Regulators should make the punishments fit the crimes

Since 2010 Ofgem has fined energy companies £191M and imposed redress payments of £255M.  Redress payments are “made by companies either directly to consumers or to programmes and funds which would benefit them.” Fines are a form of taxation, i.e. paid to HM Treasury. Ofcom fined BT £32M and the Environment Agency’s prosecution for sewage pollution cost Thames Water £20M;

Biggest by far was the multi-billion fines on the big UK banks, by the UK, US, Hong Kong and Swiss authorities, for Libor rigging, money laundering, assisting tax evasion, sanctions busting, failing to keep proper accounts and mis-selling.  The directors of said banks, their auditors and the Bank of England were, we are told, unaware of the malpractice under their noses.  Amazing.

HBOS director Peter Cummings was fined £500,000 in 2012 and banned for life but he is an exception. Generally speaking, bank directors, auditors and the Bank of England emerge Scot free.  Companies, being legal persons, pay the penalties but this is fantasy. Companies do nothing wrong.  It is their directors, employees and auditors who do what they should not do, and cover them up.

Compounding the absurdity, those responsible who do lose their jobs receive pay-offs (cash bonuses, shares and, usually, pensions benefits) as if they were innocent parties being made redundant.  Their contractual terms, we are told, over-ride any culpability.  Sacking the seven seniors at HBOS, including Mr Cummings, cost the company, namely the taxpayers, nearly £1M. The Finance Director, Mike Ellis, arguably the most culpable, became Chairman of the Skipton Building Society Act two years later albeit at half his former salary.  Nine years later the financial regulators have woken up and are making threatening noises but it is too late to fine anyone.

Tesco is a classic case: the company inflated its profits by £326M in the year to August 2014.  The CEO, Phil Clarke, was sacked on contractual redundancy terms (18 months’ salary +) in July 2014 for declining profit forecasts.  He knew nothing about the false accounting and, as CEO, how could he?  The Serious Fraud Office fined Tesco £129M and are bringing criminal prosecutions against three other former directors, Chris Bush, Karl Rogberg and John Scouler, but not the Nelsonian Mr Clarke.  Note that the company is being fined, not the perpetrators who may well, given the SFO’s track record, get off. 

Regulators sometimes acknowledge the unfairness of the clearly innocent shareholders and customers ultimately bearing the cost of these fines.  But if they do not pick up the final tab and nor do the the directors and employees, who does?

Fining companies is a useful form of income for HM Treasury but it is really grandstanding.  Perhaps it damages reputation but it is debatable how much harm it does to companies like Thames Water and BT whose reputations are hardly lily-white anyway.  And fines which do not hurt those culpable are no deterrent. Sending my speeding fines to some distant person is not going to stop me speeding.

Regulators should stop fining companies and start penalising those individuals responsible for the malpractice and those who should have published the malpractice but failed to do so – typically the auditors and sometimes the regulators themselves, notably the late and unlamented Financial Standards Authority whose ability not to see the facts drawn to its attention is legendary.  Punishment should fit the crime. The courts have already established that directors can be personally liable and not hide behind the corporate veil – see.  However the law in this area is a bit of a mess.  It would be sensible for government, perhaps with a Statutory Instrument if Parliament is not bothered, to require regulators and the courts to fine individuals and to ensure they are not compensated by their employers or insurance.  Claiming not to know what they should have known should be no defence just as ignorance of the law is no defence.  Personal liability should mean personal liability just as it does for speeding fines.  And financial malpractice that goes unpublished for two years or more should result in personal fines levied on the senior auditors and even the regulators themselves.  Obviously regulators will not fine themselves bu the courts can and should.

As a starting point, I suggest that the fines are borne 50/50 by Chairman and CEO unless they can publish who the real culprits are.  This is akin to ministerial responsibility: Lord Carrington stepped down as Foreign Secretary even though he had no idea his diplomats were inciting Argentina to invade the Falklands.  High rewards should be justified by high risks.

Regulations are only going to work if everyone knows any punishment will fit the crime.

