Labour Party finances


Funny how the Labour Party's finances reflects the mess they have made of public finances::

We had – in every year bar one – spent more money than we had raised. Year on year our debts had soared to £30million.

Peter Watt 'Peter, we've spent 10 years working with Gordon and we don't like him. The more the public get to know, the less they will like him too' Daily Mail

Chaveznomics - Venezuela's inflation


It all reminds me of Britain in the 1970s. In Venezuela, facing 25% inflation, the government of retro-Marxist Hugo Chavez has had to devalue the national currency, the bolivar, by 17%. It will drop from the official rate of 2.15 to the US dollar, to 2.60. At least, that is the official rate for 'priority' imports like food and medicines, and whatever the government itself happens to want from abroad. The rate for imports of 'inessential' imports like cars, chemicals, electronics and suchlike will be 4.30 to the dollar (a 50% devaluation).

Chavez will be lucky if this move has any effect at all, of course: even these huge devaluations do not reflect how worthless his currency really is. The unofficial exchange rate for bolivars is more like six to the dollar – that is how much people think it is really worth.

Sure, there is a recession on and people aren't consuming so much oil, but it puzzles me how a country in the world's top ten for oil reserves – and where oil generates about 80% of export revenue, half the government's income, and a third of GDP – can get itself in such a pickle. Well, actually, I do know. It is the same problem that we had in the 1970s, in fact – ultra-socialism.

One might have thought that governments would learn. (Though to quote Milton Friedman, in reply to the question: 'Don't governments ever learn?' he said sagely: 'No. governments don't learn. People learn.') I worry that perhaps they do learn, and know full well that their fiscal alcoholism is a road to ruin, but cannot stop themselves because their electors always vote for higher spending and lower taxes. Does that mean democracy itself is the problem? Or a woeful lack of public education on common sense economics?

See Dr Butler's new Alternative Manifesto here.

Economic statistics are a subset of history


9. Economic statistics are a subset of history.

Economic statistics are about the past. They are not what happened; at best they are an approximation to what happened. They are about indices and arbitrary measures constructed by humans to approximate and abbreviate a totality too large to be apprehended. Sometimes the necessarily limited nature of the statistics hides important events. The Consumer Price Index, for example, only features selected items and has to be updated to reflect changing lifestyles. Even then it can miss things not included in its list.

It is possible to study economic statistics and look for correlations between what might otherwise be seen as independent variables. Regression analysis can show that certain figures rise or fall together, or in inverse ratio. Equations can be constructed which show apparent relationships between some variables, and can give reasonably good approximations to the measured outcomes that have been recorded. This describes the past, however. It is when economic statistics are used to predict the future that problems arise. Most 'rational agent' models assume that people know past prices, and can form normally distributed expectations of future prices on that basis. But the future often defies those expectations.

From a room's doorway we can look at its contents, as we look at the past, gaining a reasonably good picture of what the room looks like. Even then, though, we are choosing what to notice out of vast numbers of things we could look at. When we turn our direction and step outside from that doorway we are stepping into the unknown, and the knowledge we take of what is behind us might be of little help in examining what lies ahead. The future is by its nature unknown and unknowable. Popper observed that since we cannot know now the content of future scientific discoveries, and since they will affect our future, we can never predict that future.

The phrase 'economic science' is misleading because economics deals with material not susceptible to the scientific method. We would think little of a scientific theory that changed its predictions "because people now know more than they did," or "because people now behave differently." Yet we are often asked to accept these as explanations of why an economic prediction failed, rather than accept that the theory itself was not up to the task.

We can, of course, conjecture relationships on the basis of past data, but these are always subject to modification or rejection on the basis of new outcomes. Economics deals with real people who all differ from each other, and who have individual motivations and social habits in a way that the material of the physical sciences do not. It has to deal with people whose behaviour changes in response to unpredictable events. The further that economic theory is removed from this world of motivated human beings, the less is it likely to tell us anything about the real world future their actions will bring about.

This is part of Dr Pirie's ongoing series: Philosophical Observations on Economics.

An icy situation


The UK government is none too pleased with Iceland’s recent antics. As has been well documented, the country’s President Olafur Grimsson has refused to sign the Bill detailing a payment schedule of £3.4bn owed to Britain and the Netherlands due to the collapse of Icesave. Instead, he has put it to a referendum. While Iceland’s political elite are keen to repay the money owed, the public are not so obliging. Firstly, they feel their money should not be used to cover the failings of a private bank, and many are fuming at our government’s use of anti-terrorist legislation to freeze UK assets. The terms of the bill are also causing anger: representing over 40% of Iceland’s GDP, the money must be paid over 14 years at an interest rate of 5.5%.

