Much of what we're told about inequality is in fact wrong

At least, much of what we're told about inequality is wrong if we go off and have a look at revealed preferences that is. Here's what is now, on the left side of the political aisle, what is generally accepted as a truism about inequality:

Inequality matters because people evaluate their economic well-being relative to others, not in absolute terms.

And it's true that if you go look at some of the experiments done on this point then there's evidence to support the idea. Ask college undergraduates (they are used because they are extremely cheap and in high supply in the sort of environments that economists inhabit) whether they would prefer $50k a year while everyone else gets $25k, or $100k while everyone else gets $200k, then the preponderance is for the lower absolute but higher relative amount. We can also think of reasons why this might be so: higher status for a male does get more babes.

However, this is also based on what people say. And it's one of those truisms of economics, known as "revealed preferences", that you shouldn't take at face value what people say. Instead, look at what they actually do.

And with this relative and absolute stuff about income we've got a very large data set: immigrants. And we see the big immigration flows as being people from poor countries coming to rich ones. So that's certainly people being concerned about aboslute incomes. But there's more than that. The immigrants from those poor countries tend not to be the poorest of those countries. It's not the landless Bangladeshi day labourer that turns up in Bradford. They simply haven't the basic economic resources to manage the move for a start. Rather, it's people some way up off the bottom of those poor societies that become the immigrants into the rich countries. Where they, at least to begin with, start off right at the bottom of the income and even social stratifications.

So what we do actually see, out in the real world, is tens of millions of people a year willing to reduce their relative wealth, their wealth or income with respect to the societies they live in, in return for a higher absolute standard of wealth and or income. 

All of which is rather at odds with those experiments about the stated preferences of American college students. And as revealed preferences tells us, when we're considering evidence about what people say they would like and the actions we can see that they actually take, then it's the evidence about people do, not what they say, which should be given the greater weight.

All of which makes the importance given to relative wealth or income very much less important than some currently claim it is. Not that I think it has no importance: but that plain and simple fact that people do, voluntarily, move to lower relative incomes but higher absolute ones means that we cannot, just cannot, insist that only relative incomes are what we use to make decisions or measurements. The claim fails because it simply isn't true.

Shouldn't we be more like Germany?

One of the standard tropes of British politics is that we are continually told that we should be more like Germany. It's pretty much a centre left idea, running that gamut from the Heseltines to the Huttons. Big government, big corporations and big unions will work together to plan and manage the economy. With a great deal of necessary guidance from the Heseltines and Huttons of course. It's a form of corporatism and perhaps the closest we actually came to it in the UK was under Wilson and Heath. But let us put that aside and consider what Germany actually did under that very system back over the past decade or so.

Around 2000 it was clear that Germany was becoming the "sick man of Europe". Labour costs were far too high for the productivity of that labour force. So what did this consensual management of the economy prescribe? That labour costs should fall. That's a pretty good answer to the problem of high labour costs of course. So, over the next decade pay rises for German labour were deliberately limited. By all sides: unions and companies and government. And the system worked. German labour costs fell with respect to productivity and German industry was saved. It didn't hurt that half the eurozone had rising labour costs at the same time but there was indeed this particular, and successful, plan to reduce the wages the workers were getting. Just hold on to that thought: this consensual and corporatist management of the economy decreed that labour costs must fall and then implemented the plan to produce that outcome.

Which brings us to the UK economy today:

The TUC said that between 2007 and 2011 real wages fell by 4.5pc in the UK, higher than in countries such as Italy and Japan, while in Australia and Canada there were increases of 6.9pc and 5.4pc respectively. Most of the decline was in 2011 - the coalition Government's first full year in office, the research found. The TUC said the Government's austerity programme had made the squeeze on living standards even tighter by cutting tax credits and welfare support for low and middle-income families. TUC general secretary Frances O'Grady said: "While most countries have suffered periods of negative wage growth, no-one has witnessed such a marked decline as the UK. "This Government's blind obedience to self-defeating austerity has ensured that we are leading the way when it comes to the squeeze on living standards.

