Blog Review 849

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"Fixing the economy"....unfortunately it's not a machine that can be fixed but an ecosystem. Strangely it's the same people who argue that ecosystems are so complex we can't interfere in them simultaneously argue that the economy is so simple that we can.

This government spending multiplier. Is it higher than one, less than one, or even possibly negative?

The Easterlin Paradox resolved or, no, inequality doesn't matter that much.

The real reason there's a squabble about short selling.

A wonderful tale of bureaucratic competence.

Ragging on Oliver James.

And finally, little known inauguration news.

Public service, private provision

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There was an excellent article in The Guardian yesterday by Geoffrey Wheatcroft.

The piece was inspired by a fire that occurred while he was holidaying in Switzerland. The owner of the guesthouse Wheatcroft was staying in had been called out at 4am one morning to deal with a raging barn fire – the point being that in Switzerland, as in much of the US, fire-fighters are part-time volunteers, rather than paid state employees. As he noted in his article, the same is true of the Royal National Lifeboat Institution over here: they do a fantastic job fulfilling what is undoubtedly a public service, but without receiving any state aid.

And yet most people would assume that fire-fighting and life-boating are precisely the sort of things that will not be effectively provided in a free market, and that the state is required to step in. The evidence, however, suggests otherwise.

Of course, there are plenty of other examples of things people think only government can provide, but have historically been provided by the private or voluntary sectors. Did you know, for instance, that the UK had higher rates of functional literacy before public education was introduced than we do now? Or that the vast majority of manual workers had health coverage (through Friendly Societies) before the National Insurance acts were passed? And what about the fact that most major hospitals were charitable until they were nationalized?

There is in fact a whole history of mutual aid, self-help, co-operatives and voluntarism that has been crushed by big government. The great shame is that the one thing the political left and the trade union movement could really be proud of  – the historical development of a 'welfare society' – was so comprehensively destroyed by their 20th Century adoption of Marxist-inspired socialism.

All that said, there are growing signs of a renaissance in this 'private welfare'. Here's hoping it will be a thing of the future, and not just of the past.

Northern Rock and bonus failure

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I’m confused by the news that Northern Rock employees are going to be given a 10% bonus, partly at the cost of the taxpayer – frankly, it smacks of double standards. It was only recently that Gordon Brown was urging a crackdown on big city bonuses in an attempt to curb excessive risk taking. 

I accept that the average employee at Northern Rock is not in a position to take the same risks as a city trader, but the government and it’s supporters cannot have one set of rules for investment banks and one set for itself. Only in September were the unions claiming that we should “Tax the bonus system out of existence". But now they are supporting the bonuses given to Northern Rock staff claiming that they "worked exceptionally hard in extremely difficult circumstances … they have experienced the loss of friends and colleagues through compulsory redundancy yet have continued working solidly with dedication and commitment."
 
Northern Rock failed at the taxpayers’ expense. The government has overlooked the fact that parts of the financial sector has still been making massive profits in the last year, for example, the Foreign Exchange markets. By rewarding Northern Rock the government is essentially rewarding failure. This is not the correct signal to be sending out to the market.

Hayek: understanding the financial crisis

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Given all the wasted ink spilt over this financial crisis, it was a breath of fresh air to read Philip Booth on The Telegraph website putting the case that the financial crisis shows why we should admire Freidrich Hayek. He is absolutely spot-on in arguing against the trend of a lot of reporting.  Austrian or Hayekian economics has indeed been strengthened by the facts and nature of the financial crisis.

A key point that has been missed by most commentators is that prior to the crisis an abundance of regulation was already in place. The simple truth is that the financial markets were not free. Booth is right to critique the type of regulation present and question the standardization of regulatory institutions use of highly quantitative risk models. This type of regulation forced our eggs firmly into one basket.

It should be made clear that Booth is not against institutions per se, but against government led institutions that distort the market and give people false expectations. As Booth states:

Hayek argues that unregulated markets develop institutions that ensure that trust and reputation become valuable commodities. But who cares about trust and reputation when we believe that everything will be looked after by the regulators or by deposit insurance?

And as for booms and busts:

Hayek suggests, too, that booms and busts are the product of poor monetary policy. Central banks hold interest rates too low. People consume too much and invest in business projects that would not be profitable at higher levels of interest rates. Resources then get misallocated. And then the whole things goes bang and we get a recession (in this case accompanied by a banking crisis).

Someone needs to explain these ideas to print journalists. Except the US Wall Street Journal, most are doing a very poor job of explaining what has gone wrong. I would suggest the journalists go back to school, though I would be surprised if many school libraries are stocked with the works of the Austrian economists.

Blog Review 848

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Adam Smith, pirates and the invisible hook.

Suspending trials for people who have been waiting years for trial? Eh?

Cognitive biases are useful, just as cliches can describe something well.

Odd to see the lump of labour fallacy in an inauguration speech.

Thre's still something of a knowledge problem out there in macroeconomics.

Yes, jobs are a cost when you do a cost benefit analysis.

And finally, why hasn't anyone thought of this before?

American Federalism and the Free State Project

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While all eyes are on Washington, D.C. to see what comes out of the Obama Administration and the new Democratic Congress, a different political scenario is playing out in each American state. Under the American federal system, states vary quite substantially on a number of public policies. Some states have income taxes and others do not. Some states ban smoking in all public places, workplaces, and restaurants, and others do not ban it at all.

