Ditching, at least for the moment, macroeconomics

I've said before here that I'm deeply unimpressed with macroeconomics, stating that as the man didn't say in the long run it's all microeconomics. However, I'm coming around to the idea that the situation is worse than that. We just don't know enough about macroeconomics to know what to do. This from Noahpinion sums it up for me:

Macroeconomics is not a science that has, as of May 2012, proven itself in the way that chemistry, biology, or various branches of microeconomics have proven themselves.

This might be betraying my own lack of knowledge of the subject, even my uninterest in it, but I'm not aware of a macroeconomic model, one that actually provides policy responses, that you could get more than perhaps 50% of economists to sign up to. Whereas there are swathes of areas in microeconomics that most would indeed agree are true, disagreements being haggling around the details or even the subjective valuations of the goals, not the objective truths of the insights.

This does come as something of a surprise to me as, like most non-economists*, from outside the profession you get the idea that all agree on what should be done to the wider economy. It's the validity of things like minimum wages, rent controls, tariffs, trade itself, incentives, the working of the price mechanism, incidence of taxes, that are still widely disputed among economists. Which is, at least as far as can see it is, entirely the wrong way around.

In macro we've still got entirely respectable economists, Nobel Laureates on every side, arguing over whether monetary policy is a sufficient cure for recession at the zero interest rate limit, helpful but not enough or near entirely irrelevant, only fiscal policy can help. The same people are similarly arguing over whether, with national debts at 80-100% of GDP, borrowing more to spend more as a fiscal policy is the only way out of recession, helpful but be careful or merely bringing the day of reckoning even closer as nations spiral into bankruptcy, counter-productive even.

I don't mean to support or argue against any of these positions here: just to note that the senior practitioners of the craft are arguing as if medicine were still based upon the four humours, chemistry upon the four elements and biology without genetics or inheritance.

Which leads me to a suggestion. We really should be concentrating on those parts of economics where we know that we're at least roughly right. Those microeconomic matters: get the incentives right, get the price system right, and leave that attempted manipulation of the wider economy until there's actually an agreement on how to do so. Or even why to do so.


*Yes, I'm self taught, no advanced degree, not a professional economist, even if well informed in a couple of specific areas of the subject.


The idiocy of the protectionist growth argument

You don't have to go far into NGO land to find people arguing that poor countries need to protect their baby industries from the big bad wolves of international capitalism. That trade barriers are a good idea, that infant industries need to be nurtured and, as is the way of these things, the Washington Consensus is the imposition of the poverty that the poor suffer from.

That this is entire nonsense does not stop those idiots wearing ideological blinkers from repeating it. Which is something of a pity as it really is trade, openness to it, which drives economic growth:

In recent years, sub-Saharan African countries have grown remarkably. According to data from the Penn World Table 7.0 (Heston et al. 2011), average annual real GDP per capita growth from 2005-9 has been over 2.5% (3.5% when excluding 2008 and 2009). This recent growth performance is remarkable given that, for over four decades since 1960, real GDP per capita growth in sub-Saharan Africa was dismal, averaging less than 0.5% per annum.

We are, as we know, talking about the poorest of the poor and any uptick in their fortunes has been both extremely difficult to find and extremely welcome when it is.

One thing that might be remembered is that, post-colonialism, most sub-Saharan countries did in fact follow the policies of infant industry protection behind tariff and licencing barriers. It was the falling apart of this in the 80s and then the gradual adoption of good old neoliberalism in the mid to late 90s which has turned the numbers around.

By casual empiricism, it is interesting to note that the average sub-Saharan African country is today over 30% more open to international trade than in1960 (as measured by the ratio of exports plus imports over GDP). The big question is, of course, whether this increase in trade openness is a cause or a consequence of the increase in economic growth.

So, we have a correlation: what is the causation?

We find that openness to international trade increases economic growth in sub-Saharan Africa. The instrumental-variable estimates suggest that, on average, a one percentage point increase in trade openness is associated with a short-run increase in GDP per capita growth of about 0.5% per year. The long-run effect is larger, reaching about 0.8% after ten years.

It is that trade openness precedes the growth.

Thuys we have an interesting piece of objectivity in economics. It is certainly possible to make subjective arguments either way about trade and growth. That everyone else had protectionism when they grew so therefore this is a necessary part of growth, just to give one currently fashionable argument.

However, such theorising does need to be calibrated against reality which is what this paper has done. And the answer is, no, protectionism is a complete crock at reducing poverty through economic growth. It is that trade that does it: we neoliberals are right again!



