Markets might not tell you what you want to hear but they don't lie

There's a great deal of huffing and puffing going on over in the US over changes to the manner in which Facebook presents news stories. This isn't, in reality, anything very much to do with Facebook but rather about the effects of the internet itself.

The UK has been a - largely enough - national newspaper market since the railways covered the country and distributed the same 10 - 15 titles everywhere. Roughly enough, pre-WWI. The US has just been going through this process in these last couple of decades, as the regional monopolies imposed by geography failed. The industry is haemorrhaging money and, of a great deal more importance to those who write for a living, jobs. Thus the wailing of those who write for a living, the insistences that Facebook and Google should pay for journalism.

Then comes this latest change, that Facebook will be showing people fewer pieces of professionally produced news and more produced by their friends and family. This is, according to some at least, a grave danger to the Republic.

Except

Mark Zuckerberg’s decision to alter Facebook’s news feed to prioritise personal posts over professionally produced news and video was spurred by a potential exodus of users, according to research.

Time spent by average members fell by 7% last August compared with the same period in 2016, and by a further 4.7% in September, according to a review of Nielsen traffic data.

The analysis, by Pivotal Research, suggested that Facebook users had become tired of being bombarded with news stories and adverts.

It appears that the citizenry who make up the Republic don't in fact care very much for the professionally produced writing.

Ah well, pity, eh? 

Markets are the scientific method of doing things

Imagine, for a moment, that you are a scientist with an idea. Go on, just a little supposition. What is it that you do in order to test whether your idea conforms to the restrictions of reality? 

You do an experiment of course. First you just try it out. Then you try to construct further tests to disprove what you think you're seeing. What you don't do is sit around in committee trying to decide whether it could work. You take real world actions to find out.

Which is what markets do. People go and try things and see if they do work. As with this fracking in Lancashire.

Cuadrilla’s controversial bid to frack for shale gas in Lancashire has struck a rare gush of good luck after tests unearthed “excellent” conditions for fracking.

The fracking firm drilled a 1.6 mile deep vertical well at its protest-hit Preston New Road site, through two different types of shale, to reveal “excellent rock quality” for fracking.

The tests also suggest a high natural gas content in the core samples, Cuadrilla said.

No, we don't know and nor does anyone else as yet. Which is rather the point. From the committee method we have:

The findings rebut a warning from a team of scientists at Heriot-Watt university last year that the UK’s most promising shale gas reservoirs had been warped by tectonic shifts millions of years ago.

The report claimed that these geological quirks meant Britain was unlikely to be able to produce economic amounts of shale gas.

Well, we've those two claims. How do we choose between them? Obviously, we've got to go and try fracking and find out. Which is, of course, exactly the thing that markets do, try things and see if they work or not.

That is, far from planning being the scientific method, as is so often claimed, markets are. That very freedom to experiment which they allow is exactly what makes them such too. For each and every one of those experiments is a scientific test of whether the whatever it is works, accords with reality.

Karl Marx explains Walmart's pay rise

We've made this point before - the combination of full employment and a market economy is the workers' best friend. Entirely obviating, for example, the need for minimum wages. This being something simple enough that even Karl Marx managed to get it right, a useful example being this announcement from Walmart:

As you know, the President and Congress have approved a lower business tax rate. Given these changes, we have an opportunity to accelerate a few pieces of our investment plan. We plan to continue investing in you, in our customers through lower prices, and in our future--especially in technology to help improve your jobs and the experience for our customers.

So, we’re pleased to tell you that we’re raising our starting wage to $11 an hour for Walmart U.S., Sam’s Club, Supply Chain, eCommerce and Home Office hourly associates effective in February.

No doubt the tax changes have had some effect. It is usual to assign at least some - the amount open to argument - of the costs of the corporate income tax to the workers through their wages after all.

However, this does strike us as being rather closer to the heart of the matter, political announcements notwithstanding:

"Walmart would have had to go to at least $11 in many markets in order to retain reliable employees," University of Michigan business professor Erik Gordon said. "The tax cut made it easier for the company to swallow."

