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.


Fixing our broken police force

The Home Secretary, Theresa May, is proposing Tom Winsor as HM Inspector of Constabulary – the regulator of Britain's police service. Naturally, a lot of people are alarmed at this prospect.

In the first place, nobody expects that Winsor would conduct the regulation of the police in a genteel manner. He has a reputation for speaking his mind, and uttering a few sharp words when he thinks people aren't doing their job properly. That is certainly what he did at the Office of Rail Regulation.Then of course there was his two recent reports on the police, in which he proposed a radical programme of reform, major changes in pay and conditions, and a demand that police officers shed their 'clock in, clock out' reputation with the public. He's not a man to take prisoners. It's partly down to his recommendations that 30,000 police came out on the streets to protest about their pay and pensions.

Police bosses, of course, argue that Winsor has no history or experience of policing. But maybe that is exactly what the police service needs, someone coming to it from outside who can see it from the point of view of the public, and of managerial and economic efficiency, rather than being bound up in the status quo. One of Winsor's criticisms of police recruiting is precisely that officers start on the beat and have to to work up to the higher ranks, steeping them in the status quo – when really we should be recruiting intellectually able managers straight into the higher, managerial ranks such as superintendent. And usually it is only a police insider, an existing chief constable, who has come up in this way who gets to regulate the whole system.

Sure, the Chief Inspector has traditionally been more than just a regulator. Part of the job has been to advise senior police officers on difficult issues such as public order and the policing of large events, policy on terrorism and suchlike. Winsor, with no past day-to-day involvement in such issues, might not be the best person to advise. But again, maybe we need a police regulator who is not poacher and gamekeeper at the same time. Perhaps the advisory job needs to be done by someone else, or through some other mechanism, so the regulator can get on with regulating.

A public monopoly which starts people on the lowest rank, and through which people are promoted on the basis of longevity and clubbability as much as on brains and skill, is an outdated concept. If ever there is an example of producer capture, the police service must be it. That is why I am so looking forward to Dr Tim Evans's talk to the ASI's Next Generation Group tonight. He goes even further than Tom Winsor, arguing that the only way to change the nationalised-industry culture in the police, and make them properly responsive to the public's demands, is to introduce competition and privatization. 

Persistent fallacies

I have been Acemoglu and Robinson's insightful new book Why Nations Fail. One section in particular struck me. In one chapter of the book, they talk about why economic growth cannot be sustainable under a set of extractive political institutions. They discuss the case of Soviet Russia and emphasize how their rapid growth during the 1950s and 60s was unsustainable since it wasn't supported by economic dynamism or innovation, i.e., there were no forces of creative destruction.

They managed to achieve growth simply by reallocating a huge number of people from under-productive agriculture into industry. It was only natural that rapid growth would follow since productive resources (labour and capital) could now be used in a much more efficient way, and close to full capacity. However, when this reallocation ran out of steam (70s and 80s), a collapse was imminent.

What was surprising was that a large group of academics, policymakers and intellectuals in the West were mesmerized by this astonishing growth. In fact, many people believed in the 1960s that it was a matter of time before Russia would overtake the USA in its economic and global power. In fact, the argument was that not only do the Soviets grow faster, they manage to do that under full employment and a society based on altruism instead of individualism (and apparently better ethical values).

Sound familiar?

Now, I was aware of all of that, but this I didn't know:

"...the most widely used university textbook in economics, written by Nobel-prize winner Paul Samuelson, repeatedly predicted the coming economic dominance of the Soviet Union. In the 1961 edition, Samuelson predicted that the Soviet national income would overtake that of the United States possibly by 1984, but probably by 1997. In the 1980 edition there was little change in the analysis, though the two dates were delayed to 2002 and 2012." Acemoglu and Robinson (2012) "Why Nations Fail", pp. 128.

In fact, during the years Samuelson predicted the Soviet Union would overtake the US, Russia went bankrupt twice(!). It has returned to a system of extractive political institutions which have again been able to produce some growth and improve living standards based on rising oil and gas prices during the 2000s. But, as the West is again beginning to realize, this is unsustainable. As soon as Russia starts experiencing a twin deficit and when its growth stops being driven by booms in energy prices (as production in the rest of the world increases to meet demand), it is doomed.

However, many pundits believe that China's own "miracle" will continue indefinitely. But, as the authors of the book clearly emphasize in their final chapter, China's growth now is as unsustainable as Russia's was during the mid-20th Century.