We're fascinated by this definition of success

As we all know little snippets of information get bandied about in the public conversation and then take on the aura of incontrovertible facts. George Osborne, in a political speech, claims that raising the minimum wage does not cause job losses. That is taken to be true by all too many, when the actual official report accompanying the speech insists that the latest rise will cause 60,000 job losses.

"See, Osborne said it" is not what we would take to be a great standard of proof but it's enough for some people, sadly.

What really interests us here though is what people will take as the standard of success. To take an example from this morning's papers, Laurie Penny tells us that gender quotas in organisations make those organisations better:

Plenty of people do, according to another study, this time from the London School of Economics. It showed that companies with a strict 50-50 gender quota performed far better, partly because it meant men were expected to work harder to prove themselves – and fewer mediocre men ended up in positions of power. 

Well, no, that's not what the study shows actually. It's about gender quotas inside a political party:

Our study provides a unique window on quotas and, at the same time, pushes forward the measurement of competence in political selection. It uses the fact that, in 1993, Sweden’s Social Democratic party voluntarily introduced a strict gender quota for its candidates. 

We wouldn't insist upon it but we'd be willing to wager that political parties work a little differently from organisations where output can be measured in detail.

However, we will admit that their measure of competence is interesting. By looking at the wages of candidates (adjusted for experience, job, education etc) they show that insisting upon 50/50 quotas raises the general level of candidate. The assumption is that someone earning over the odds in the private (well, they include public sector workers as being "private" here but still) sector is likely to be more competent than someone not.

Hmm, OK. But let's go back to some measure of the actual output of the organisation. We seem to have evidence of the quality of the inputs increasing. But what of the quality of the output? 

Well, the year after this change marked the peak of the vote for the Social Democratic Party in the national parliament elections. It's fallen from the 45% achieved in 1994 to 31% at the last election. We're deeply unsure that that is a useful measure of an increase in the performance of the organisation. The point of political parties being, we're really quite sure of this, to gain and exercise power.

No, we most certainly do not claim causality here but we do still think this is a useful example of how these stories don't get the examination they probably need. The claim being made is that gender quotas make companies more efficient, the proof being offered is that a political party with gender quotas loses 33% of its vote. The more detailed look tells us that inputs seem to have increased in quality while output has decreased.

These stories do need a little more examination, a touch more investigation into what is success, don't they?  

The Campaign for Tariff Disarmament

With all the Brexit talk of trade deals and tariffs, an idea occurred to me. Rather like the CND (the Campaign for Nuclear Disarmament) I'd like to see the CTD - the Campaign for Tariff Disarmament, where all nations unilaterally agree to abolish all tariffs globally in a 5 year timeframe (for administrative reasons) whereby tariffs are reduced at 20% a year for the next 5 years, resulting in zero tariffs worldwide, and every nation and its citizens being better off as a result!

To see why this would be a good idea, we need to remind ourselves why tariffs are a bad idea. The golden rule about all economic inefficiencies — be they minimum wage laws, rent controls, tariffs, or any regulation of that kind, is that politicians get away with selling the bad policy as popular because the benefits are quite easy for everyone in the country to see, while the costs (that far outweigh the benefits) are more difficult to see because those costs are spread more widely and thinly throughout the nation as a whole.

To illustrate this, suppose there is an ageing firm in the UK called Steve's Steel that employs 3,000 people in Yorkshire. Understanding how the gains and losses of tariffs are distributed is key to understanding the problem with tariffs. The obvious benefits of lumping a tax on foreign competitors are felt by all the workers at Steve's Steel. The cost of saving those jobs, however, is distributed more thinly through the economy, which means as far as voters go, they see a tangible benefit to 3,000 of their fellow country folk and perceive no real cost to themselves. 

Moreover, since the workers and families have every incentive to lobby the government to save their jobs, and the rest of the population have little or no incentive to lobby the government to not subsidise Steve's Steel, there is more of an incentive for the government to listen to those connected to Steve's Steel.

But, alas, while you can see the losses connected to Steve's Steel quite easily, what you don't see quite so easily are the losses that occur around the rest of the country by subsidising Steve's Steel – the numerous other workers that lose their jobs for every one job saved at Steve's Steel – you never get to see all those who lost their jobs because the tariffs were enacted. 