We'd be entirely happy with the description there, that Walmart wanted to do this anyway, the tax cut allowing them to do so. But then the underlying point is one that even Marx did get right. When there's that reserve army of the unemployed then employers don't have to share the profits, or any rise in them through things like productivity improvements, with the workers. For there are those unemployed who can be brought in to do the work. Either because more labour is required or because the current lot get a bit bolshie.

When there are no unemployed then the various capitalists are in competition with each other to find the labour they wish to exploit. That competition raising the price paid for the labour, that is, wages go up. Full employment really does mean wages rise.

It's worth noting that minimum wages have somewhere between little and nothing to do with this. The current Federal such is $7.25 an hour. Walmart already pays $10 an hour, from next month $11. Competition in markets is thus very much more powerful than legislation, no?

Rent control increases rents

It is a curious truth that when economists agree (a rare occurrence), politicians usually disagree.  Free trade is the obvious one (as Paul Krugman says, “If there were an Economist's Creed, it would surely contain the affirmations 'I understand the Principle of Comparative Advantage' and 'I advocate Free Trade”). Another candidate for the Economist’s Creed would surely be “I understand that rent control reduces the supply and quality of affordable housing”. When IGM polled 41 leading economists just one thought that rent control policies in San Francisco and New York had positive effects. Yet despite, the near-unanimous opposition to rent control from economists, politicians persist in proposing rent control policies. Take Jeremy Corbyn, in his party conference speech he announced that if elected he would give cities the power to cap rents to tackle the housing affordability crisis.

A new NBER Working Paper looks at the effect of rent control policies in San Francisco. In 1994 San Francisco expanded rent control to small multifamily housing units built before 1980. The 1980 cut-off was designed to prevent rent control from deterring new construction, a common objection to rent control. But, it also created a natural experiment. Researchers could compare the ‘treated’ group with a control group who lived in small housing units built after 1980.

Who benefited and who was hurt? Unsurprisingly, long-term residents living in rent controlled property came out better-off. They were about 10-20% less likely to move than the control group.

And who was hurt? Pretty much everyone else. Households living in pre-1980 housing for just a few years found that landlords would actively try to remove them. Landlords incentivised to reset the property to market rates could remove tenants in a few ways. They could move-in themselves, announce a plan to remove the property from the rental market, or they could bribe the tenant to move. The result was that rent-controlled buildings were much more likely to be converted into condos. This lead to a 15% fall in the number of people living in the pre-1980s units compared to the control.

But the real harms came to residents outside of rent-controlled property (including migrants to SF). The landlord’s response led to a significant fall (6%) in the supply of rental properties. The researchers estimate that this caused a 5.1% city-wide rise in rents. Not only did this hurt existing SF residents who didn’t live in rent-controlled properties but it also hit those who moved to SF in search of better jobs. Rather weirdly, the authors estimate that the benefits to existing residents of rent controlled properties ($2.9bn) are almost exactly equal to costs to those not living in rent controlled properties ($2.9bn).

But there’s reason to think that this underestimates the problem. Studies looking at the impact of restrictive planning policies indicate that they don’t just harm residents by forcing them to shell out more for rent, but they also trap people in lower paying jobs in one place when they would be better off if they moved to another. This lowers productivity and GDP, and also means that existing residents do not benefit from the spill-overs of growth.

The evidence is clear. Rent control doesn’t work. The young voters courted by Corbyn’s proposal to cap rents should be wary. Price caps protect incumbents at the expense of future renters. So unless you’re ready to settle down where you currently live, you should expect to pay more if rents are capped.

It’s time to remove international students from the net migration target

I’ve recently been arguing that the government should remove international students from the net migration target. You can read my letter to the Evening Standard below:

Bravo to the six Senior Tories who intend to vote for removing international students from net migration figures. The net migration target, like all state-mandated quotas, is folly, but including students in this measure is especially damaging. In her opposition to this measure, the Prime Minister mistakenly believes she can win the confidence of voters by appearing tough on immigration. But ComRes polling last year found that only 1 in 4 British people consider international students to be immigrants.

There is no justification for shutting our doors to some of the best and brightest from abroad, who typically stay here for three to four years, contribute billions of pounds to our economy (£2.3 billion in London alone), and create hundreds of thousands of jobs—not to mention taking British culture, values and business practices back to their home countries. The Prime Minister should listen to her colleagues and U-turn towards a global, liberal, outward-looking approach to migration.

