Young Writer on Liberty 2012/13

This year we ask students to submit three essays for the ‘Young Writer on Liberty’ competition on the theme:

Three policy steps to a freer, better world

The title of each article is entirely up to you.

1st Prize:
£500 cash prize
3 articles published on www.old.adamsmith.org
3 books on the subject of liberty
2 weeks work experience at the ASI

2 Runners up:
2 articles published on www.old.adamsmith.org
A collection of Adam Smith Institute books

Entrants must be 20 or under on the closing date, the 1st February 2013. All articles must be under 400 words. All entries and questions should be submitted to pete@old.adamsmith.org. Good luck!

Inflation for the rich

Sheldon Richman, sadly no longer the editor of The Freeman, has an intriguing piece for the American Conservative this month. In "How the Rich Rule", he points the finger at the nexus of the state-protected financial industry and the state-run central bank:

In short, financial intervention on behalf of well-heeled, well-connected groups begets recessions, depressions, and long-term unemployment, which in turn beget vulnerable working and middle classes who, ignorant of economics, are willing to accept more powerful government, which begets more intervention on behalf of the wealthy, and so on—a vicious circle indeed.

Worst of all is inflation, a massive transfer of wealth from the poor to the rich:

Government debt makes inflation of the money supply an attractive policy for the state and its central bank—not to mention major parts of the financial system. In the United States, the Treasury borrows money by selling interest-bearing bonds. When the Federal Reserve System wants to expand the money supply to, say, juice the economy, it buys those bonds from banks and security dealers with money created out of thin air. Now the Fed is the bondholder, but by law it must remit most of the interest to the Treasury, thus giving the government a virtually interest-free loan. With its interest costs reduced in this way, the government is in a position to borrow and spend still more money—on militarism and war, for example—and the process can begin again. (These days the Fed has a new role as central allocator of credit to specific firms and industries, as well.)

Meanwhile the banking system has the newly created money, and therein lies another way in which the well-off gain advantage at the expense of the rest of us. Money inflation under the right conditions produces price inflation, as banks pyramid loans on top of fiat reserves. (This can be offset, as it largely is today, if the Fed pays banks to keep the new money in their interest-bearing Fed accounts rather than lending it out.) ...

Price inflation, of course, is notorious for favoring debtors over creditors because loans are repaid in money with less purchasing power. This at first benefits lower income people as well as other debtors, at least until credit card interest rates rise. But big businesses are also big borrowers—especially in this day of highly leveraged activities—so they too benefit in this way from inflation. Though banks as creditors lose out in this respect, big banks more than make up for it by selling government securities at a premium and by pyramiding loans on top of security dealers’ deposits.

When people realize their purchasing power is falling because of the implicit inflation tax, they will want to undertake strategies to preserve their wealth. Who’s in a better position to hire consultants to guide them through esoteric strategies, the wealthy or people of modest means?

Read the whole piece. It's a provocative and worthy reframing of the traditional Austrian story about inflation causing business cycles. I'm becoming increasingly frustrated by macro-level focuses on deficits and the like; they may be important, but only because they end up having an impact on individuals' lives on a 'micro' level.

Matt Zwolinski on Social Justice

Ending employer pension plans

Last week’s autumn statement was further proof that Britain’s pension arrangements are out of date, grossly inefficient and far too complicated. The system benefits politicians, bureaucrats and the pensions industry to the detriment of savers, pensioners and employers. It’s time to sever the link between employment and pension provision.

To refresh your memory, the Autumn statement called for further reductions in annual contribution limits and in the total lifetime limit. Like Lucy in the Peanuts comic strip who pulls away the football just as Charlie Brown is about to kick it, so the government moves the goalposts. No wonder the vast majority of people can’t be bothered to save for their retirement – they know their hard-earned nest egg won’t be all it’s cracked up to be.

Yet again, the politicians couldn’t help mucking about with rules and regulations - it’s in their DNA to endlessly tinker and tweak. Bureaucrats have justified their existence by dreaming up new wrinkles that now need to be ironed out. And the pensions industry? Well, more complexity, more changes and more confusion can only mean more fees.

Way back when pensions were first created, the world of work was pretty straight-forward – you signed up with Metal Bashers Ltd., slogged away for them for the next few decades and then collected a pension for a couple of years before you dropped dead. It made some crude sense for the employer to be the officially designated pension provider.