But of course regulation doesn't hamstring the economy!

We've been told, by a man with impeccable economic credentials no less, that red tape and regulation just isn't important to the economy at all:

The truth is that, if there is money to be made, businessmen will invest regardless of the level of regulations. This is why the 299 permits that were needed to open a factory in South Korea in the early 1990s did not prevent the country from investing 35% of its income and growing at 10% per year at the time.

As I've said elsewhere already this is the statement:"Look, a factory exists! Red tape isn't a problem!". When of course M. Bastiat would have us ask how many factories would there have been in the absence of the red tape? As I've also mentioned on this point, that Ha Joon Chang teaches economics at Cambridge tells us that we might have the occasional problem in our education system.

Which brings me to this little snippett of information from Bloomberg:

France has about 1,500 companies with 48 employees and about 1,600 companies with 49 employees, but only 660 with 50 and 500 with 51, according to a December 2011 report from state statistical unit Insee.

The full lunacy of French employment law kicks in when a company has 50 workers. That's when you have to set up three workers' councils, apply to a court to make redundancies and so on. Which is rather glaring evidence, don't you think, that at least in the minds of employers red tape does have an effect? People are deliberately not growing their payroll through that 50 person barrier in order to avoid the costs of that red tape. And, as ever, it's not actually what the Reader in Economics at Cambridge thinks ought to be happening that is important: it's what people are actually doing out there in the real world that is.

It's also worth taking issue with another point: even if red tape were only a minor factor this is still not an argument in favour of red tape. Even a minor disincentive to growth and investment is still a disincentive, one that we probably would prefer not to have. As an analagous argument, as a middle aged, fat, bespectacled and balding (and married!) male I'm not going to be a great success with the young ladies. But that doesn't mean I should put spinach between my teeth just to make sure of it, does it?

I must admit though, I'd love to know how many of those French firms that are under 50 employees have grown to that size: and the number that are over 50 have been shrunk to that size by the effects of the red tape.


The Hayek Club goes to the Financial Times

Congressman Ron Paul had an op-ed in the Financial Times yesterday (£). As part of their series on the future of central banking, Paul wrote about the 'intellectual bankruptcy' of the world's central bankers. It's quite a coup for the Hayek Club, our informal list of people who see central bank credit expansion as the root cause of the financial crisis and post-2008 recession. Paul wrote:

Economists understand that having wages or commodity prices established by government fiat would cause shortages, misallocations of capital and hardship. Yet they accept at face value the notion that central banks must determine not only the supply of one particular commodity – money – but also the cost of that commodity via the setting of interest rates.

Printing unlimited amounts of money does not lead to unlimited prosperity. This is readily apparent from observing the Fed’s monetary policy over the past two decades. It has pumped trillions of dollars into the economy, providing money to banks with the hope that this new money will spur lending and, in turn, consumption. These interventions are intended to raise stock prices, lower borrowing costs for companies and individuals, and maintain high housing prices.

But like their predecessors in the 1930s, today’s Fed governors behave as if the height of the credit bubble is the status quo to which we need to return. This confuses money with wealth, and reflects the idea that prosperity stems from high asset prices and large amounts of money and credit.

The push for easy money is not new. Central banking was supposed to have ended the types of periodic financial crises the US experienced throughout the 19th century. Yet US financial panics have only got worse since the centralisation of monetary policy via the creation of the Fed in 1913. The Depression in the 1930s; the haemorrhaging of gold reserves during the 1960s; the stagflation of the 1970s; the dotcom bubble of the early 2000s; and the current recession all have their root in the Fed’s loose monetary policy.

Each of these crises began with an inflationary monetary policy that led to bubbles, and the solution to the busts that inevitably followed has always been to reflate the bubble.

This only sows the seeds for the next crisis. Lowering interest rates in an attempt to forestall a recession in the aftermath of the dotcom bubble required massive credit creation that led to the housing bubble, the collapse of which we still have not recovered from today. Failing to learn the lesson of the bursting of both the dotcom bubble and the housing bubble, the Fed has pumped trillions of dollars into the economy and has promised to leave interest rates at zero through to at least 2014. This will only ensure that the next crisis will be even more destructive than the current one.

The article is behind a registration wall, but it can be read in full here if you don't have an FT account. 