Equally you never see all the reduced consumer income that Brits have due to these tariffs, via the increased prices they pay, nor the lost job opportunities by not having that money to spend elsewhere. You also never see that a British import tariff against, say, Chinese imports would mean the price of the yuan measured in pounds falls, making Chinese goods more expensive to Brits and British goods more expensive to the Chinese.

The upshot is, if you stifle foreign competition directly, you stifle domestic industries too, because somewhere down the line in the complex nexus of global trade, your fellow country folk are the competition. Therefore, even if it’s highly unlikely to ever happen, the reality is, if only we and all our trading partners could sign up to a multilateral agreement to discontinue tariffs over the next five years, it would be a collective agreement that would make pretty much everyone involved better off.

The museum to markets – The Museum of Failures

As regular readers will note around here we tend to like markets. On the grounds that they generally - except where they don't - work. But it's important to understand what it is that markets generally work at and that's not success, not at all. Markets work well because they work well at failure.

Which is why we're rather tickled by this new Museum of Failure.

LEARNING IS THE ONLY WAY TO TURN FAILURE INTO SUCCESS

That's their tagline and we'd quibble a bit with it even though we agree with the general idea. Rather, as we'd put it, you can only succeed if you work out what's failing. Some of the ideas, like that Coke Blak, could have, might have, succeeded. They didn't. Others it's a bit more mysterious why they didn't succeed:

Bic For Her pens are also on display. The supposedly female-friendly pink and purple pens launched to widespread derision and mockery in 2012. "I mean, you know that women can't use regular pens. You need special pens for their delicate hands," West said. "And they're double the price of regular pens because they're specially for women." 

Quite why that didn't work is unknown, pink razors do cost more than blue as we're so often told they do. The important part of it though is this:

West told The Local.: 'You can fail at any point during the process. It's better to have a lot of cheap mistakes early in the process, than to do so on a large scale. Then it costs billions.'

That's why market systems work better than planned ones. What it is possible to do, what people want to have done, is an ever moving feast. The technology with which we can do things is always changing and so are personal tastes. We want thus some method of sorting through what can be done and what people want to have done. And the finest way yet discovered of doing this is for every lunatic to try. We, the rest of us, will then sort through what is available and decide upon which of these possible things that can be done add utility to our lives.

Imagine wandering into GOSPLAN one day to explain that we need an overlay to the telecoms network so that people can swap cat pictures with each other. Mr. Zuckerberg would have been laughed out of the room and yet 2 billion people later that experiment he cooked up in a dorm room seems to add utility to some number of lives.

And thus the glory of that Museum of Failure, it's a museum to why markets work. Precisely and exactly because so many innovations get absolutely nowhere - that's how we find out which ones we want.

Haven't these people ever heard of the price system?

Well, yes, they have, but they've not absorbed the point of it:

Big-name stores including Selfridges and Harrods are being lined up to sell the range in the UK, but WWF wants to make this a global project. It is determined to prove to the fashion industry that it is possible to design and produce clothes with zero impact on the environment.

“It’s hugely challenging,” says Alfredo Orobio, founder of the online community AwaytoMars that is working with WWF. “Everything from the buttons, zippers, labels, tags and packaging to the fabric and production process itself – all of it has to be sustainable.”

Ah, yes, sustainable. Let's use fewer resources so that we walk more lightly upon this Earth. 

Sure, why not? That's just another name for economic efficiency after all. If we use fewer resources to make one thing then we've resources left over to make another one. Or one of something different. Sure we want to be sparing in our use of resources.

We've even a method to work this out in a market economy. A higher production price will mean that we're calling on more resources to make whatever it is, a lower one fewer.

We do of course think this is amusing about fashion. Clothing is a little different, yes, because why not wear the same clothes for decades? Possibly even wash them occasionally. But the entire point of fashion is that it is a signalling exercise, that one is hip, with it and moving with the seasons and styles. Making something which is fashionable and also lasts for decades seems to us to be violating the basic social purpose of fashion itself.