That world is long gone – companies come and go while employees switch jobs far more often and work for far longer. Increased life expectancy will only heighten those trends as the modern world rewards flexibility, mobility and nimbleness.

Much of this well known but here’s one aspect that isn’t – the insidious effect of employer-provided pensions on companies themselves. At a recent seminar of pension trustees, the chairman of trustees for one of the UK’s biggest retailers detailed the impact of the current system on that company and its scheme. Here’s just a sampling of the issues:

• The scheme still has a now-closed defined benefits section with some 1,300 active members, 4,000 deferred members (not retired but working somewhere else and with pension assets left behind) and 3,900 pensioners. Its new defined contribution section has nearly 2,000 actives and 2,100 deferreds. That’s a lot of people (about 13,300) to keep track of – the majority of which are long gone. And it’s just going to get bigger as auto-enrolment kicks in.
• Among many other things, the company and trustees are now planning for the new auto-enrolment rules, mulling closing the DB scheme to future accrual or even buying out all the DB liabilities, restructuring the DC scheme and, of course, struggling to deal with the under-funded DB scheme. No shortage of consultant fees there.
• The chairman of the scheme last year attended five normal full-day trustee meetings, one ½ day meeting, three conference calls, nine special meetings on the DC scheme, two meetings with advisers, two with fund managers and another 20 conferences, seminars, etc to keep abreast of developments. Who’s minding the shop?
• Then there’s the endless stream of either ill-informed or simply confused current and former employees seeking advice, guidance and information as they transfer in, transfer out, quit, retire, take leave, work abroad, marry, divorce, move from full-time to part-time and back again. The company is like a harried parent working fulltime but also charged with the well-being of its children except that it has over 13,000 of them and thousands more due imminently.

The old joke used to describe General Motors as a large pension scheme with a subsidiary that made cars. Some companies may be able to cope but many others certainly can’t. If a company is very good at making state-of-the-art widgets, there’s nothing to suggest its expertise extends to administering the government’s welfare system. (General Motors proved itself a failure at both.)

So here’s the big idea: cut employers right out of the pensions business altogether in favour of a simplified universal savings scheme – a giant ISA, if you will. It would need some mandatory minimum contribution levels from both employers and employees with some restrictions on applying those savings to ensure adequate pension provision when the time comes.

The result would greatly increase transparency for savers because they will know exactly how much they’ve got. That same transparency will limit the scope for skullduggery by politicians, bureaucrats and pension professionals because any changes will immediately pop up in savers’ retirement accounts as a bigger or smaller number.

And, for companies, this is probably the biggest opportunity to reduce the regulatory burden that everyone claims they’re in favour of.

Steve Keen's Debunking Economics

Anti-Dismal, that outpost of economic rationality down under, points out that Steve Keen's rubbishing of standard microeconomics in "Debunking Economics" doesn't actually pass the test, that quite important test, of being correct. My own view is that even if the critique is correct it doesn't actually matter.

Now I'm about to do a little violence to Keen's point but this is as I understand it. That standard perfectly competitive market, where producers are price takers, depends in the end on the idea that there are an infinite number of producers. For that's the only way that the production of one producer doesn't change market prices: thus, in our absence of an infinite number of anything at all the theory fails its first test. It's actually impossible - thus we cannot have competitive markets and everything is really some mixture of monopolistic and oligopolistic markets. Leave aside whether this is true or not. Our question really is does it matter if it is? At which point I'll offer some anecdata and then an analogy.

I'm intending to do a little mining over the next couple of years. Two men and a dog sort of stuff, not going to shake the world's commodity markets. One product would be one of the rare earths: we'd be producing some 20% of current global supplies. Keen's point about producers is that their own production influences the prices they face, thus they'renotprice takers. And for this project for this metal this is obviously true. We've actually assumed in our calculations that our production will halve the world price of this metal. So far so Keen. Another metal to be produced, we'd be 0.2% of global production. OK, yes, agreed, in the strict model this will indeed change global prices, this additional supply. But it would be pretty silly of us to worry about that in our projections. What happens to the Chinese demand for machine tool steel will be a much more important influence on price than our production. We're assuming that we're price takers. The final metal will produce more like 0.01% of global production of that one. At which point it would be absurd for us to even consider how that is likely to change prices. Which way the war is going in Congo will have more influence than we will.

So even if Keen's actually correct in hismathematics it doesn't actually matter. For we do pretty rapidly get to a number of producers in a market where they are price takers. Where they act as if they're in a perfectly competitive market even if the maths doesn't add up. And as we're trying to describe the real world, not perfect our mathematical models, the critique of standard micro rather falls apart at this point.

