Hauling down the kite

In his first Reith Lecture this year (video), Niall Ferguson draws attention to the debt overhang confronted by most democratic countries.  He points out how much worse it is than commonly supposed, in that much of it does not appear in the official figures.  For example, when unfunded liability for US Medicare, Medicaid and Social Security are included - the programmes America is committed to pay for in future years - the US debt is thirteen times the officially published figure.

It used to be called 'kiting' if you kept issuing bigger cheques to pay for the previous ones.  The problem is how to bring down the debt kite, and The Adam Smith Institute published part of its answer in 1995.  Instead of having future generations dependent on the support of future taxpayers, the ASI proposed a means whereby they could, starting at birth with an initial gift, build up funds over a working life that would pay for their own needs in retirement.  The ASI called this "The Fortune Account" (PDF), and it attracted much favourable attention and publicity.

Before the child reached working age, relatives could help build up its account with tax-protected gifts, and once paid employment began, each person would pay into their own account to build up enough funds for their future needs.

A major advantage of the proposal is that it removes a huge liability from government and lifts a huge burden from future taxpayers.  It builds up real funds, creating a massive investment pool to facilitate future growth.

The IPPR later produced a much weakened version of the proposal, and now the Centre for Policy Studies has helpfully responded with a fairly vigorous one, calling the funds super-ISAs.  This is good news.  This is an idea whose time has come again 17 years after it was first mooted.  With debt and future liabilities very much ringing alarm bells, it is time to look one by one at these entitlements, and to devise alternatives which replace future dependence with self-funded responsibility by people for their own futures.  The Fortune Account is back on the agenda.

Economics Is Fun – 40,000 views and counting!

The series of 20 videos that Madsen and Xander made early this year is still going strong.  Total views have just passed 40,000, and are still climbing steadily.  The idea arose after Madsen published "Economics Made Simple," (just £2.84 on Kindle!) and the aim was to put across the essential (but often ignored) truths about economics in a light-hearted and if possible, entertaining way. 

They decided to keep to a very brief format, with each YouTube video about two-and-a-half to three minutes long.  The idea is to show how economics builds up in a series of logical steps from first principles derived from common sense. 

At a time when large parts of the world economy seem to be tottering on the brink of chaos, it has never been more important to have some grasp of how economics actually works, and what governments and others can and cannot do about it.

The ASI has attracted new readers and new fans from this successful series, whose videos can be seen here.

Tomorrow never comes

So that's sorted, then. Greece has given the pro-bailout parties a narrow majority (thanks to a quirk of the Greek electoral system that gifts fifty extra seats to the party that wins the most votes). Greece will take another bailout; the markets can stop panicking; the crisis is averted; the euro is saved.

Well, not quite. Had the anti-bailout far-left SYRIZA coalition won, the situation would be moving a lot more quickly towards a Greek exit from the Eurozone and, in all likelihood, a rapid acceleration in the Eurozone crisis. That Greece will probably take a bailout will soothe bond market traders' anxieties for a while. But look at how short-lived that period of calm following a bailout has become — Spain's sovereign debt yields fell for just a few hours after its bailout last weekend, and then quickly returned to historical highs.

In all likelihood, it seems that the next Greek bailout will be no more final than the last two were. Spain is rumoured to be seeking another, governmental bailout (as opposed to last weekend's one, aimed at bailout out Spanish banks).

The upshot of the last few weeks' developments in the Eurozone is that bailouts of banks and countries have become institutionalized. The lack of any real objection to the Spanish bank bailouts underline the reality that there is no European bank whose losses, if great enough, will not be moved to taxpayers in that country. Ireland's landslide "Yes" vote for the Fiscal Compact Treaty means that the European Stability Mechanism bailout fund is now a feature of EU law. The settlement is now more-or-less official: If banks are irresponsible, taxpayers will bail them out; if states are irresponsible, taxpayers will bail them out.

The political economy of this settlement should not be a surprise. Clients of the state — the various interest groups comprising interconnected banks, public sector workers, pensioners, subsidized and otherwise-protected businesses, and others — appear to be so embedded in the political fabric of the Eurozone states that policies for the good of the country, such as orderly bank defaults or radical competitiveness reforms, are impossible. Ireland's "Croke Park Agreement" that protects public sector workers from layoffs is just one example.

Mancur Olson, in his masterpiece The Rise and Decline of Nations, argued that this is a pattern of history. Olson argued that states may flourish when their leaders aim to act in the general interest, but over time special interest groups will accumulate, eventually causing politicians to become hostage to them over the interests of the numerous, but voiceless, citizens.