But the real problem is here:

One of the key barriers to consumer take-up is that the expense involved in turning every part of the life cycle of a garment green means the cost of sustainable clothing is out of the reach of most. Current prices at AwayToMars, for example, range from £50 for a T-shirt to £390 for a wool jacket. Cridland’s signature 30-year jacket costs £190 while a T-shirt is £35.

They're missing that lesson of the price system, aren't they? If it is vastly more expensive to do this in a "sustainable" manner then by definition they must be calling upon more resources to make these "sustainable" clothes. 

As anyone who has ever met any of us knows we're not really up with this fashion thing anyway but we do wonder about the idea of using more resources in order to claim to be using fewer.

Riddle us this if you would, riddle us this

Rather like those rains on the plains in Spain, the floods in Australia have led to certain crops being destroyed. Thus there will be a little gap in the variety of diet there for a time. At which point serious thinkers turn their minds to what might be done to lessen this problem at times or points in the future. All well and good but what worries us is how anyone can then make the following two insistences:

Key features of a resilient food system are likely to include:

geographic diversity in production, which spreads the risk of crop damage from extreme weather events across a number of different production areas;

more local food production, to reduce transportation and storage costs and avoid over-reliance on particular regions;

What?

How can we both concentrate food production right by where we are ourselves and also insist upon supply from widely dispersed geographic areas? That second we do agree is the crux of the matter. If, say, the world contains 50 (just an invented number) weather zones, we get 1/50th of our food from each one, then extreme weather in any one zone can only threaten 1/50th of our food supply. That's great.

But that's also entirely inconsistent that we should be growing more of our food within walking distance of wherever our boots happen to be.

And no, it's no good saying eat local except when the crops fail at which point we'll buy in. If we're not regularly buying in then that production system further away won't have the capacity, will it? That security of the system depends upon us sending some of our local food off to them, they sending some of their local grown to us, all the time.

This burble was the product of no less than four academics. At which point we've got to wonder what's happening in academia. The answer being akin to religion. Everyone knows that local food production is a good idea. Therefore, even when the very point being made is that reliance upon it is a bad idea the incantation still has to be made. It's akin to the medieval philosopher proving with unadorned logic that God does not exist and ending with an All Praise the Lord comment. Local food must be good so even though we've just proven that reliance upon local food kills when the floods come we must still praise local food.

Jon Platt should sue the state for kidnapping

The Daily Mail’s campaign to ‘end rip-off holiday charges’ is another example of the lunacy you get into when you allow government to do things that it has no business doing. 

The fuss stems from the Supreme Court’s finding against a parent, Jon Platt, who took his daughter on a family holiday to Disney World during term time. The Platt family argued that holiday packages became unaffordably expensive to them during school holiday periods. The state argued that removing a child during term time damaged their education, and that the law required children to be in school. The Supreme Court, which rules on points of law, agreed and found against Mr Platt.

School leaders hailed this as a victory, arguing that 20,000 parents do much the same each year, which is disrupting children’s education.

The point remains, however, that holidays taken in the Easter, Christmas and Summer breaks are very much more expensive than those taken in term time. And of course, transport links and tourist centres are much more crowded at these times. The populist Daily Mail criticises this as ‘ripping off’ parents who (now) have no choice about when to take their children on holiday, and are calling for stern regulations on ‘exploitation’ by travel agencies.

They can’t really believe this nonsense, though, can they? Holiday are much more expensive during school breaks because the demand then is much higher. As Adam Smith pointed out as long ago as 1776 (and he wasn’t the first). By now it should be, well, kind of obvious.

Interestingly, private schools help their parents get round the problem by having different holiday periods—typically starting a week before the state schools. So all those rich parents that Labour Leader Jeremy Corbyn wants to slap a 20% tax on can jet off to the Canaries a little cheaper than the rest of us. So what is it about the state system?

Ah, that’s just it. The words ‘state system’ speak silent volumes. State systems are notoriously uniform (which is why the nation’s school holidays all start and finish within days of each other). And they are notoriously run in the interests of the producers rather than their customers (which is why those education leaders are so delighted that parents have now been put in their place).