My one regret is that the FT chose to ask Ron Paul to represent the Austrian perspective. Paul has had a profoundly positive impact on the world by promoting this point of view, but he a politician, not an economist like those writing in the rest of the FT's series. Like Bloomberg TV pitting Ron Paul against Paul Krugman, it's a lop-sided debate. There are some superb Austrian school monetary economists around, like George Selgin, Larry White, Steve Horwitz and our own Kevin Dowd, who are more qualified to make the case against central banking than Paul in a relatively technical newspaper like the FT.

Still, it's remarkable that any Austrian was asked to give this point of view. As I've written here before, it all adds to my feeling that the Austrians are on the rise.

The Bennites strike back

Tim Worstall made himself (more) unpopular with Compass last week by pointing out that their idea of creating a form of national socialism rather resembled the sort of economy favoured by National Socialists. In a think piece entitled ‘Progressive Protectionism’, Colin Hines espouses a system in which countries “rebuild and re-diversify their economies by limiting what goods they let in and what finance they choose to enter or leave the country.” This happens to be much the same policy favoured by the British National Party. Hines has responded by calling this a “libellous smokescreen” and I have no wish to poke this particular hornet’s nest, other than to say that while ‘Progressive Protectionism’ is certainly unoriginal, it borrows less from Herr Hitler than from Mr Benn.

In 1976, Tony Benn came up with his ‘Alternative Economic Strategy’, of which Hines’ scheme is a virtual carbon copy. As described by Dominic Sandbrook in the latest volume of his monumental history of post-Churchillian Britain, Benn believed he could save the British economy by cutting the country off from foreign competition.

“The premise of the so-called Alternative Economic Strategy was that, in a globalized world, Britain could only reboot its stalled economy by temporarily cutting itself off from external pressures. Under this strategy, the government would introduce stringent controls on foreign imports and the flow of capital, effectively throwing up a protectionist barrier to stop too many foreign goods getting in. Behind this trade wall, they could adopt a properly socialist policy, with full employment, steadily rising wages, booming demand and hence a resurgent manufacturing sector, all under the direction of a souped-up National Enterprise Board.”

This was justifiably viewed as economic lunacy by the rest of Jim Callaghan’s Cabinet (who were hardly a band of Randian objectivists). They understood that such an anachronistic policy would lead to international retaliation on a grand scale which would further cripple British industry. In addition to violating various free trade agreements, including EEC membership, Benn’s “siege economy” was almost certain to lead to mass unemployment, severe deflation and shortages of essential imports. In the long term, it would stifle innovation and savagely curtail economic growth.

The only significant difference between Benn’s ruse and that of Hines is that the latter believes in turning the whole EU, not just the UK, into one large protectionist bloc. It is a matter of debate whether that would make the policy more or less disastrous, but disastrous it would surely be. “Benn’s alternative strategy would probably have been a catastrophe,” Sandbrook writes. “For one thing, he consistently refused to accept that a siege economy would probably annihilate what was left of British manufacturing. What was more, he seemed completely indifferent to the importance of financial discipline and international confidence, as if he could just wish away the new world of global competition and fluctuating exchange rates... in Benn’s imagination the rest of the world appeared as a sinister conspiracy of American bankers, European moneylenders and multinational corporations, plotting to undermine British socialism.” Benn, he concludes, “remained a little Englander to the last.”

After politely listening to Benn’s protectionist fantasies, Callaghan rejected the Alternative Economic Strategy in its entirety, but the scheme remained popular with many on the left of the Labour party and it was eventually incorporated into the 1983 election manifesto, famously described by Gerald Kaufman as the “longest suicide note in history”. Michael Foot’s crushing defeat in that election forced the party to abandon many of its most reactionary and economically illiterate ideas, of which the Alternative Economic Strategy was surely one. It seems that there are some who think it is time for a revival, but if resurrecting policies from Labour’s most dismal period of opposition qualifies as “progressive” then this much abused word no longer has any meaning.


Why I think voting matters

I disagree with Sam's view on voting.  I think I might be more Popperian than Sam, in that I never expect to find a candidate whose views correspond with mine.  We're all different, and the best I can hope for is some agreement.  That's not why I vote.  I vote to turf out, or keep out, the bad guys, the ones I don't want to see holding office.  This follows Popper's view that democracy helps us to prevent bad or incompetent rulers from doing too much damage.

I could take the position that even if I don't vote, other people will do that job for me, so I can save myself the inconvenience and free-ride on their efforts.  I know that many critics of free-marketeers accuse us of acting only in self-interest, but many experiments in game theory situations show that the default position is not selfishness but co-operation and goodwill if others reciprocate.