In Olson's words, states become victims of "institutional sclerosis" as groups who will lose from any reform establish themselves, making political change impossible. He used the post-1945 success of Germany, Japan and Italy as examples of countries whose client groups were obliterated, allowing their governments to carry out generally beneficient reforms without significant opposition. (I wonder if post-reunification Germany's labour market reforms are another example of this. I don't know.)

European leaders have, it seems, learned that voters will choose a known decline into destititute service to reckless banks and clients of the state over an unknown economic disorder that contains much destructiveness, even if it may prove to be creative. I doubt Greece will manage to stay in the Eurozone and avoid sovereign default. (It has already defaulted once during the crisis, despite the euphemistic language used to avoid calling it that.) But I am much less certain that the Euro crisis will ever come to the head that constantly appears to be on the horizon. 

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What on Earth is Sir David King talking about?

Regular readers will know that I'm perfectly happy to take what the climate scientists tell me about climate science. Where I start to stray from the path of green orthodoxy is those same scientists then tell us the economics of what we ought to do about it all. Something they are not competent to comment upon as they really don't understand the economics. I do accept the economics of climate change as laid out by the economists who have studied the economics of climate change. William Nordhaus, Nick Stern and so on, tell us that if the climate science is right then a simple revenue neutral carbon tax will be the solution.

That's fine by me. But it does still puzzle me as to why the not economists feel competent to pronounce on the economics of climate change. Are they intellectual supermen who can master two widely different subjects? Simply succumbing to politics: something must be done, this is something, do this? I think I've found a little clue actually, something that might guide us to a conclusion. It's in this interview with Sir David King, lately the chief scientific advisor to HMG.

He also believes it is imperative to fund other major infrastructure projects, such as the Severn Barrage, which would provide three gigawatts of electricity and still run in 200 years with minimum maintenance.

"The problem is that the longest time an economist will work on investment returns is 25 years. We need to look at taking a much longer view. What is missing is clear direction from number 10 and 11."

I wonder if someone would like to tug very gently on Sir David's sleeve and ask him what on Earth he thinks he's burbling about?

Here is the cost benefit analysis for the Severn Barrage. In its various different forms. Beginning on page two you can see that the costs and the benefits are calculated out for 120 years: the expected lifetime of the asset if it is built. That is, the economists looking at the Severn Barrage did not limit themselves to a 25 year investment return. They, quite properly, looked at the whole lifetime costs and benefits.

Which leads us to our conclusion. The reason the scientists are so in conflict with what the economists of climate change are saying about the economics of climate change is simply that the scientists are entirely ignorant of what the economists are saying. And I'm afraid that, despite the popularity of the stance among politicians, ignorance is not a notably successful form of governance.

The importance of a market economy

Vuk picks up on an important point about the Soviet economy of old. Growth in that economy was almost entirely a matter of greater inputs into the economy. This is a strategy that clearly runs out of steam when you've no more inputs to add: and run out of steam that sort of economy did. But we can take this argument further, as Paul Krugman did when examining the Japanese economy of the 80s and 90s. Here.

How, then, have today's advanced nations been able to achieve sustained growth in per capita income over the past 150 years? The answer is that technological advances have led to a continual increase in total factor productivity--a continual rise in national income for each unit of input. In a famous estimate, MIT Professor Robert Solow concluded that technological progress has accounted for 80 percent of the long-term rise in U.S. per capita income, with increased investment in capital explaining only the remaining 20 percent....()......But what they actually found was that Soviet growth was based on rapid--growth in inputs--end of story. The rate of efficiency growth was not only unspectacular, it was well below the rates achieved in Western economies. Indeed, by some estimates, it was virtually nonexistent.

What it boils down to uis that it is the strictures of the market that lead to that greater efficiency and technological progress. William Baumol has noted the reason why: either system can create the inventions, make the new technology. But only a market based system gives the freedom to experiment with it to increase that efficiency and then, as others become more efficient, that impetus for others to adopt in order not to go bankrupt.

The most important lesson of which in modern terms is for the various greens and environmentalists. If you really do want an economy in which resource use is reduced then you really do need to have a market economy. For planned ones just aren't any good at increasing efficiency: efficiency meaning here a reduction in resource use for any given level of output.

And when I meet, if I ever do, another environmentalist like me who argues for the free market precisely because it is environmentally sound to do so I shall rejoice. Until then, looking at the greens that we do have I can only consider them with horror. Why is it that they continually argue for policies like planning so inimical to their actual desire, reduced resource use?

Do we need government?

After Tim Evans's great speech on private policing at our Next Generation event on Wednesday, I came across the video above, which goes into more detail than Tim had time for. Ed Stringham argues that government might not be necessary even for the "night watchman" roles that most assume it is required to play. Is government the only agency that can provide law enforcement? Stringham says "no", lucidly and engagingly.