Both are based on extractive political systems which can only achieve temporary growth via reallocation of resources, rather than technological advancements or creative destruction. As long as China’s leaders oppose political freedom and continuing with their anti-entrepreneurial agenda, censorship of the media and technological growth based on adoption rather than innovation, their growth will be unsustainable.

No matter how big the advantages of its supply chain economy or its competitive labour force, this won't be enough to prevent a gradual decline in the many decades to come. I just wonder how long it will take for more Western pundits to realize this.


Granny mugging

Nick Petford, vice-chancellor at the University of Northampton, wants to take money from law-abiding pensioners and savers in order to give it to convicted criminals. In the spirit of the times, let’s call it granny mugging.

To be precise, Prof  Petford is urging British universities to use at least £1 billion of their annual £7 billion procurement budgets by purchasing from “social enterprises” as part of a campaign called £1 Billion University Challenge whose objective is a “fairer society.” Prof Petford described social enterprises as companies where profits are reinvested in the business rather than paid out as dividends. As an example, he cited buying furniture from Goodwill Solutions which employs ex-offenders.

Clearly, to Prof Petford and many like him in the ivory tower, dividends are a bad thing, conjuring up visions of fat cats sucking on cigars while gathered round a big table covered with stacks of cash. Perhaps a better understanding of dividends is in order.

Companies are in business to make a profit. If they’re successful, they then pay tax on those profits, commit some of the balance to further investment and pay out the rest in dividends. Those dividends are earned by folks who risked their capital in the company in the first place and those folks have to declare those dividends as taxable income. What they do with what’s left can vary – re-invested in the same company, invested elsewhere where returns might be better or spent on a good night out.

Many of these folks in receipt of dividends are pensioners or savers with an eye to their retirement. They either hold a company’s shares directly, perhaps through an ISA or SIPP, or more likely through a mutual fund or through their participation in a pension scheme. Indeed, Prof Petford’s own cushy pension scheme is greatly dependent upon a lot of dividends being paid to ensure his comfortable retirement.

Now, we have no problem with social enterprises if they can provide a good product at a competitive price – that’s what a free market is all about. But Prof Petford then wants to play fast and loose with other people’s money (ie taxpayers’ and tuition fee payers’) by admitting that restricting some procurement to social enterprises would cost “a bit more” but is counting on reaping big social rewards in a couple of years.

What about the “social” rewards from profitable companies hiring lots of workers and paying lots of dividends to the nation’s grannies while producing ever better and cheaper products?

Even The Guardian has got the point about the Spanish banks

The general tenor of the screaming about the British banking system comes, of course, from the general ignorance of those doing the screaming. Apparently it's this mixture of casino banking with retail that caused all the bank falling over syndrome. That and the general greed of shareholder driven banking which must also be curbed.

Except, of course, it wasn't either of them: RBS fell apart over an expensive acquisition too far, Northern Rock didn't even have any casino banking, HBOS just lent too much into the property boom and got stuck by the bust and Lloyds gor shafted by merging with HBOS. Several mutuals fell over from the property bust too: and Lehmans didn't even have a retail arm so couldn't have been brought down by the mixture of that with casino banking.

But whatever, it's not what is true that matters it is what people believe is true which does. And there's very definitely a movement (from points Compass, nef and other idiot lefties) that what we really need is to stop having this capitalist banking at all. We should have regional, perhaps mutual perhaps state owned, banks. Run by a mixture of stakeholders and very definitely including local politicians so that the wider interests of society can be considered: not just the demands of Mammon.

Which brings us to The Guardian on the subject of the Spanish banking system:

Chairmen were often unqualified politicians, with academic investigators finding a close relationship between the size of a bank's bad loan book and the inexperience, lack of qualifications and degree of politicisation of the chairman.

Neatly illustrating one of the basic points of agreement of all of us here at the ASI. We do not say that markets are perfect. We do however say that all too often, any alternative to a market is worse.

In English terms the Spanish caja system was run on the basis that when not Mayor of London Ken might drop in to run the Bank of London. Or in an area controlled by the other lot, Boris. With perhaps Lee Jasper or Seb Coe running the audit committee. And there really has been a serious proposal that Prem Sikka, Richard Murphy and Anne Pettifor should be on the board of one or more such mooted regional banks.