The British problem was indeed that wages were too high as compared with productivity. Real wages thus needed to fall: or at least, wages as compared to the value of output did. This has been achieved: it's one of the reasons the unemployment numbers are not vastly higher. As in Germany, instead of higher wages for those who remain in employment, we've seen real wages stutter or fall while unemployment has not skyrocketed as many predicted it would.

Which brings us to the point about how we cannot be like Germany. We've achieved the same result, lowering labour costs, but we've had to do it by a different method. For as you can see, the TUC, that voice of Big Labour, is complaining bitterly about that very outcome. The German unions agreed that wages should be limited: it is not possible to conceive of a polity in which the British unions would similarly agree. Thus that sort of corporatism, that sort of managerialist approach, to the UK economy simply will not work in the UK. For one of the necessary components just won't support the necessary actions.

Please do note: this is not to support the German style. Nor is it to support the Heseltine/Hutton axis that insists we'd all be better off if the Heseltine/Hutton axis determined things. It's simply to point out that even if it were desirable that we be ruled that way, it simply wouldn't work here. We simply cannot be more like Germany because we don't have German unions.

How to privatize RBS

With Mervyn King saying yesterday that we ought to get on with re-privatising RBS, the issue becomes how to do it.

As we discovered in the 1980s privatisations, you have to take out all the bad and unsaleable bits of a business before people will buy it. For example, the highly-risky nuclear element had to be taken out of the electricity sale. Likewise we need to pull out ABN-Amro. And to set up a 'bad bank' and put into it all the toxic business of RBS, and for that matter, Lloyds TSB too. That would free up lending and crystallize or segregate the banks' zombie obligations. It takes a bit of time to root everything out, but there is plenty of international expertise around to help.

Should RBS and Lloyds RSB be split into retail and investment arms? After the Vickers Report this idea is wearing the yellow jersey, but retail banks are not inherently safer than mixed ones, as Northern Rock and others showed. It is also hard to define the retail/investment boundaries. A split like this would just slow the process down.

While we are setting up the bad bank, it seems sensible to split the banks so as to promote competition and reduce systemic risk. Lloyds TSB could be split into Lloyds, Halifax and BoS. RBS could be split into NatWest and RBS, or into smaller pieces. That again would take time, and would mean re-engineering some back-office systems (most of which, in RBS's case, are hopelessly outdated anyway), but it gets rid of the 'too big to fail' problem.

How then to privatise? We could just give out shares to taxpayers, since they were the ones who stumped up for the bailout. But nearly everyone is a taxpayer, paying VAT and other indirect taxes, and it would be controversial to give out more shares to people earning enough to pay more tax than others. So what about giving out shares to everyone? Well, the mess of Russia's 'voucher privatisation' suggests that is a bad idea. People just sell their shares on right away, probably for too little money, and conventional owners step in.

But share giveaways raise no money on what should be a valuable asset. So a better route is to sell the banks and then distribute the proceeds to everyone. A staged sale would help to maximise the returns, and people would get several cheques, not just one. Perhaps some of the proceeds could be returned to the public and some could be put to paying off the national debt.

A broad privatisation is preferable, as selling to another bank just re-concentrates risk. Of course, it might be possible to sell to a completely different outside player – an Asian bank, for example – but people are nervous about foreign ownership.

And a popular privatisation bonanza just before the 2015 election could give Osborne and Cameron quite a boost – which I am sure enters their calculations.

The budget we need

This is a waste of breath, because there is no Plan B and no Plan A+ (and therefore no prospects of the Conservatives being part of the next UK government), but here goes.

The policy of letting public spending drift slowly upwards, hoping it will be outpaced by growth, is shot. There is no growth. Our trading customers (mainly US and EU) are floundering, and domestic investors, businesses and customers are in lock-down, waiting to see what happens.

The Bank of England tries to cheer things with rock-bottom interest rates and money-printing, to no avail. Vince Cable wants us to go into debt to build roads. Another hopeless cause.

When you have had a long cheap-credit boom as we have, you must expect a long recession as resources are reshuffled back to where they ought to be. We have to liquidate all those boom-time investments that are simply unsustainable in normal times. But we haven't had much of a recession. The authorities are trying to re-stoke the boom. We need to let the market do its job of reallocating assets to better uses.