Putting aside the rights and wrongs of this case, it is heartening to see the President recognizing that this debt will be paid for out of the pockets and hard work of the Icelandic people. Standing at a debt of over £10,000 per person this is a large sum for current and future generations to be saddled with; and as such the public has been given a chance to voice their opinion. As Mr Grimsson explained on Newsnight: “The difference between the British and Icelandic constitution is that in Britain parliament is sovereign. In Iceland, it is the nation and the will of the people that is sovereign." Considering the way in which vast sums of taxpayer’s money has been thrown about on the say-so of an over-powerful executive, Iceland’s respect for the decision making ability of its people is in comparison refreshing.

Sadly, our government is (perhaps understandably) more interested in getting its hands on a few billion than taking lessons in democracy. Even though the proposed referendum is entirely constitutional by Icelandic law, the country is threatened with international isolation and having its chances of joining the EU dashed. Then again, perhaps for a country that values the sovereignty of its people this is no bad thing.

Panmure House


The development and restoration of Panmure House – Adam Smith's home in Edinburgh – has been the subject of long drawn out discussions between the Edinburgh Business School (its new owners), Historic Scotland, and the Edinburgh City Council planners.

Everyone is keen that this historic house should be accessible to the public as a venue for public meetings, concerts, seminars and other events. But it is obvious that the building's footprint is not large enough to accommodate both the meeting rooms and the services (staircase, toilets, lifts, kitchens) that a modern venue requires. Edinburgh Business School's architect solved this problem by creating a glass atrium housing an external staircase. It is a brilliant solution. It provides the necessary access in a stylish way that does not violate the house, nor require some ghastly solid extension, and indeed which keeps the main elevation visible and allows it to be attractively lit.

Historic Scotland have objected to pretty much all proposals for an external stair. It would be a shame if Edinburgh's planning committee, which meets next week, takes its cue from them and rejects the proposal. Panmure House will survive only if it has a viable function. Without that, it becomes a useless hulk that nobody will care for, and which will decay. I am sure that Historic Scotland does not want that. And given the sorry state that past public-sector owners have left it in – the only remaining original feature is one fireplace in the attic – the Edinburgh Business School's sympathetic restoration plans are definitely a welcome improvement. Let's not allow Adam Smith's home to decay and be forgotten as it has been over the last half century.

Schools surpluses


Despite government plans to teach children ‘money management’ lessons from the age of five, thousands of schools that have effectively controlled their finances are facing unpleasant repercussions. The Department for Children, Schools, and Families has released the expenditure of our schools and seeks to ‘name and shame’ those that have amassed significant surpluses. Headteachers of such schools have been warned that they should return ‘extra’ money to their local authorities, and might well be forced to do so under law.

This is an absurd idea: punishing schools for prudence and careful budgeting will simply lead to a further degeneration in the quality of the country’s education. Most schools control spending and generate surpluses in order to invest in large projects or improved facilities, such as a new science lab. Compelling schools to spend their entire budget each year creates little incentive to take a long-term view to investment for either the school or its pupils. By frittering away money for the sake of it, this creates an even greater waste of taxpayer’s money.

While we rightly don't like the idea of schools hoarding public money for the wrong reasons, the best way to combat this (and solve many other problems) would be through educational reform. With vouchers Parents should be free to send their children to the school of their choice, with the money following the child. In this way, schools which appear to stockpile funds yet make scant improvements would see themselves very short on pupils and money.

Climate change or poverty?


In The Australian today Alan Oxley, chairman of the US based NGO World Growth, outlines why he thinks the Copenhagen climate summit failed. For him the core reason is due to the presence of severe poverty in developing countries.

In the article, the leading American climate change economist William Nordhaus from Yale is cited as saying: “if developing countries cut emissions too sharply and too soon as advocated by Greenpeace, WWF and the European Union, they would further impoverish their people". This makes commitments to emission cuts contradictory to the political interests of politicians in developing countries, since immediate poverty clearly should overrule any real or perceived climate change. Perhaps a rather rosy view of democratic accountability in action, but it might just be true.

Mr. Oxley’s point is to “fight poverty first then tackle emissions". However, do we really need to tackle emissions at all? Emissions comes from the use of fossil and organic fuels, therefore the most efficient way of decreasing the use of those would be to find a more cost efficient way of producing energy. Making innovation affordable instead of taxing it would certainly help the governments to reach their political goals of decreasing the use of oil and coal.

Regarding the fight against poverty, the solution advocated for by environmental activists of increasing developing aid is simply unsustainable. Instead, breaking down trade barriers and government subsidies to agriculture and industry would be by far the most effective and sustainable way of fighting poverty.It is not the whole solution, but it is the best place to start.