I'm happy to go along and co-operate with my fellow electors in trying to turf out, or keep out, the bad guys.  In the election for London Mayor I regard one of the front runners as well worth keeping out, and will vote accordingly, hoping that enough of my fellow electors do likewise.

The financial crisis: finger pointing at last

Four years on, Mervyn King has finally admitted to some of his culpability for the banking crisis.  At the same time, he rpoints to the Treasury, FSA and Bank of England “Tripartite” for its combined responsibility.  He is right about that. Incredibly, during the ten years leading up to the crisis, i.e. as it was slowly developing, the Tripartite met only once.  King notes the mea culpa from the FSA, again only partial, but also notes the absence of penitence from Gordon Brown and Ed Balls.

He also failed to mention Sir John “Teflon” Gieve.  As a senior Treasury official he helped draw up the Tripartite agreement that almost guaranteed its failure.  He was then Permanent Secretary of the Home Office during the years the auditors refused to sign off the accounts.  His financial sagacity was further confirmed when, as link man between the FSA and the Bank of England during the lead up to the crisis, he effectively neutered them both.

King has had some hard words for the banks who, notably Barclays, have failed to admit responsibility, pay mega-bonuses based on profits from mis-selling and resolutely obstruct attempts to increase capital ratios to prevent a recurrence.  I have some sympathy with the banks on that last point.  Regulation was not, and is not, the solution.  We are unlikely to have another such crisis until the memory of this one is fully expunged, i.e. half a century.  We can already see the effects of higher capital ratios damaging our ability to escape recession.  To increase capital ratios, banks have to lend less to SMEs and increase their margins to everyone.  Look at LIBOR and mortgage interest rates increasing while the Bank of England rate has been stable at 0.5%.

At this particular time we need less capital ratios and more lending at keener prices.  When recovery comes, then by all means think again.

We are still in the doldrums of the banking crisis and are likely to continue to be for some time.  Yes, Sir Mervyn, we do need a proper independent enquiry and we need it now that the pressure is off but memories are, or could be, clear.

It is extraordinary, when you think of it, that we are mesmerised by the peccadillos of the Murdochs which have had a marginal, if any, effect on our way of living but ignore the far more grievous failures of the banks and the Tripartite which have brought the country to its knees.  We have a years long judicial review of the former and no review at all of the latter.

Economic ideas and politics

I addressed a meeting of Cambridge University's Marshall Society in King's College last night.  It was in Keynes Hall, with a bronze bust of Keynes looking in from the side of the stage.  My theme was "The Influence of Economic Ideas on Politics," and I began with Adam Smith, the Scottish economist who overturned the prevailing view that nations became rich by exporting more than they imported.

Influenced by Smith's ideas, successive British governments liberalized duties, taxes and regulations, culminating in the repeal of the Corn Laws in 1846.  It unleashed a period of unparalleled prosperity in Britain.

Next I cited John Maynard Keynes, who taught that governments could regulate the business cycle to some extent by "priming the pump" with public spending at times of insufficient private spending to boost employment levels.  The Keynesian approach dominated the post-war consensus, with government playing an active and leading role in economic management.  Politicians liked to be seen to be doing things and in control instead of simply reacting to events.

Although Milton Friedman was famous for monetarism, I suggested he probably played a larger role in discrediting government intervention and boosting the case for private enterprise and opportunity in its place.  He certainly played a leading part in emboldening governments to undertake privatization and the reassertion of market economics in the final quarter of the last century.

Following the financial crisis of 2008, I suggested that the Austrian School was now winning the argument about its causes, pinning responsibility firmly on the cheap borrowing instigated by governments and central banks that lay behind the credit bubble and the careless risk-taking that accompanied it.

My final note was that despite what economics teaches, politicians would probably continue to advocate silly things such as a financial transactions tax, or punitive tax rates on high achievers, and would continue to damage and limit wealth creation by an excessive preoccupation with its redistribution.


Why I won't be voting

Today, Londoners will vote for the next Mayor. I won't be among them. I don't think that voting is any more one's "duty" than supporting a football team. Indeed, in large-scale elections (like the Mayoral election) it is probably a lot less important than cheering on your favourite team. If your aim is to affect policy, voting is irrational. If you want to act ethically, voting is irrelevant.

Mathematically, the chances of a single vote actually determining the outcome of an election in a meaningful way (that will affect policy outcomes) is infinitesimally small (ten million to one for voters in US swing states in 2008). The closest general election result ever in the UK was in 1997, when Lib Dem Mark Oaten was elected by two votes. Not only would one vote still not have made a difference here, the result was annulled and a new election held in which Oaten won by a landslide. Even if one vote did make a difference, the result would (apparently) be annulled.