Today, I wrote for The Telegraph on the same topic. You can read the full article here—and an extract below:

To succeed outside Europe, we'll need to strike up new trade links with China, India and the rest of the world. But as the Government lays the groundwork for post-Brexit trade negotiations, the Prime Minister’s insistence on including overseas students in the net migration target has left our potential trade partners bewildered.

Making it harder to study in Britain not only impoverishes our world-class higher education sector, it also hurts the Scotch distilleries who want to sell to India’s growing middle-class. Indian officials are baffled by attempts to close the door on Indian students.

We are already facing stiffer competition for international students from Asia as they become a bigger player in the market, and President Trump’s wide-ranging crackdown on immigration to America presents the UK with a chance to advertise itself as a prime destination for foreign students considering studying abroad.

The Adam Smith Institute has been talking about this issue for years, and it’s starting to look as though there’s a real possibility of change!

The greatest liberty, the right of exit

This could be taken the wrong way around so, to clarify right at the beginning, we do not mean that those who don't like Brexit should leave. However, this is a good example of one of the great - perhaps not the greatest as in the headline but still hugely important - freedoms and liberties:

The number of British nationals applying for French citizenship has increased nearly tenfold in three years, France’s interior ministry has said.

The ministry said 386 Britons filed applications to become French in 2015, rising to 1,363 in 2016 – the year of the Brexit referendum – and to 3,173 in 2017. Over the same period, the number of UK nationals obtaining French citizenship increased from 320 to 1,518.

Le Figaro newspaper said many applicants were motivated by considerations such as avoiding queues at airports, the Channel tunnel and Eurostar terminals or a desire to secure rights to healthcare and social benefits after the UK leaves the EU.

But Fiona Mougenot, a British woman who runs an immigration consultancy in France, said she was handling more than 20 naturalisation applications filed in 2017, many prompted more by a wish to retain European citizenship than to minimise potential bureaucratic issues.

“Practical matters are important for our clients, of course,” Mougenot told the paper. “But for most, the primary motivation is to stay European. Many could not vote in the referendum, are horrified by the prospect of Brexit and feel betrayed. France is vital to them because their lives are here, but beyond France it’s Europe they don’t want to abandon.”

Again, the point is not that those who don't like an independent Britain should wander off. Rather, it's to point to that freedom, the right of exit. If you don't like a polity, for whatever reason, then it is essential that you have that liberty to leave it. This is true of bureaucracies, taxation systems, nations, food suppliers and transport systems.

It is, in fact, the basic argument against monopoly and in favour of competition. That you, we, are able to select the organisational system, supplier of such, which best suits our own desires.

You don't like what your fellow citizens do? So, go and commingle with a different group in a different citizenry. That is the great freedom, that right of exit, just as it is in any other quarter of life.

Will Hutton's latest bright idea

As we know, Will Hutton has many ideas about how the world should be run. There always seems to be something of a flaw with said ideas. Here it's that his basic assertion, that re-nationalisation can take place at no cost to taxpayers, which is simply wrong

It seems impossible, but building on the proposals of the Big Innovation Centre’s Purposeful Company Taskforce, there is a way to pull off these apparently irreconcilable objectives – and without spending any money.

The government should create a new category of company – the public benefit company (PBC) – which would write into its constitution that its purpose is the delivery of public benefit to which profit-making is subordinate.

Public benefit companies aren't exactly new. One reasonable definition of them would include the East India Company. And the BBC in fact. And we'd note that the BBC's licence fee is, in law, a tax. Which means that this desire of getting the borrowing of such PBC's off the government books might not work.

But rather more importantly:

Because the companies would remain owned by private shareholders, their borrowing would not be classed as public debt. The existing shareholders in the utility would remain shareholders, and their rights to votes and dividends would remain unimpaired. So there would be no need to compensate them – no need, in short to pay £170bn buying the assets back.

The idea is that the current shareholders should receive no compensation. Yet look at what is being suggested. Their right to profit maximise is taken away by the new constitution of the company. There are other restrictions proposed as well by Hutton. Something of value is being taken from them - thus they should and must be compensated. This would be rather clearer under US law, where the concept of "a taking" is constitutionally established.