Regulation deadens the market. We need radical pruning. Why not take small firms out of employment regulation completely: make them more confident to hire and expand.

Tax kills economic activity too. We need a corporate tax rate lower than Ireland's and to scrap capital gains taxes, which just lock people into outdated investments. We need to move swiftly to take everyone on minimum wage out of income tax entirely, to encourage people off benefits and into work.

To balance the short-term loss of tax revenue, we need expenditure savings. But not salami-slicing. We should focus on what the state really needs to do and cut out whole programmes and departments (like Vince Cable's Business Department) that nobody would miss.

And we need to let the private sector into everywhere that it is excluded: into education, infrastructure, healthcare, public and local services, and much else. Stand out of the light, and watch the economy grow.

The mediocrity of chasing the middle ground

The economy is stagnant, government spending continues to rise, and we’ve lost our AAA rating. With the recent rejection of boundary reforms, and the UKIP-led humiliation at Eastleigh, it’s no surprise that some Conservative backbenchers are grumbling.

Cameron is adamant that he will not “lurch to the right” in response. His focus remains on the centre. After all, the median voter theorem tells us that majority rule voting will select the outcome most preferred by the median voter. But is success as simple as chasing the middle ground?

Firstly, the median voter theorem only works along one-dimension, 'Left' v 'Right'. This is hopelessly simplistic as the public’s views vary across issues. When we vote, we are limited to choosing a party package and we each have different priorities within those packages.

Secondly, it relies on there only being two parties, and assumes that those at the extremes will vote on side. Yet there are at least three significant parties.By some estimates UKIP cost the Conservatives a number of key marginal seats at the last election too. The winner of the 2010 election was actually ‘none of the above’ – more people avoided the ballot box altogether than voted Conservative.

Thirdly, the theorem assumes that preferences are ‘single-peaked’. Instead it’s possible to have different views on the same issue depending on the scenario. For example, one might in theory oppose paying for state schools. Yet, after being taxed for education, one might then prefer to pay a bit more voluntarily to get better state schools and thus avoid the additional cost of going private.

Finally, chasing the median voter has limited grounding in the public good. Public Choice theory teaches us that politicians and voters are liable to government failure. Some will act selfishly, voting to promote their wellbeing at the expense of the masses. Excessive focus on the centre also guarantees that principles are left behind in the wake of the latest opinion polls. U-turns can turn off past loyalists. Many who did support the Conservatives now lack enthusiasm, and the Government is generally criticised for its chameleonic approach.

Yes, the Conservatives had lost three elections in a row, and were ‘toxic’. Yes, there are votes to be won in the centre, and policies should be presented in terms that resonate with the public. However, votes may also be won by pursuing radical policies, by building enthusiasm amongst core voters, by reengaging non-voters and even by turning 'right'. One shouldn't just focus on the middle ground, there are many votes to be won elsewhere.

Having never won a General Election, Cameron might consider his predecessors. Margaret Thatcher was radical, faced an entrenched socialist status quo and was more ‘right-wing’. She delivered three electoral majorities, enthused her core vote, won over many ‘working class Tories’ and left a legacy that shaped the political world.

James was a founder of the Liberty League, who are hosting the upcoming Freedom Forum.

Ideas matter

What do you think of when picturing an ‘innovator’? I would hazard a guess that the skinny, t-shirted frame of a computer developer forces his way into mind. He is likely in the middle of developing a new app or website, and is keen to end his summons before your mind’s eye to get on with typing inscrutable code and eating pop tarts.

This is a shame. Not the interruption of our computer nerd - who we’ll leave alone now - but the fact that innovation has become such an internet and computer centred phenomenon. It is also, however, no coincidence. The ‘techy’ sectors have enjoyed huge advances in recent years in no small part because of the relative lack of regulation and red tape they’ve faced.