As to the analogy, one way of looking at calculus is that curves are really made up of lots of very short straight lines. By making this assumption we're able to do all sorts of useful things. But the assumption is wrong: that doesn't make calculus not useful. We can do things like sending rockets to the Moon by using this known to be wrong assumption. And so it is with standard microeconomics: even if that original mathematical assumption is incorrect it still describes our actual world better than the alternatives. For just as curves are not lots of straight lines, but it's useful to think that way, so, sure, we don't have an infinite number of producers. But we do have a very large number of markets where everyone acts like there are an infinite number so the assumption is a useful one to make when trying to work out what people are going to do.

Eppur si muove

Tuesday evening offered the entertainment of seeing a well watered (but not, I insist, inebriated) think tank wonk dancing in the street  shouting "Eureka!", "Eppur si muove", "it works!" and similar. The reason for this display of entirely unedifying proof that white middle aged men indeed cannot dance was that there was a window cleaner cleaining the windows of the pub.

Yes, yes, I know, Worstall's finally lost his rocker and fallen off the plot. But note the most important word above: evening.

The window cleaner turned up to do the pub's windows at 10.30 at night. And your corresponding think tank wonk asked why: "Congestion charge innit. Used to cost me a fortune so now I do my round at night". And thus is one of the Adam Smith Institute's long running campaigns vindicated.

For decades now the ASI has been saying that the way to deal with congestion is to price it. This changes incentives, changed incentives change behaviour and thus charging will reduce congestion. It was Ken Livingston who actually brought the Congestion Charge in, not quite the exact method we would have chosen, but it is at least a start, a proof of the basic concept of road pricing.

For as our window cleaner has explained, that very charge has moved his cleaning rounds from commuting type times, when the roads are crowded, to non-commuting times, when they are not. Which is the point and purpose of the whole thing.

At which point, "Eureka!", "Eppur si muove" and similar.

BTW, if you happen to have windows in central London in need of a regular cleaning drop me an email and I'll pass on Ted Johnson's number to you. Least I can do for one providing the empirical proof of a nice theory.

Out-innovate the state

Even in the face of high taxes, borrowing and debt, the history of modernity gives us every reason to be optimistic. Economic growth and the rise in living standards since around 1780 has been immense. In Britain, not even accounting for improvements in the quality and choice of consumer products, the average person is 1500% wealthier than their ancestor in 1780. Crucially, this progress has been the result of sustained innovation, increasing the productivity of existing processes and products, and displacing the markets for old goods with newer and better substitutes in a process of creative destruction. Perhaps more importantly however, innovation is also able to displace government provision and restriction of certain goods.

As I pointed out yesterday, innovation trumps all. It was able to make Britain one of the most prosperous nations even despite its high taxes and protectionist mercantilism back in 1780. Even on a theoretical level, the unlimited powers of human ingenuity and imagination will always be able to find a way around existing physical circumstances. Right now, it continues to undermine existing policies, forcing progressive change, with the effects of the internet still being felt.

For example, massive online communities like Fitocracy provide the incentives to exercise and keep fit. As they grow in popularity and effectiveness, they may undermine the case for government anti-obesity interventions. Similarly, sites like Amazon and eBay have their own internal arbitration and regulation mechanisms for when things go wrong, reducing the role for external governmental regulators. Even education, which has experienced little in the way of productivity increases for centuries, can now be disseminated via free online courses like memrise to people across the world, without the need for expensive state grants to both universities and students.

Even in extreme circumstances, innovation is able to markedly increase living standards while undermining coercive monopolies. For example across Africa, the diffusion of mobile phones has allowed money to be transmitted directly to the intended recipients, circumventing corrupt officials and local elites who were otherwise able to confiscate physical cash as it changed hands or traveled.

Apart from the effects of the internet, emerging technologies like additive manufacturing (3D-printing) promise to totally undermine patenting and copyrighting of physical objects. As it becomes cheaper, the need for production lines will become increasingly irrelevant, allowing producers in the home and in business to create products that are the exact likenesses of otherwise costly brands. Perhaps design will experience the same constant creative destruction as in the fashion industry, where only trademarks are protected. Ingenuity has even been able to circumvent bans on research, for example with recent breakthroughs in extracting stem cells from blood reopening potential avenues for future life-saving medical innovations.