You might try to claim, as no doubt Hutton would, that this new set of restrictions is not a diminution of value. And yet he is arguing that it transfers value, that's his very argument for the change. Some value will move from shareholders to some more nebulously defined public interest as a result of the change. That's why Hutton is arguing for it.

It's thus a taking for the very reason that Hutton is arguing for it. Compensation must be paid.

Stop worrying about buybacks

Are financial markets fundamentally broken? If you read Charlotte Pickles’ article on share buybacks, then you would be inclined to think so. She argues that firms are forgoing real investment and engaging in ‘financial engineering’ to artificially meet earnings targets at the expense of long-term shareholders and the wider economy. In fact, she argues that buybacks are the key driver of the post-2009 stock demand. Perhaps unsurprisingly, I disagree.

The problem with Pickles argument is that it relies upon incomplete analysis and financial myths. A recent paper from hedge fund superstar Cliff Asness’s team at AQR Capital separates myth from fact.

1.     Let’s start with the headline – “US companies spent $2 trillion buying their own shares in the last five years. Money that could have been spent on R&D, workforce training or higher pay for their workforces.”

As I tweeted earlier, this is only a problem if the previous shareholders burned the money. As Asness points out: ”investors’ proceeds from share repurchases do not simply disappear. Rather, these funds are received by equity investors, who can (and do) allocate the proceeds elsewhere, thereby funding other investments”.  

But there’s a wider point, Pickles has the causation backward. Firms do not forgo profitable investments to repurchase shares, rather firms repurchase shares because of a lack of profitable investment opportunities. It may be the case, indeed it seems likely, that the most profitable investment opportunities will be pursued not by large, old firms but by nimble young companies.

As my former colleague Ben Southwood puts it, “Would it have been better to try and invent smartphones through existing camera companies like Kodak? Would on-demand video have turned out better if Blockbuster, not Netflix, had been the first big player? There is a reason that young entrepreneurs and start-ups have grown to dominate some businesses, creatively destroying older players in the process. Young firms are nimbler and more flexible and manoeuvrable.”

2.   Pickles claims that the reason firms engage in buybacks is “because fewer shares means higher earnings per share (EPS) – the magical measure of corporate success that Wall Street watches.”

This is a common objection to buybacks. There is an intuitive appeal to the idea that CEOs are buying back shares to game earnings growth targets. The problem is that this strategy simply doesn’t work in the long run.

Back to Asness: “The idea is that by repurchasing shares, a company decreases its share count and thus mechanically increases its earnings per share. The problem with this argument is that it ignores the fact that decreased cash means lower earnings, either due to less interest earned on the cash or the loss of returns from other uses of the cash.” If a firm is leaving profitable investments on the table to fund buybacks, then their EPS should fall in the long-run.

Asness goes a step further, he compares EPS growth rates for firms in the Russell 3000 (a leading stock index) that engage in share buybacks and firms that don’t. He finds no link between share buybacks and EPS growth, in fact firms that do not engage in buybacks have higher EPS growth. This he points out is what we would expect given that firms buyback stock when they lack investment opportunities.

There’s a caveat here. A well-timed buyback ahead of an earnings announcement could artificially boost quarterly EPS, though not long-run EPS. But, there’s no evidence that this is the primary motivation. If it was then investors could very easily modify executive compensation to adjust for repurchase effects. This, by the way, is already done for dividends for employee stock options.

3.     Pickles claims “Buyback isn’t actually good for shareholders (at least not long-run investors)”

She cites a study by McKinsey Analysts which finds “Based on a sample of 250 non-financial S&P 500 companies McKinsey analysts found no link between share repurchase intensity and total return to shareholders.” Furthermore, she claims “just three of the ten largest share repurchasers since 2003 have outperformed the S&P 500 Index.”

That sounds persuasive, but it’s important to remember why firms engage in buybacks in the first place. Firms issue shares when they want to raise capital and pay back capital when they lack profitable investment opportunities. Firms therefore engage in buybacks because they are pessimistic about future investments, so the McKinsey results do not actually prove that repurchases lead to worse performance. More likely is that firms expecting to underperform the S&P 500 are more likely to engage in buybacks.