While most states avoided the fiscal profligacy of the federal government over the past eight years, the economy and recent over-spending are hitting some states harder than others. My own state, New York, is facing a $15 billion deficit, and the governor is pushing 137 new or increased taxes or fees to close it.  New Yorkers already “enjoy" the second highest state and local tax burden in the country, at 11.7% of personal income.  Meanwhile, New Hampshirites pay only 7.6% of income to state and local governments, and the rate in Alaska is lowest of all: 6.4%.

In a forthcoming study published by the Mercatus Center, entitled Freedom in the 50 States: An Index of Economic and Personal Freedom, co-author William Ruger and I discover that New Hampshire, Colorado, and South Dakota outpace all others on both “pocketbook" and “lifestyle" freedoms considered together, while New York is by far the worst. We argue that the outliers at the bottom and the top owe their status not to a marked surplus or dearth of libertarian ideology in the voting populace, but to unique institutions, such as New Hampshire’s world’s-largest legislature (in terms of voters per legislator) and elected executive council, and Colorado’s Taxpayers’ Bill of Rights (now suspended).

Taking advantage of the powers that states enjoy to set many of their own economic and social policies, the Free State Project proposes that classical liberals and libertarians move to a single, low-population state to advance the idea of strictly limited government and robust individual freedom. The idea is that a few thousand savvy activists can leverage many more votes. The state they’ve chosen? New Hampshire. (Full disclosure: I’m one of them, although I don’t yet live in New Hampshire.) So far several Free Staters have been elected to the legislature, and about 500 have moved to the state. If this “freedom migration" continues, American politics might get much more interesting.

Guest author Dr Jason Sorens is Assistant Professor, Dept. of Political Science, University at Buffalo, SUNY

Tax is bad, says OECD

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Over on Cato-at-Liberty, Dan Mitchell has a good couple of blogs (here and here) analyzing the OECD research on tax. As Dan points out, the OECD is a little schizophrenic on tax – while their Committee on Fiscal Affairs always seems desperate to stamp out tax competition in order to enable higher tax rates, their economists usually seem sensible, pro-growth and free market. Here are a few examples Dan pulls from their recent reports (on Japan and Investment and Productivity):

(1) Lower corporation taxes have a laffer curve effect

[T]he impact of lower tax rates on government revenues is likely to be limited by positive supply-side effects. Indeed, in some OECD countries, revenue was boosted by lower tax rates, thanks to higher profitability and the increased size of the corporate sector... [T]he amount of taxable income in the corporate sector tends to be higher in countries with low corporate tax rates... [T]here is almost no correlation between the statutory corporate tax rate and corporate tax receipts as a share of GDP.

(2) Progressive taxes are bad for economic growth

The weak degree of progressivity in the personal income tax system thus has a positive impact on both labour inputs and on human capital and labour productivity. Maintaining the relatively low degree of progressivity, or even reducing it further subject to the fiscal constraints, would be beneficial for Japan’s growth potential...

(3) Taxes in general are bad for the economy

The findings of this paper suggest that taxes have an adverse effect on industry-level investment. In particular, corporate taxes reduce investment by increasing the user cost of capital... The paper finds new evidence that both personal and corporate income taxes have a negative effect on productivity... High top marginal personal income tax rates are found to impede long-run productivity working through the channel of entrepreneurial activity...

All of which makes it sound to me like the OECD should be in favour of a low, single-rate flat tax.

Mutiny on the Rails

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altAre the rail franchise operators heading for ruin? You could be forgiven for thinking so if you have read the papers this week. The Independent reported that, “Rail passengers face cut in services as recession bites”, while similarly The Guardian reported that, “Railway firms ask Hoon for state aid as years of growth hit the buffers”. But is any of this true?

At the meeting with the Transport Secretary, this week, the top five transport operators (Stagecoach, National Express, Go-Ahead, Arriva and FirstGroup) on the rail network apparently asked for a “bailout”. The Guardian raised the spectre of shorter trains and subsidy payments for an extra 1,000 staff, while The Independent, waded in with claims of shorter trains and higher prices. However, according to the Association of Train Operating Companies, “The specific ideas reported (in the Guardian) were not raised with the Department, but train companies underlined both their commitment to deliver quality services to passengers and their willingness to contribute actively to the economic recovery of the UK.”

What is needed in these times is an elastic market that can react efficiently to demand. What we have of course is the exact opposite. A market, riddled with contractual obligations for the good times but little room for manoeuvre during a “downturn” (if you can call 5% passanger growth a downturn). Rail operators need flexibility to operate efficiently, the repeated need to ask Geoff Hoon if they can and can’t do something has meant that since 1997 the railways have come no further than than they were in 1939. Rail franchise operators should start operating how they want, and ignore the consequences that the government tries to heap on them. It is a shame that Dagny Taggart isn’t in charge of any of these rail operators.

Blog Review 847

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Civilisiation is undone. At least the online subset of it. There's now more money in politics than there is in porn.

A reminder of what a certain political approach to the real world always seems to result in.

Two interesting pieces from the OECD. High taxes reduce productivity and high taxes do have Laffer Curve effects.

A bold statement about climate change and quite possible a true one as well.

All too often plausible theories turn out not to be all that plausible when you really study them.

One reason many economist fall into error is that not many economists have actually read Adam Smith.

And finally, not new but now it's official.