Educators in a wholly private school system would be taking parents’ wishes into consideration, rather than taking parents to court. Exactly how is a matter for the market rather than me. They might stagger their holidays at different times, or arrange for catch-up teaching for children who’ve been off for a week or two, or provide videos or an app to allow children (and parents) to keep up with what they’re missing, or any of 101 other methods. But then in a wholly private system, the way schools teach would probably have been revolutionised anyway. (Today’s private schools just have to be a bit better than the state’s. Faced with real competition, they’d have to be a lot better.)

So there you have it. The Establishment feeds the very populism that it decries. Populists want the state to intervene in the holiday market because parents are forced by law to commit their children to penal servitude in monolithic school system dictated by the opinions of ‘experts’, not the needs of customers.

If I were Jon Platt (assuming he has any money left after going through the other state monopoly that is the legal system), frankly I’d now be suing the government for kidnapping. It’s time to set our children, and their parents, free.

The curse of the cross subsidy

John Cochrane's wrote an interesting piece on what he calls "the second original sin of healthcare regulation" (the first being the tax deductibility of employer provided group insurance of course). His post describes what's fundamentally broken about the US healthcare system, but his observation applies to far more than just healthcare.

Our political system is allergic to the word "tax." Instead of straightforwardly raising taxes in a non-distortionary way (a VAT, say), and providing charity care or subsidies -- on budget, please, where we can see it -- our political system prefers to fund things by forcing cross subsidies.

Medicare and medicaid don't pay what the service costs, because we don't want to admit just how expensive that service is. So, large hospitals make up the difference by overcharging you and me instead. The poster child (though not really a cost driver) is emergency room care. The government passed a law saying hospitals must provide emergency room care for free. But money does not grow on trees, so again you and me (via private insurance) must get overcharged to cross-subsidize. The ACA tried to force young healthy wealthy (not getting subsidies) to vastly overpay for insurance, to cross subsidize the poorer and sicker.

Cochrane argues that this is much more harmful than simply raising the money through taxes and doling it out through the state.

Low prices, efficiency, and innovation in the provision of services like health care come centrally from competition, and especially disruptive competition.  With no competition -- especially no entry by new doctors, hospitals, clinics, insurance companies -- costs spiral up. As  costs spiral up, the cost of the charity care spirals up. As that spirals up, the size of the cross-subsidies spirals up. As that spirals up, the need to restrict competition spirals up.

In a sensible world, government assistance lives beside a free market, where innovation and price discovery happen. That keeps the cost of government assistance somewhat in check. But when we choose assistance by cross-subsidy, then kill off competition and force us all in the regulated system, that check disappears.

The UK obviously doesn't have this problem with healthcare, but the problem of cross-subsidy still creeps up in a number of markets. 

"Affordable Housing" mandates are a classic example. In the absence of real planning reform there'll be a shortage of housing within the price range of ordinary Britons. Policymakers looking for a second best solution have a choice. Either leave the market alone and offer cash subsidies to those who struggle to afford a home, or require house builders to not only build what the market is demanding, but also to sell a percentage of the houses they build at "affordable" (below market value) rates. The latter option is clearly sub-optimal, it's essentially a specific tax on new construction and makes construction much riskier for developers raising barriers to entry. Affordable housing requirements are meant to make housing more affordable but by penalising new development they make the shortage worse for all.

Another example is the energy market. Prof. Stephen Littlechild (who served as a top energy regulator in the 80s) has set out in great detail how over the past 10 years Ofgem undermined competition in the energy market. Energy companies used to offer low prices online and in competitors' areas to encourage consumers to switch supplier. Ofgem decided that firms should instead offer the same price to everyone. The price sensitive consumers who frequently switch were to subsidise the lazier consumers. But just like in the case of healthcare, the results were much worse than simply taxing one group and giving it to another. Not only did prices rise for price sensitive consumers, but prices didn't fall for the rest. The number of people switching suppliers fell and the market became much less competitive. 

Rather than a lesson being learned, this was followed by calls for even greater cross-subsidisation. The consumer affairs magazine Which? then called for energy companies to provide a simple, uniform price. That would have required massive geographic cross-subsidisation but thankfully Ofgem rejected the proposal. The coast isn't clear however with Theresa May seriously considering capping the difference between the 'cheapest and 'most expensive' tariff.