This was with a turnout of 62,000 – the larger the turnout, the less likely it is that the vote will be tied or won by a single vote. In the last London Mayoral election, turnout topped two million. The chances of a single vote determining this election are extremely slim – less slim than they'll be at the next general election, to be sure, but still very slim. (Incidentally, some people will always reply to this, "If everyone thought that way, nobody would vote!". This is silly. We act marginally as individuals. If everyone went to the cinema tonight, there would be no room for me. This is a bad reason not to go to the cinema.)

Voting isn't instrumental, aimed at affecting policy, it's expressive. Like supporting a football team from home, you do it because it makes you feel good, not because you think it'll make the team win. But there isn't really much reason to care who wins the Mayoral election. The Mayor's powers are extremely limited, and the differences between Boris and Ken (the only two people who have a hope of winning) are more about personality and style than policy. Sure, Ken gives me the creeps, but Boris has disappointed me by resorting quickly to spending pledges whenever he's challenged about things like transport or policing. Maybe that's what it takes to win, but don't expect me to care enough about you to go out and vote for you if it is.

Some people like to say that voting is everyone's duty as citizens in a democratic country. This is nonsense. States establish and enrich themselves by violence. Don't believe me? See what happens when you choose not to pay all your taxes because, say, you don't want to use the NHS. You have no more of a duty to vote than you have a duty to go down to your local Mafia's consultation meeting about how to make protection money collection as pain-free as possible.

Voting is a remarkably poor tool in determining socially-optimal outcomes. When I go to the bookstore, I can pick from thousands of different books and even pay more to buy obscurer titles. Even if I'm in a minority wanting to learn Polynesian nose flute-playing, I can pay extra to express the intense wish I have to learn, which will allow my minority wishes to go fulfilled.

Voting can't measure intensity of feeling like markets can. It's blunt, uniform and heavily weighted towards the wishes of a majority that often chooses poorly. Democracy is a bookstore where you can have any novel you want, as long as it's Twilight.

To be fair, things might be different in your local elections, where one vote sometimes can make a difference. That's a good argument for more localism, so democracy can be a little less tyrannical and local government a little more attractive to talented people. But in this large Mayoral election where the candidates are offering, more or less, the same thing, there's no point. Instead of trudging down to the polling booth today, I'll be going home and reading a good book. I suggest you do too.


Our Spring sixth form conference

Last week we held our first sixth form conference of 2012 in Westminster. ISOS, the Independent Seminar on the Open Society, has been running for many years and is extremely popular with sixth formers and teachers.

One teacher I met at our conference told me how her pupils were much more free market than her and were keen to come to all our student events. A number of pupils attended independently and a couple of students travelled all the way from Yorkshire to take part. Hundreds of the free books we provided were snapped up within minutes and we were inundated with requests for work experience and for more events for sixth formers.  The enthusiasm of those attending and the quality of the questions asked were truly inspiring - encouraging me that there may be many more libertarians amongst the next generation.

As always, the speeches at ISOS were excellent and can be viewed on our YouTube page [We didn't get the debate at the end of the day between Jamie Whyte and the nef's Nic Marks, but I'm going to embed rest of the videos on the blog later today - ed.]. Dr Tim Evans’s talk on ‘The Morality of Markets’ was the highlight of the day for me and sparked challenging discussions on the myth of ‘market failure’ and controversial topics such as whether the banks should have been bailed out.

I wasn’t alone in my enjoyment of the day. In our feedback forms, 100% of the attendees rated the day as ‘excellent’ or ‘good’ (with the majority voting excellent!). The comments on the forms were all very encouraging with pupils writing “Absolutely great, outstanding and highly intellectual seminar. Thank you!” and “Excellent conference. Really widened the way I thought about the topics discussed.” And that’s just a glimpse. The feedback was overwhelmingly positive and served as a great reminder to us of why we choose to focus so much of our energy on student work.

Plans are already underway for our next ISOS conference in November 2012 and details will be out soon. If you are a sixth-former who is interested in attending, please do get in contact. And if you are a teacher or know of a teacher who would benefit from hearing more about our student conferences, please do drop me an email at sally@old.adamsmith.org.

We’d really like to increase the frequency of these events, but that is only possible with the support of people who share our vision of educating the next generation on the importance of free markets and a free society. If you would like to donate towards our work in this area, we would of course be delighted to hear from you!