The exciting list of innovations is endless, and should give libertarians and others hope for the future. But we need to keep defending creative destruction from those who favour envy and redistribution, as well as acting upon our words. While there is a role for rhetoric, proving the effectiveness of market exchange and innovation by being the entrepreneur is also vital. Thankfully, some have been urging this revolution onwards. Douglas Carswell's new book, The End of Politics and Birth of iDemocracy, for example, reads as a manifesto for citizens freeing themselves of state-imposed hierarchy through sheer ingenuity. So long as our capacity for progress is celebrated, then we will be able to out-innovate the state.

Remember innovation

For the first time in decades, Britain's economic growth is stagnant. With a predicted -0.1% for 2012, Treasury forecasts for the years ahead look wildly optimistic. Yet the Chancellor's tinkering around the edges is unlikely to achieve much. The problem is that the debate over achieving higher economic growth totally ignores its causes. It forgets the important distinction between what the Nobel Laureates Kenneth Arrow and Robert Lucas Jnr. describe as "level effects" and "growth effects".

Level effects are one-off shifts that cause some economic growth by reshuffling resources to their most valued uses. For example, pushing for free trade and the division of labour are only likely to get you so far. They allow resources to be reallocated towards more valuable uses, but they don't substantially alter the trajectory of economic growth. Adam Smith, David Ricardo and Thomas Malthus, all champions of the gains to trade, recognised this. They thought that after tearing down domestic and foreign barriers to trade, that growth would eventually plateau to a stagnant, "stationary state". 17th Century Holland would be a pretty good approximation of where they expected the pinnacle of economic progress to be.

Advanced as it was for the age, 17th Century Holland doesn't remotely compare to today. Fortunately for us, growth effects can put us on a trajectory of sustained economic growth, with innovation as the crucial factor. What Smith, Ricardo and Malthus didn't see coming was the Industrial Revolution: not steam and chimney stacks, but a wave of sustained innovation in all industries. In a nutshell, modernity began. Britain became the envy of the world not only for its ability to invent, but its remarkable capacity for adopting others' inventions and making them work. An instructive contrast is between France and Britain. France poured significant government funding into trying to make industrialisation work, and had lower taxes and lower external trade barriers too. Yet Britain had the comparative advantage in innovation, trumping all. It undermined taxing governments, guilds and aristocracies in the 1770s, and endured 1970s socialism too.

If Britain really wants sustained economic growth, it needs to radically improve the conditions for innovation. But this requires a cultural change as well as government allowing it to take place. The eminent economist and historian Deirdre McCloskey describes this as the dignity and liberty for innovation: a willingness to embrace and celebrate the creative destruction of new products and processes supplanting the old. Modernity was born when Britain went from condemning Shakespeare's Shylock in the Merchant of Venice, to honouring James Watt with a statue in Westminster Abbey. But we are in danger of falling back into the ancient distaste for commerce and innovation. As Allister Heath rightly pointed out in his address to the ASI Christmas Party, we must combat the emerging politics of envy and redistribution, and embrace the optimistic impulse of innovation.

The Autumn statement shows that economic stagnation is here to stay

One thing became clear today: economic stagnation is here to stay. There is no growth and no prospect of growth without a change of course that focuses on deregulation and targeted tax cuts. There is no trade-off between growth and deficit reduction. You can’t have one without the other.

The key is to go for private sector growth. Government regulation is smothering small and medium-sized businesses, and today’s rate relief announcement is not enough to help them. Employers' National Insurance is a tax on jobs and prevents the creation of over 500,000 jobs by small and medium businesses. It should be scrapped. The best way to stimulate the economy is to give small businesses a break.

The highlight of today’s budget is the rise in the tax-free personal allowance, which the Adam Smith Institute has long called for. It should be raised to the minimum wage level so that the poorest earners pay no tax at all. Scrapping of the fuel duty hike is a good thing, but we should not be too impressed at a Chancellor deciding not to raise taxes – we need cuts to regressive consumption taxes.

The government and media have focused on trivial changes in spending like the £5bn newly allocated to capital projects. Meanwhile, the state is borrowing that amount every two weeks – or another £331 million every day.

Deeper cuts to public spending are clearly needed to cut the deficit, but these are not possible without a fundamental shift away from socialistic monoliths like the NHS. The only way real cuts to expenditure can be made is by shifting to more efficient, market-based models of social insurance for healthcare and welfare. The claim that we can make substantial savings by ‘trimming waste’ is a lie – and we’re fast learning what a dangerous one it has been.