This has kept start-up costs low, compliance with legislation cheap, and product development swift. The economic benefits of this business freedom have been extraordinary. In 2010 the UK internet economy contributed £121bn to GDP, in 2016 this is set to be £225bn. This is a remarkable 86% growth in 6 years. According to McKinsey in 2011 2.6 jobs were created for every (mainly high-street) job lost. It is no surprise that London’s ‘Silicon Roundabout’ has grown in notoriety in recent years. We would do well to follow the advice of Dominique Lazanski’s recent ASI paper to keep the stellar growth going.

Other sectors have not been so lucky – over the decades industries like pharmaceuticals and food production, which once saw equally impressive innovation, have been overwhelmed by creeping legislative burdens. The rise of the grisly ‘ealf and safety brigade, backed by big business eager to block new entrants, has gradually put a stop to the leaping advances. The regulatory obstacles are so great now that aspirin would not be passed by the FDA (it would be red flagged because it risks causing gastrointenstinal bleeding). Similarly, rising levels of regulation contributed to the end of so-called ‘green revolution’ in food production between the 1940s and 70s, which hugely increased yields and lowered prices.

The risk of failing to comply with standards discourages businesses from engaging in the kind of innovation that can lead to radical break-throughs. It is safer to opt for more mundane improvements safe in the knowledge that they will be allowed to make it to the market-place.

I can hear the hard-hatted inspectors and boardrooms bursting to object. ‘This regulation is designed specifically for the benefit of consumers, they clamour; in its absence people would be exposed to improperly tested, and therefore potentially lethal medicines and foods. ‘Are you in favour of sacrificing human lives at the altar of innovation?’ they ask.

I can think of two replies to this. First, in the developing world millions die of starvation and disease; if more rapid advances were allowed many more lives would be saved than lost. Second, as our President Dr. Madsen Pirie argued so persuasively on the Daily Politics, the expectation of progress and improvement is an important component of a society’s well-being. Increased optimism about the development of new life-saving medicines and lower food prices would be a welcome addition to looking forward to the new iPad.

A bonfire of regulation would attract the best innovative minds from around the world and reignite economic growth and job creation in Britain. Exit double dip recession, enter double digit levels of growth. Who knows, we might even discover another drug as effective as aspirin. 

The truth is, we have no idea how much money bankers deserve

The daffodils are out and the annual uproar at bankers' bonuses is upon us. The EU’s bonus cap is a well-timed, predictably silly play to the gallery, but we shouldn't assume that our own banking rules are much more sensible.

Any rules about what private firms pay their employees are, of course, absurd. Aside from the base illiberalism of interfering in people’s privacy, there is the practical problem that a cap on pay would drive bankers abroad. Imagine if there was a cap on footballers’ pay – within a year, the Swiss Premier League would be world class.

A cap on bonuses will also make financial firms more sensitive to downturns in business. The purpose of bonuses is to give firms flexibility in how much they pay, so that they can pay employees much less in bad years than they would in good years without having to sack people.

In a free market, the problem of bonuses encouraging short-term profit maximisation at the cost of long-term sustainability would not be an issue – the firms that pursued that strategy would go out of business soon enough. The problem is that any large firm that acts badly like this is protected from its mistakes by things like deposit insurance and bailouts.

The other problem is that the government has already bailed out quite a few banks, and those banks also want to pay bonuses to their employees. On the one hand, this is perfectly sensible – it’s crucial that we have competent executives in government-owned banks to minimise the loss of value to taxpayers.

On the other hand, aren’t we against extravagant public sector pay? The big problem with the public sector is that, internally, it lacks the price signals that make markets work relatively efficiently. It’s true that the public sector can mimic market prices to an extent, but only very crudely. RBS can borrow money at a significant discount because of the implied promise of government backing. (All banks operate under the promise of an implied government bailout, and explicit deposit insurance.) Without a functioning price system, there’s no way of telling how much RBS’s CEO deserves.

The reality is that nobody really knows how much to pay RBS’s executives. Mimicking the private sector isn’t enough – without private shareholders to answer to and a genuine threat of loss, RBS’s bonuses are no more wiser spent than Bury council’s iPads for its binmen.