We don't say that the City is perfect but Spain shows how much worse the alternatives can be.


More green jobs nonsense

As I've said here and elsewhere often enough those who preen upon how many green jobs they are creating simply do not understand the most basic point: jobs are a cost of a scheme, not a benefit. Thus the pointing at how many green jobhs are being created is really the squeals of the innumerate telling us all how expensive their schemes are. However, I've just found out that it could be considered worse than this. For here is what the US's Bureau of Labor Statistics defines as a green job:

Green jobs are either:
A. Jobs in businesses that produce goods or provide services that benefit the environment or conserve natural resources.
B. Jobs in which workers’ duties involve making their establishment’s production processes more environmentally friendly or use fewer natural resources.

What this means is that absolutely everyone who works at an oil refinery has a green job. For everyone who does work at an oil refinery is trying to "use fewer natural resources". In fact, everyone who works in anything at all of a capitalist or market nature now has a green job. For all of us are, always, attempting to reduce the resources we use in order to produce our output.

So we might in fact simply claim that the entire concept of a green job is so nonsensical that we should just abandon it. Or perhaps we shoud be cleverer about it than this?

It is indeed true that all of the 24 million private sector workers in the UK are at least attempting to reduce the inputs into whatever it is that they do. So therefore all 24 million private sector workers are in green jobs. It's the 6 million in the state sector who do not so concern themselves: which gives us the optimal path to maximal greenery. Move state workers into the private sector, where they will naturally concern themselves with economy of resources, of inputs, and we will have entirely greened the economy.

It's the sort of plan I could get behind you know.


On not giving a stuff about privacy online

I’m in today’s City AM debating about whether we can trust social networking sites with our data. My basic point is that, if we want it, they will provide it:

If people want privacy, the profit motive will give social networks a good incentive to offer it to them … Social networks have to constantly innovate and compete with each other to stay alive. If ever there was a good reason for other sites to improve security, losing users – valued for Facebook at $121 each – is it.

Against me is Big Brother Watch’s Nick Pickles, who I like very much and who has spoken at ASI events in the past. I won’t try to paraphrase his argument, but I strongly recommend reading his side too.

What I didn’t have space to discuss is my suspicion that most social networking users just don’t care about their privacy. Many might say they’re concerned about keeping their activity secret, but talk is cheap. When you look at actual user behaviour, the evidence that people really care about privacy is fairly thin.

Facebook is notorious for its difficult-to-understand privacy controls, yet it’s the most popular social network by a country mile. I couldn’t find any data about this online, but most active Twitter accounts seem to be public instead of private. When Google+ launched, it sold itself as a privacy-friendly alternative to Facebook, but has not succeeded despite massive backing and cross-product integration from Google. (As a Google fanboy, I’m a little disappointed by that!)

Diaspora, a community-built alternative to Facebook which has placed privacy protection at the centre of its mission has not attracted many users. True, the network strength of a Facebook or a Twitter mean that switching sites can be costly for users – a social network is only as valuable as its user base – but that didn’t save MySpace, Orkut or Bebo in countries where they were popular, and I strongly doubt it will save Facebook or Twitter when a genuinely superior service emerges.

Even security – not having your account hacked into – may not be very important to a lot of users. Many people still use awful passwords like, er, “password”, “123456”, “qwerty”, and so on. It’s possible that they’re just ignorant of the dangers, but given the media coverage for any large website security breach, this seems less to me than the idea that they just don’t really care if their LinkedIn account is hacked into.

Fundamentally, I see the relationship between users and social networking sites as being far more benign and positive than Nick and others who are concerned about privacy. Like when I give the bank my money for a trivial interest rate, I am effectively giving up my data in exchange for “free” services – ATM use from banks, and reasonably decent communication tools from Facebook and Twitter.

As I say in City AM, the great thing about these websites is that they’re utterly disposable. Nobody needs Twitter to lead a good life. Those social network users who want better privacy can go to the sites offering them. But, since most people don’t use social networks at all, maybe we have that divide already.


Some books to look forward to

I'm looking forward to the release of a couple of interesting books.

One is The Golden Guinea by Michael Nevin, who runs a blog with the same name.