Minimum wages: examining the research

The Economist's Free Exchange column recently analyzed some of the existing research on minimum wages. They point out to a number of results that claim how moderate minimum wages do more harm than good for the economy, and can, in fact, have a net positive impact on total employment.

The argument from the left of the political and economic spectrum usually claims that employers tend to sometimes act as monopsonists and can set wages below a competitive rate. In addition minimum wages are supposed to solve the problem of wage inequality and increase the disposable income of lower paid workers. The Economist calls upon the results on two "noted labour economists", David Card and Alan Krueger, who accounted an increase of employment in New Jersey's fast-food restaurants to its newly legislated minimum wage. They used a DD (differences-in-differences) approach comparing total employment in February 1992 and in November 1992, so in two different points in time between which the (supposedly) only difference is the introduction of the minimum wage (in April 1992).

However, it is easy to dispute this type of research by referring to the omitted variable bias where the net employment effect was most likely affected by a factor that has nothing to do with the minimum wage law. Perhaps it was the general economic climate in the state during the observed period, or within-state differences that can explain the effect of employment increases at the given time in New Jersey. It's very hard and demanding to conclude of a causal relationship between a minimum wage law and employment, at least without taking into consideration a series of control measures. In addition there is a whole bunch of papers that can overrule the argument empirically and give it a completely different direction. This happens too often in the economics profession.

Something that empiricists often omit is the general effect a minimum wage could produce. Here’s a good point from a book by Jason Brennan: "Libertarianism, what everyone needs to know",

If Wal-Mart started to pay high wages, Wal-Mart jobs would become attractive to skilled workers. People who currently work as medical assistants or car mechanics would want Wal-Mart jobs. Since they are more productive and have more skills - since their labor is worth more - they will outcompete the kind of people who currently work at Wal-Mart. So, raising wages above market levels is unlikely to help unskilled workers. Instead, it causes job gentrification. (Imagine if Wal-Mart offered to pay its workers $100/hr. Then many of my colleagues would consider becoming Wal-Mart cashiers). (HT: Bryan Caplan)

This I fear is the problem. Even if an increase of the minimum wage could have a positive net effect on employment, as some research seems to show, the problem is re-specialization of people with higher skills for currently low-paying and low-skilled jobs.

It's interesting that the research by Card and Krueger (1993) actually did look at fast food restaurants. Increasing the minimum wage made this easily accessible job more attractive than the alternative of investing into gaining more skills or finding another, more demanding job.

The result is a reshuffling of the labour market towards certain types of jobs, rendering some higher paying jobs a lack of skilful employees, while the net effect for lower-skilled workers is negative. It would be interesting to observe the total effect on all industries during the observed periods, not just on one, favourable industry, to prove the employment effect of minimum wages.

In Britain, there are similar results:

"Britain’s experience offers another set of insights. The country’s national minimum wage was introduced at 46% of the median wage, slightly higher than America’s. A lower floor applied to young people. Both are adjusted annually on the advice of the Low Pay Commission. Before the law took effect, worries about potential damage to employment were widespread. Yet today the consensus is that Britain’s minimum wage has done little or no harm."

It is very difficult to conclude this based on the available evidence. Since the introduction of the minimum wage in 1999 Britain's economy experienced a boom decade which saw an upsurge of productivity and declining unemployment, but also an increase in labour costs and real wages. It is very hard to conclude that the minimum wage was a cause of all this. One can easily conclude that the labour market conditions improved despite the introduction of the minimum wage, not because of it. 

As for the effect on increasing the relative wage for the bottom 5% thus lowering wage inequality, it would have been arguably much better for both the employers and the employees to increase the personal allowance which would have lowered the tax burden for the employers and leave the employees with more disposable income.

It would require a careful empirical analysis to prove this, but I suggest that an increase of personal allowance would have had a similar if not better effect on lowering inequality in Britain, than what the minimum wage floor did. For simplicity, compare the current net minimum wage in Britain with a personal allowance of £12,875 p/y which the Adam Smith Institute has proposed on several occasions, and calculate whether or not low paid workers would benefit from it. This doesn't necessarily imply that every employer would pay his employees the upper limit of the personal allowance, but it would open up the market for lower-skilled workers much wider than it was with the minimum wage, contributing to the liberalization of the labour market, and better occupational heterogeneity.