Inflation and unemployment


8. Inflation and unemployment are not inversely related

Over half a century ago William Phillips argued that inflation and unemployment were inversely related. Put simply, the higher the rate of inflation, the lower the rate of unemployment would be. The 'Phillips Curve,' taken up by economic writers including Paul Samuelson and Robert Solow (both of whom later repudiated it), became the basis for government policy. Governments thought that they could reduce unemployment by allowing a higher rate of inflation.

In the 1970s this apparent relationship broke down, and very high rates of inflation coincided with very high rates of unemployment – a condition called 'stagflation.' The Phillips curve went vertical, with increased inflation having no effect on unemployment. Although some proponents of interventionism have tried to save the Phillips theory by introducing notions such as 'rational expectations,' many economists now recognize that the inverse relationship is only short term. In the longer term expectations change, and many economists suppose that only brief temporary changes can be made to the long-term non-accelerating inflation rate of unemployment (NAIRU). Some still try, however, to incorporate both short- and long-term effects into "expectations-augmented Phillips Curve" models.

When governments and their central banks inflate, the extra money and easy credit enter the economy at specific places, not spread evenly throughout it. The credit affects asset prices differentially. The money and credit send false signals which lead to over-investment in some types of producer goods. In the short term this does indeed mop up some of the unemployment, giving the illusion of an inverse relationship. People grow accustomed to expecting the inflation, however, and change their behaviour accordingly. When the extra spending stops, the long-term 'natural' rate of unemployment reasserts itself. The lesson is that governments cannot "spend their way out of a recession," soaking up the unemployment it features by means of huge public sector programmes, or by huge monetary stimulus (the fallacy offers a false rationale to both). These only distorts the economy and builds in future unemployment when economic reality reasserts itself. Nor can governments 'smooth' the business cycle by using high public spending to cushion against (and if possible prevent) cyclical downturns. Governments might enjoy more success if they devoted their energies not to preventing economic downturns, but to mitigating their social consequences, and in helping people to deal with them.

This is part of Dr Pirie's ongoing series: Philosophical Observations on Economics.

Blame Bush

Dan Mitchell makes a good point over at Cato@Liberty, as he attacks Karl Rove’s “hypocritical call for fiscal rectitude":

I’m a big fan of condemning Obama’s big-government schemes, but Rove is the last person in the world who should be complaining about too much wasteful spending. After all, he was the top adviser to President Bush and the federal budget exploded during Bush’s eight years, climbing from $1.8 trillion to more than $3.5 trillion. More specifically, Rove was a leading proponent of the proposals that dramatically expanded the size and scope of the federal government, including the no-bureaucrat-left-behind education bill, the two corrupt farm bills, the two pork-filled transportation bills, and the grossly irresponsible new Medicare entitlement program.

Similarly, in this opinion piece on Sphere Dan makes clear that since the fiscal year does not coincide with the political year, Obama actually inherited a far larger budget deficit than Republicans like to admit. This graph pretty much sums it up:

I don’t cite these articles in defence of President Obama, whose overriding objective seems to be the growth of the state. Rather, my point is that the problem is not Republicans or Democrats, but big government. And that argument applies just as much to our political parties as it does to those of the United States.

Gilts – Losing their lustre?


In the light of the unprecedented banking crisis, it is hardly surprising that UK gilt yields have remained quite low as investors have sought security in government-backed stocks. However, demand for gilts looks likely to change, a very worrying development given the Government’s horrendous borrowing requirement - £178 billion in this year alone. For 2010/11, a similar net borrowing figure has been projected.

To date, funding the Government’s borrowing has been surprisingly easy: much of this year’s enormous £225 billion gilt issuance programme has been undertaken successfully. The key to this success has been the Bank of England’s £200 billion Quantitative Easing programme, which seems sure to end shortly. Moreover, tighter capital rules have persuaded leading banks to buy more gilt-edged stock. Gilt yields, though, continue to fluctuate, with the 10-year 2019 benchmark stock currently yielding 4.1%.

With many major economies running formidable deficits, the UK may find it increasingly difficult to find buyers for its massive gilt-edged issuance. The recent decision of Pimco, the world’s leading bond house, to reduce its exposure to UK gilts and US government bonds is hardly reassuring.

If demand for gilts falls steeply, yields will rise. For 2010/11, the Government has projected a gross debt interest cost of almost £43 billion. This vast figure may prove to be an under-estimate. Indeed, if the outcome of this year’s General Election is a hung Parliament, the UK’s sovereign debt may be downgraded by the credit rating agencies – this would raise borrowing costs still further.

For the next Government, cutting the enormous public sector net borrowing deficit is paramount: substantial cuts in public expenditure are vital to achieve this aim. But political considerations are preventing the implementation of this policy – at least for the moment.

The current deficit is certainly unsustainable. But will the markets suddenly take fright and make it unfinanceable?