It is a sort of Greek Tragedy in three acts, describing the roots and (inevitable) resolution of the current euro-turmoil. First, in traditional Greek Tragedy style, comes hubris. Over-optimism and cheap credit fuelled a giant bubble, drove up asset prices, and made us all feel rich. But then, of course, comes nemesis, the fall, as the boom turns into an inevitable crash. The Golden Guinea records how the consequent collapse of asset prices red to a sharp rise in bad debts, driving banks into insolvency. Nevin congratulates world leaders for acting quickly to avert complete meltdown, but accepts that quantitative easing, even lower interest rates and all those keynesian make-work measures simply poured more cash into an insolvent system. As the euro leaders are doing right now.

The third act, catharsis, could turn out tragic – but maybe not. Nevin is reluctant to leave markets to sort things out unaided, but argues for the conditions to make markets work better – sound monetary policy, more sensible banking regulation, and common sense in the international monetary system. He's like to see a new currency – the Guinea – convertible into gold, so it could not be inflated into oblivion like the paper currencies of the US, the UK and the eurozone. It's an interesting idea.

The second book, coming out mid-August, is called Shadowbosses. If I tell you the subtitle is How Government Unions Control America and Rob Taxpayers Blind, I think you might get the sense of what it's about. The authors are US businessman, professor and political activist Mallory Factor and his lawyer wife Elizabeth. I liked the review by Fox News correspondent Michelle Malkin: "Coercion, Corruption. Violence. Secrecy. Special Waivers. Backroom deals. Featherbedding. And nationwide classroom indoctrination. Welcome to America's taxpayer-funded government-employee unions."

The authors have come up with some interesting statistics that are otherwise hidden in the public accounts, like just how much US taxpayers stump up for government-sector union officials to take paid time off on union business. It's an eye-watering sum. Not only are US government-sector unions a multi-billion dollar industry, but they are also protected by a wide range of state and federal laws that give them special privileges, that force workers to join or pay for union activity whether they want to or not, and give power to the union bosses that should rightly belong with individual workers. And then there is all the political activity of these rotten boroughs...

Shadowbosses is available for pre-order on Amazon.

Rombama means more of the same

Following his victory in the Texas primary last week, Mitt Romney is now effectively the candidate for the Republican Party (putting aside the issue of unbound delegates). Therefore, we can all look forward to an Obama vs. Romney showdown this November. Unfortunately, both candidates appear to agree with each other on all issues of importance.

On foreign policy, neither are concerned about following the Constitution and getting a declaration of war from Congress. Meanwhile, neither are willing to rule out a war with Iran. So whatever the outcome of the November election, America's foreign policy will be unchanged until at least 2016.

On social issues it’s difficult to compare the two, because both are prone to changing their minds. Whilst Senator Obama appeared to be quite ‘progressive’ on the issue of drugs, President Obama has been all too willing to keep the same drug laws in place that would have led to his own incarceration had he been caught smoking marijuana or using ‘a little blow’ earlier in his life. Indeed he hasn’t even been willing to defend the rights of states to allow patients to use medical marijuana.

Meanwhile, Romney’s flip-flopping on the issue of abortion is well documented. Having been pro-choice in Massachusetts, he then became pro-life during the Republican primary. Who knows what he would actually do as President? I don’t think it’s likely that he would repeal Roe v. Wade, and if not, the differences in their rhetoric on abortion means very little.

Nor is there much disagreement when it comes to anti-terror legislation. Both support The ‘Patriot’ Act (or as Ron Paul calls it, the Repeal the Fourth Amendment Act). They also both support the National Defence Authorization Act, which effectively throws the presumption of innocence out of the window, as it allows suspects to be detained indefinitely without a trial.

Both Obama and Romney supported the TARP bailouts - the biggest single transfer of wealth from the poor to the wealthy in human history. Mitt Romney is also committed to stimulus packages and quantitative easing being used to boost economic growth and employment, which are the same policies that Obama has pursued (which have failed to create growth or employment). Neither are even paying lip service to the idea of sound money or reigning in the corrupt Federal Reserve system. In short: both are corporatists, not capitalists. This is obvious to anybody who has looked at the top contributors to both campaigns – the same investment banks and other corporate interests are funding them both. The winner of the 2012 election has already been decided: it’s Goldman Sachs. Sorry taxpayers, you lose either way.


A cheer for constitutional monarchy's restraint on government

As the Queen’s Diamond Jubilee celebrations wind down, it may be well to reflect on an aspect of public choice theory which supports constitutional monarchy — principally its rôle as a brake upon self-aggrandising politicians.