I anticipate some negative reactions to my posting this video. Even many liberals and "minarchist" libertarians find anarcho-capitalist ideas frustratingly utopian and a distraction from the challenges of the real world. I can sympathise, but I think it's also important to take nothing the state does for granted. I could be (and, honestly, I probably am) persuaded that we need some kind of Leviathan state to minimise violence, but I don't see why we should assume that.

Happy birthday, Adam Smith

It's Adam Smith's birthday. Well, sort of. His birth was registered at the church in Kirkcaldy, Scotland, on 5 June 1723. So he was probably born around 3 June 1723. But in 1872 the calendar changed and a few days were added, so that works out to 14 June, which is the day we celebrate it here at the Adam Smith Institute.

And so we should. The Scottish philosopher and economist, best known for his pathbreaking book An Inquiry into the Nature and Causes of the Wealth of Nations (1776), transformed our thinking about the principles of economic life, from an ancient to a distinctively modern form, based on a completely new understanding of how human society works.

In Smith's time, the common understanding was that wealth meant gold and silver. Countries imposed import barriers, and subsidised their export industries, in the attempt to keep gold and silver flowing into the country and stop gold and silver flowing out. Trade, people thought, benefited only the seller. It was Smith who pointed out that trade actually benefits both sides. People simply would not trade if it did not: why should either side agree to a bargain that leaves them worse off? If people were left free to trade as they wished, the benefits of exchange would spread all over the world, argued Smith, and the welfare of everyone – especially the working poor – would be raised, since the existing labyrinth of regulations and controls tended to benefit the rich and powerful who shaped them, rather than the poor who suffered under them. Such ideas became hugely influential and ushered in the great nineteenth-century era of free trade and rising incomes.

But Smith was a moral philosopher as well as an economist. And it was his 1759 book The Theory of Moral Sentiments that actually made his reputation and his fortune. In it, he sought to explain our moral ideas in terms of human social psychology. A hundred years before Darwin's On the Origin of Species, he explained that nature has given us moral traits that promote our welfare and survival. Indeed, we would all be dead if this were not so. And human beings have a natural 'sympathy' for others, and wish to be thought well of by others, and these traits provide the foundation of what we think of as moral and virtuous.

Today, some people see a conflict between Smith's explanation of economics, based on self-interest, and of morality, based on human empathy. But Smith reconciles the two in the very first line of Theory of Moral Sentiments:

How Selfish sover man may be supposed, there are evidently some principles in his nature, which interest him in the fortune of others, and render their happiness necessary to him, though he derives nothing from it except the pleasure of seeing it.

In other words, human nature is complex. The same baker who supplies us with bread out of self-interest rather than benevolence is the same person who would dive into a river to save a drowning stranger. Smith's books are complementary attempts to identify how self-interested human beings manage to live together peacefully (in the moral sphere) and productively (in the economic). Self-interest may drive the economy, but as long as there is no coercion and genuinely open competition, that is a force for good. If we simply remove 'all systems of preference or of restraint', and rely on 'natural liberty', says Smith, we will find ourselves settling, as if by an invisible hand, into a harmonious, peaceful and efficient social order. Smith's quest was to identify the natural principles of human action that would in fact create this fortunate result. Happy birthday, Adam Smith.

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A quick Eurozone geography recap

This just landed in my inbox and seems to be doing the rounds:

1. “Spain is not Greece.”
Elena Salgado, Spanish Finance minister, Feb. 2010

2. “Portugal is not Greece.”
The Economist, 22nd April 2010.

3. “Ireland is not in ‘Greek Territory.’”
Irish Finance Minister Brian Lenihan.

4. “Greece is not Ireland.”
George Papaconstantinou, Greek Finance minister, 8th November, 2010.

5. “Spain is neither Ireland nor Portugal.”
Elena Salgado, Spanish Finance minister, 16 November 2010.

6. “Neither Spain nor Portugal is Ireland.”
Angel Gurria, Secretary-general OECD, 18th November, 2010.

7. "Spain is not Uganda"
Rajoy to Guindos... Last weekend!

8. "Italy is not Spain"
Ed Parker, Fitch MD, 12 June 2012

Well, that's clear then.

It’s time to end our exploitative minimum wage laws

As a libertarian student, I was always opposed to minimum wage laws on the grounds that they restricted free choice and would increase unemployment. I was often told that after living in the real world for a while, I would see that a minimum wage is absolutely essential and that living below it would be exploitation. Well, since entering the ‘real world’ last year, my views on the minimum wage remain unchanged.

Firstly, exploitation is subjective. For those who are 21 years old or over, the national minimum wage is currently £6.08 – do we really believe that the moment they earn £6.07 they are being exploited? Why should it be left to government bureaucrats to arbitrarily decide what constitutes exploitation? Payment should be between the employer and employee. If the employee doesn’t like the offer being made they are free to refuse it and if they are willing to accept it, then it’s not for anybody else to label it exploitation.

