invested in through education and training, and can improve both the quality and the level of production.  It has a rate of return that can be measured, albeit inexactly.

Gary Becker controversially compared the rates of return on human capital with the rates of return on children.

When human capital is abundant, rates of return on human capital investments are high relative to rates of return on children, whereas when human capital is scarce, rates of return on human capital are low relative to those on children.  As a result societies with limited human capital choose large families and invest little in each member; those with abundant human capital do the opposite.

We have empirical evidence that people in poor countries have large families.  They need the economic contribution the children will make to the family budget, and they need children to support them in old age.  As societies grow richer there are more opportunities to educate and train children instead of putting them to work.  Furthermore, social benefits, rather than children, can support the aged.  These factors explain why wealthier societies have lower population growth.  Indeed, most European populations are in decline, and it is immigration, rather than fertility, which contributes to those that are not.

It should be noted that the rate of return on human capital rises, rather than diminishes, as the human capital increases.  The more there is of it, the more worthwhile it is to invest in it.  This, in turn, implies better future production, both in quality and output.  Resources can increase even if population rises, contrary to what Malthus thought.

The doomsayers tell us that a massively over-populated world will have neither the food nor the resources to cope, and predict wars and starvation.  But set against them are the optimists, including Becker, who think that rising stocks of human capital will reduce population pressure and make more efficient use of resources.  Yet again, Becker seems to be on the winning side.

Minimum wages cost jobs

The leader of the UK's opposition Labour Party, Ed Miliband, outlines plans today to tackle low pay with a five-year plan to set a new, higher, minimum wage, linked to average earnings. This, it is said, firmly puts tackling inequality at the heart of the party's 2015 general election campaign.

The motive may be noble, but the policy itself is mistaken. A minimum wage helps only those who are already in work. It makes life more difficult for the very poorest, namely those who are out of work.

A minimum wage raises the cost of employing people. That is its whole purpose. But higher wage costs mean that employers – already under financial pressure from domestic and foreign competition, from everyday business costs, and from the costs of government regulation and taxation – have only two options. They can either hire fewer people, or toughen working conditions – cutting holidays, providing fewer breaks, spending less on the work environment.

Professors Richard Vedder and Lowell Gallaway from the United States – which has a much longer history of minimum wage legislation than the UK – explained all this as long ago as 1995, in their Adam Smith Institute report Minimum Wage Costs Jobs.

And the evidence is clear. When minimum wages were introduced in the UK in 1999, they did not seem to add to unemployment. But the starting rate was set very low initially; and the UK was then already on the cusp of one of the biggest (and as we now know, disastrous) credit-fuelled booms in history. With business and employment racing ahead, the job-killing effect of a low minimum wage was hard to see.

It became much easier to see after the 2008 financial crash, though. The first people that hard-pressed employers dispense with, and the last they choose to hire, are people like unskilled workers, young people who need to be trained up, women who want flexible hours, minority groups, and people on benefits who may have to learn or re-learn the habits of work.

These are the very groups that the policy is intended to help. But the post-crash unemployment statistics, with close to a million young people out of work, show that it does exactly the opposite. Starter jobs (remember all those cinema ushers, petrol-pump attendants, and bag-packers in grocery shops?) dry up. Young people or those on benefits cannot even get on the first step of the jobs ladder.

As well as harming those it wants to help, the minimum wage helps those who are already better off, or soon will be. They include students doing low-paid jobs that they regard as purely temporary, a means of getting skills and references for a better job. And second or third earners in a household, working to bring in a little extra cash for luxuries. But these are not the people that the minimum-wage policy is designed to help.

The minimum wage is well-meaning policy – but sadly, a wholly counterproductive one. If you really want to help the poorest, you should help them by improving their access to paid work, by cutting workplace regulation and taxes.

Sadly people still aren't understanding the actual climate science

One of the most irritating things about the debate surrounding climate change is that people don't actually look at the evidence beinf presented. Instead, they use whatever evidence is presented as simply a bolstering for their own pre-extant prejudices. Any evidence of the effect of climate change is used to support the argument that we must do more and more quickly. Any evidence of not much happening is taken to prove that we need do nothing: this is a pox on most houses argument, yes. Too few people are actually reasoning from the evidence to what ought to be done. Take this for example, from The Observer:

The last assessment report of the Intergovernmental Panel on Climate Change (IPCC) put a modest figure of one to three feet as the likely rise in sea levels that will be experienced this century. The disintegration of the entire West Antarctic ice shelf changes that forecast drastically. A figure of more than 10 feet is now a more likely option. Vast tracts of heavily populated coastline around the world face inundation. Millions are likely to lose their homes. It may take more than a century for this devastation to occur. Nevertheless, it now looks to be inevitable, says Rignot. Nor will the residents of low-lying regions such as Bangladesh or Florida be surprised at this forecast. They are already experiencing the consequences of rising sea levels triggered by melting icecaps.

The actual report said that the melting of those West Antarctica glaciers is now inevitable and will lead, over time, to a rise of four feet in sea level. whether it's true or not we have to take on trust: but how can you take that evidence, of four feet plus one or three and make a risen of 10 foot this century? Especially when the West Antarctica figures are not for "maybe take more han a century" but "will take some centuries at a minimum" but are now inevitable?

There's nothing at all wrong with campaigning to avert a perceived danger. Whether that danger is the costs that climate change might bring or the costs that will be incurred by trying to deal with it. But wouldn't it be nioce if everyone really did use the evidence with which they're presented as a useful starting point for logical thought rather than simply a prop for whatever prejudice they might already have?