Public choice argues that, contrary to the myths propagated about the selfless motives of public servants, politicians and bureaucrats can be as self-interested in their public personas as they are as private citizens.

This is not the time to examine the unitive functions of the Crown, nor the acts of public service performed by the Royal Family — and how monarchy either refutes or conforms to the political landscape sketched out by public choice  theory (though I personally believe the opportunities for gain are very few, while the burdens are many).

Neither is this an argument for constitutional monarchy as against republican forms of government; indeed, this may be one of the few areas where both forms, when modelled on justice, are equally serviceable according to the respective country’s traditions and national character — quite in variance, by the way, with respect to economics, where all the arguments are in favour of classical liberal/Austrian theories and quite contrary to Keynesian prescriptions.

Moreover, let it be admitted that constitutional monarchy is rarely an active force in limiting the power of politicians (minority parliaments being one exception, where the Crown has legitimate avenues of intervention), but serves rather more as a passive agent in limiting the State.

First, the very hereditary nature of British constitutional monarchy — i.e., non-elective — disinclines government to aggrandise the Head of State.  Governments are reluctant to invoke public criticism for expenditures which do not in some way flatter the ‘heirs’ of democracy (especially when the House of Windsor is itself exceptionally well-endowed financially):  Witness the absence of a royal yacht when H.M.Y. Britannia was decommissioned.

Second, the constitutional role of the monarch in the Westminster parliamentary system means that the prime minister is a servant of the Crown and cannot therefore with impunity rise above his station.  It is at best to be guilty of lèse-majesté, and at worse an affront to the parliamentary party which can always be relied upon to remember that the inhabitant of No. 10 is simply primus inter pares.

The theoretical ground of this public choice defence is laid out by Austrian economist Hans-Hermann Hoppe who, while he may not necessarily be a monarchist, sees the unrestrained growth of elective governments as far more destructive of personal liberty and economic freedom.  When absolute monarchy reigned, Hoppe argues, the State and its appurtenances were held as private property, and husbanded wisely as a future inheritance; subjects were jealous of their rights and defended them tenaciously (arising from an awareness of ‘class consciousness’), leaving the Crown on guard not to exceed its authority.  Democracies, to the contrary, do not arouse a corresponding scepticism — Why, one day I too may be leader of the country! — but nor do they engender similar feelings of safeguarding wealth:  Without the responsibility of bequeathing royal estates to one’s children, politicians become mere ‘caretakers’, and the spoils of State become transitory gifts that must be enjoyed and shared with one’s cronies while the democratic gods shine (a form of present-orientedness that is reflected in citizens’ consumption rather than investment).

Arthur Seldon called this ‘the dilemma of democracy’, noting four weaknesses in popular government:  short-sighted with material resources; over-expansive with a tendency to ‘grow’; liable to conspiratorial patronage; and uncritical of majoritarian electoral decisions.

All of which leads me to wonder why classical liberals are so often enamoured of the republican ideal.  As Hoppe observes:

From the viewpoint of those who prefer less exploitation over more and who value farsightedness and individual responsibility above shortsightedness and irresponsibility, the historic transition from monarchy to democracy represents not progress but civilizational decline.

One can understand their inability to appreciate a Tory reverence for tradition and continuity, yet why do they so cavalierly dismiss the public choice arguments that demonstrate that limited government in the age of the Welfare State is held hostage to democratic fortune?

‘It is the highest impertinence and presumption, therefore, in kings and ministers, to pretend to watch over the œconomy of private people, and to restrain their expence,’ wrote Adam Smith in The Wealth of Nations.  ‘They are themselves always, and without any exception, the greatest spendthrifts in the society.  Let them look well after their own expence, and they may safely trust private people with theirs.  If their own extravagance does not ruin the state, that of their subjects never will (II.iii.36).’

Let not the irony be lost:  Britain has gone from the time when a burgeoning representative democracy set in motion the end of the divine right of kings, transformed thus into constitutional monarchy — which itself has become the most visible restraint on elected politicians who behave as if themselves graced with divine sanction.  We may no longer fear kings, but their ministers remain a threat to our rights and freedoms.  Elizabeth II embodies the limits we must impose upon the political classes; her Diamond Jubilee an occasion to remember the State is the servant of the people.  God Save the Queen!