Yes, a cap on bonuses is a dumb idea. But so is any state involvement in the banking sector. If the government’s going to fight against the latest example of EU overreach, it would do well to get its own house in order as well.

How Patent Trolls Kill Innovation

Just when you've beaten back one set of nonsense along comes another ignorant

Long term readers will recall that for some years now I've been saying that we've not really got a gender pay gap. We've a motherhood pay gap, that we do, but not a gender one. In this I am supported by all sorts of interesting evidence. Like this from the Telegraph, this from this here blog, and even this quite delightful piece. Where the Statistics Authority chief rapped Harriet Harman over the knuckles for misleading people with bad statistics. You know, the crime of being a politician.

Now, the proof that we do not have a gender pay gap comes in the details of the (correct) statistics. Single no children women in their 40s earn more than their male age cohort. Women in their 20s on average make more than men in their 20s. There is indeed a pay gap though: one that opens up in the average pay for women as they enter their prime child rearing years. And we can even see that it really is child bearing years as well. A generation ago average age at first birth was in the low 20s. And that's where the pay gap started. Today it's around 30 years old and that's where the pay gap starts now.

And between all of us we've managed to get this basic fact across to the political classes. Shared parental leave might not be everyone's cup of tea but it is indeed an admission that since it is childcare that causes the pay gap then perhaps parents might want to share that pain? All of which is lovely. Then enters Viviane Reding:

16.2%: that’s the size of the gender pay gap, or the average difference between women and men’s hourly earnings across the EU, according to the latest figures released today by the European Commission. The news comes ahead of the 2013 European Equal Pay Day on 28 February. The EU-wide event marks the extra number of days that women would need to work to match the amount earned by men: currently 59 days, meaning this year the day falls on 28 February.

Sigh. As we know domestically in Britain the pay gap is not a gender pay gap. It's a motherhood/child rearing one. Which, even assuming that you wanted to solve it means rather different policies to do so, no?

To make matters worse they also peg the UK pay gap as being at 19.6%. Which as we know from the Statistics Authority chief isn't actually the correct number at all.

This is the problem with multiple levels of government. You beat back ignorance and idiocy at one level and it just reappears at another.

One way to know that you're doing the right thing

Is to look at peoples' reactions to what you're doing. If, for example, you decided that you wanted to clean up the MPs' expenses system and every MP then started howling about how we mere ignorant citizenry aren't supposed to control them then we'd know that we were on the right track. Similarly, if every criminal in the country (to the extent that this is a different group from MPs) starts to complain about the length of sentences after just and righteous trials then you would at least begin to suspect that you might have created sentences which have a deterrent effect.

And when you're doing supply side reforms to the economy if you start to hear loud wailing from those suppliers being reformed then you've got a pretty good indication that you are achieving your goal. As with this letter to the Telegraph: 

As doctors and health-care workers, we are concerned about the Government’s proposed secondary legislation (under Section 75 of the Health and Social Care Act) to force virtually every part of the English NHS to be opened up to the private sector to bid for its contracts. These regulations were proposed on February 13 and will become law on April 1 unless MPs first insist on a debate and then vote them down. Parliament does not normally debate or vote on this type of regulation, but it is possible. We urge parliamentarians to force a debate and vote on this issue to prevent another nail in the coffin of a publicly provided NHS free from the motive of corporate profit.

There then follows 1,000 or so signatures. Which is, as I say, a signal that something is going right. The aim and point of the NHS reforms is indeed to introduce a market. Competition among suppliers that is. The reason for doing this is that in the absence of competition the producer interest will dominate, not that of the consumer. This is why we insist upon more than one electricity supplier in the economy, welcome that there are many sources of food (whether trivially in shops or more importantly from many different farmers and producers), sell off four licenses for mobile telephony at a time, not just one.

We desire to have this competition because it stops that producer interest from ossifying and then taking over the entire system. Very much to the detriment of the consumer who is the person we're actually concerned with.

As a result we've got those producers howling about how just ghastly it is that people will be able to compete with them. Screaming about how undignified it is that such august personages might have to consider what consumers want rather than what producers might deign to provide.

Great eh? It's working!