There’s good evidence that this is the case. It is hard to separate correlation from causation when studying financial markets as share prices reflect the expected long-run value of a stock. But, one way we can identify whether repurchases hurt or helped share prices is by looking at how markets respond to unexpected announcements. According to Asness, the academic evidence finds “the announcement impact on returns of share repurchases is between 1 and 2% on average.” In other words, the best evidence we have is that buybacks increase share prices.

Why is this the case? There’s three reasons:

1. It signals that management believes that the company’s shares are currently undervalued.    

2. If buybacks are debt-financed, then the company’s tax burden will fall as debt-interest payments are tax deductible.

3. Investors don’t like large cash reserves as managers who aren’t owners may be tempted to use the cash pile for empire building.

When it comes to stock buybacks, we should follow the advice of Bart Simpson – ‘Don’t have a cow man!’.

It's essential to have a sense of scale about numbers

Political debate is both vital and interesting. But it does help if it's informed by a sense of scale about the underlying numbers. This is a complaint we here normally make about the arts graduates who make up most of journalism but the problem exists in the wider population as well. Here's a retired doctor (you know, one of those very bright people who got into medical school) telling us how social care and the NHS can be paid for:

The divide between medical and social care is very vague. Medical care is available 24 hours a day seven days a week and is free; social care is largely only available 9 to 5, Monday to Friday and is means tested. Breaking up the system through outsourcing and privatisation only complicates matters. Basically both need to be provided by government and be taxpayer-funded. Expensive? Why not have a levy of 5% on all inheritance over £100,000, including trusts. The rich who would benefit most in life would pay more in the end.

Of course, we disagree that both must be government provided - as do GPs of course, who are government funded but not employed by said. But our ire here is at the complete lack of understanding of the scale of these numbers. We are not, at all, blaming this individual, just pointing to the more general point that people don't understand.

For total - and yes, this is total inheritances, including that stuffed donkey Granny brought back from Torremolinos - are nowhere near enough to solve this problem.

The combined total of all inheritances received over the two year period was estimated at £75.0 billion. 

And:

In 2015–16, the UK public sector spent £220.2 billion (2016–17 prices) on health, social care, and benefits to support people with disabilities and health conditions.

It's true that they're not directly comparable numbers but still, that proposed tax is less than 1% of the current budget. It's not going to solve anything., is it? 

In fact, if we taxed all inheritances at 100%, including that donkey, we'd only have some 15% of that budget. Which, given that higher inflation rate (usually pegged at about double the one for the entire economy) of the NHS and such services is an amount that will get swallowed in only a few years.

We most certainly have strong opinions on a number of things and we admit and agree that others have equally strong and different ones on the same points. But really, we've got to be doing this informed by reality.

The taxation of inheritance just isn't enough to solve the costs of the welfare state. There's just not enough of it about to tax.

Certainly there will be some planning, but who does it and how much?

A useful reminder from Ronald Coase:

In my 1937 article [“The Nature of the Firm“], I argued that in a competitive system there would be an optimum of planning since a firm, that little planned society, could only continue to exist if it performed its co-ordination function at a lower cost than would be incurred if it were achieved by means of market transactions and also at a lower cost than this same function could be performed by another firm.  To have an efficient economic system it is necessary not only to have markets but also areas of planning within organizations of the appropriate size.  What this mix should be we find as a result of competition.

The importance here being that we need not just a market in things, or services, but a market in forms of organisation. 

We do not know all of what is possible within the current technological envelope - nor, obviously, what will be possible with that of tomorrow. We're also rather at sea over what people would like among the things which are possible. Thus we must use markets to explore that joint set of possibilities.

But more than that, we don't know what is the efficient mode of organisation to do any of these things. Which means we must use markets again. If a planned - and there is some planning in everything of course - solution works better then it will outcompete those non-planned in such markets.

An interesting corollary of this is that a state monopoly on something is the wrong way to go. Precisely because such competition cannot happen. If the state running something, a politically planned operation, really is more efficient then it will outcompete, won't it? And we'll never know unless people can compete with it, will we?