Taxes do affect behaviour and discourage productive activities, but the solution isn't to cook the books and shift taxes off the balance sheet. Doing so only makes things worse. It distorts prices and damages competition. Worse of all, it leads to even deeper calls for regulation when the existing rules fail to deliver. Subsidies are bad, but cross-subsidies are worse.

Adam Smith Songs!

 By the end of 2017, my band will release an album inspired entirely by the works of Adam Smith. Spanning eight songs and covering both Theory of Moral Sentiments and The Wealth of Nations, the album will highlight the beautiful prose and infinite wisdom found in Smith’s writing.

The eight songs are not meant to be a comprehensive summary of Smith’s two books, but rather a mosaic of Smith’s wisdom. I see them as eight of the most illustrative concepts he uses to explain human nature and political economy.

The inspiration came about when I attended a gathering of singer-songwriters in New York. As an economics graduate student, I stood out amongst the crowd that otherwise featured people doing creative work as their day jobs. I was in an Adam Smith reading group at the time, loving his writing style and description of the world around him, and realized there was a niche to be filled by writing music based on the works of the classical economist.

Early on in the process of writing the songs, I came to see how biographical and relatable the themes were. Within Smith’s concept of the Impartial Spectator, we can all relate to the desire to “not only be loved, but to be lovely.” Smith describes a poor man’s son yearning for the luxury and ease of having riches, only to regret his efforts on his death bed: Every one of us has at one time or another overestimated what accomplishments and riches will do for our happiness.

Overall, I hope the album will inspire people to learn more about Smith and his rich, nuanced, and wise view of human nature and economics. Too often, he is depicted as an extreme free-marketeer that sees human beings as being governed purely by a cold self-interest. This caricature overlooks his significant descriptions of market failures and the central role of sympathy in his view of human nature, among other things. If “Hamilton” could inspire everyday people to learn more about a centuries-old American thinker, so can these eight songs.

Our first single featured here is called “Silent Revolution,” inspired by Book 3, chapters 2-4 of Wealth of Nations. Smith describes how the introduction of commerce, through no intention or foresight of any parties involved, allowed for the gradual liberation of the masses away from feudalism. Interdependence replaced dependence, prosperity ensued, and power became more decentralized.

You can listen to the song here.

 

Nicky Morgan in Brexit fake news shocker

We are warned these days that we must be most careful about fake news. Indeed, that we must vigilantly fight back against the purveyors of it. What is meant is that anyone who states that Donald Trump might have a point must be mercilessly mocked and banished from public life, but the actual effect of taking the injunction seriously is that we will all end up exposing the usual political falsehoods.

Yea, even from former Cabinet Ministers. Such as this from Nicky Morgan:

Its consequences would be very dangerous: this would be an extremely perilous economic path. Leaving the EU with no deal means Britain would default to World Trade Organisation rules with our biggest trading partner. The resulting tariffs on imports and exports would raise prices for British consumers buying imported goods,

The problem with this is that reversion to WTO rules doesn't mean that Britain must impose import tariffs. That's fake news. If Ms Morgan knows that it is untrue then she's being economical with the actualite. If she doesn't know then she's remarkably ill informed on the subject she wishes to pontificate about.

This isn't unusual, Nick Clegg has been wandering around spreading the same fake news.

WTO terms means that there is a maximum tariff schedule that other people can charge against our exports. There's also a maximum that we're allowed to impose upon imports into the UK. But it is a maximum. We are entirely at liberty to impose any rate we like below those various maximums as long as the same product from different sources is equally treated. That includes imposing rates of 0%.

We did in fact go and check this at the source, the WTO itself in Geneva. We can move, as Patrick Minford has been saying we should, to unilateral free trade under WTO rules. There is absolutely no insistence whatsoever that we should or must impost import tariffs.

To claim that Britain must impose import tariffs is incorrect, it is not true, it is fake news. Yea even though we're told we must by an ex-Cabinet Minister who should know better.

A little offer to Ms. Morgan. If she'd care to tell us whether she's being economical or merely ill informed we will publish the answer she gives us.