It’s true that many will receive a low income under such a system. Those who are more fortunate may feel sympathy for them and have a genuine desire to help. Yet by enforcing minimum wage legislation they are in danger of hurting those very people they are intending to save. The workers in question are likely to be young and low skilled, which means an employer is unlikely to hire them if they’re forced to pay a high wage. This principle is already widely accepted and it is why the minimum wage for 16-17 year olds is just £3.68. This gives them one advantage over those who are older and better skilled.

An important factor in this debate that is often overlooked is that those earning less than the minimum wage would be gaining valuable experience and leaning new skills. The importance of this is not to be underestimated – thousands of young people in this country are willing to take on unpaid internships in order to gain these benefits.

Presumably those who believe that earning less than the minimum wage is ‘exploitation’ are also opposed to internships, on the same grounds. Yet I myself was an intern receiving ‘expenses’ that amounted to less than the national minimum wage (whilst living in London). It’s true that I had to be frugal, but it paid off as the experience has now led to full time employment. If the national minimum wage supporting do-gooders had their way, I would never have been able to move to London and I would be worse off.  Well intentioned or not, nobody else should have had the right to stop me from freely choosing to pursue that opportunity and that is why the concept of a national minimum wage is wrong.

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Cold comfort

Oliver Blanchard, Chief Economist at the International Monetary Fund, blogged on Latvia's economic miracle this week. Latvia has begun to recover from a deep recession of about 10% in 2008, despite or because of a deep austerity plan and little monetary stimulus (in order to maintain a peg with the Euro). With 5.5% growth in 2011 and an estimated 3.5% growth in 2012, Latvia now has "one of the highest growth rates in Europe, the peg has held, and the fiscal and current accounts are close to balance."

Among the causes of Latvia's success, Blanchard names the following as being important:

3. Wages were flexible, at least relative to the generic European labor market.  The initial adjustment came with a dramatic reduction in public sector wages, and thus a direct improvement in the fiscal position.  Together with unemployment, lower public sector wages put pressure on private sector wages to adjust.  A note of caution is needed here however: private sector wages, which are the wages which matter for competitiveness, have adjusted much less than public sector wages (by how much is a matter of some disagreement).  Indeed, I worry that nominal wages have started to increase, while more adjustment still has to come to maintain current account balance as output recovers.   One has to hope that increases in productivity will do the trick.  This takes me to the next point.

4. There was—and, looking forward, there still is—substantial room for productivity increases.   Latvia has income per capita of half the European Union average.  Being far behind the technology frontier, it has a lot of room for catch up. [This is always important to remember when comparing economic growth across different countries: playing catch-up is a lot easier than leading the field.]

5. Latvia is a small, open economy—although less so than its Baltic neighbors.   With exports around 50% of GDP, improvements in competitiveness can have large effects on both imports and exports, and in turn on GDP.

6. Public debt was very low to start, less than 10% of GDP.  Even today, public debt remains around 40% of GDP.   This more or less eliminated foreign investors’ worries about default on sovereign debt, and allowed for a quicker return of Latvia to international financial markets.

7.The Latvian financial system was largely composed of relatively friendly foreign banks—better than unfriendly foreign banks, or friendly but weak domestic banks.For the most part, the Swedish banks recapitalized their banks and maintained their credit lines to the Latvian subsidiaries, reducing the intensity of the sudden stop and of the credit squeeze.

Latvian policymakers would surely want me to add yet another reason—the strong front loading of fiscal consolidation:  over the first two years of the program, the cyclically adjusted primary balance was increased by 11% of GDP.   I am not sure.

Latvia's neighbours in Estonia have experienced an even greater reversal of fortune. Last year, Estonia grew by 8%, and that trend looks set to continue. Despite this, Paul Krugman used a rather misleading graph to suggest that Estonia cannot claim any "economic triumph", because output is still below its 2007 peak. (Which the Estonian president laid into Krugman over on Twitter.)

The problem with Krugman's graph is that it is context-free, and ignores the rapid (and clearly unsustainable) boom that Estonia experienced in the 2000s. It seems likely that much of Estonia's growth in the 2000s, like many Eurozone periphery countries, was malinvestment driven by credit expansions.

As such, recovery is not just a matter of boosting demand again, but liquidating those malinvestments and regearing the economy towards, as Arnold Kling called it in his paper for the ASI, "patterns of sustainable specialization and trade". This lumpy, disaggregated view of the economy is a surprisingly fringe one, but it's quite a lot more convincing to me than the focus on enormous aggregates that conceal the processes of change that take place in economies.

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