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Bias in TCS 5

Saturday, February 14th, 2009

Fifth of 8 weekly articles documenting bias in “The Cambridge Student”: Lent 2009 Issue 5.

This week it’s jobs, and economic bias (or perhaps economic ignorance). The Cambridge University Press are to cut 133 jobs. (Confusingly, the article prefers to use the numbers 160 and 170 more often, even though these appear to be overstatements.) The article does not quote anyone in favour of the cuts, and does not even quote the Press itself to justify them. It apparently hasn’t occurred to TCS that any job cuts anywhere could ever be justified.

Without job losses, economic growth would be impossible. Not just hindered, but impossible. Without job losses, living standards would never improve and we’d be stuck in the middle ages, with everyone much poorer. The reason is that the very definition of economic growth — each person becoming more productive — means that firms can do the same work with fewer people, and fewer firms are needed. These people are then available to go into new or expanding sectors. Job losses are scary for those who lose their jobs, while they look for other jobs. But they are essential to allow some sectors to shrink and others to grow as the market adapts itself to the changing desires of consumers. In a recession, this is restructuring is essential.

Cambridge University Press appears to want to leave the printing business altogether, and just be a publishing business. Presumably they believe that printing is not a sector they will be able to remain competitive in. Indeed, printing is one of the most competitive sectors in the world. A CUP employee says “the decision on the printing side is perverse; the Press as a whole is currently operating at a profit.” This is disingenuous: even if the University Press is making a profit overall, its printing section may be making a loss. There is no point throwing away profit to subsidise wasteful jobs, when the profit should be used to support the University of Cambridge.

Why do people feel the need to claim offence on others’ behalf? (It’s rather like claiming to represent people who haven’t asked for it.) There was a rather over-the-top comment by a student in a story about Emmanuel College’s “Empire” May Ball: “Throwing the party in the name of ‘Empire’ will damage the Emmanuel College’s reputation indefinitely and stop people, who have the potential to be here, from applying to Cambridge”! So good on TCS for including the following charming story in an article about “Golliwogs on sale at souvenir shop”: “An African gentleman had come in to collect a Stieff Bear he had ordered, and while he was in the shop a white girl came in and said we should be ashamed for selling the dolls. The man turned round to her and said, ‘it doesn’t offend me; so why should it offend you?’”.

More on the occupation of the law faculty. 56 academics have signed a letter to the Vice Chancellor condemning the University’s response to the protesters. The pull-quote is “The letter describes the occupation as ‘peaceful and dignified’”. Non-violent protest is laudable, but it’s not enough. If some people entered my house to demonstrate against something that had nothing (or very little) to do with me, pointing out that they were non-violent would hardly make it okay. Trespass is trespass. The university did not “deprive” the protesters of food — it merely stopped them taking food into a building that the university owned. The protesters were free to leave and eat elsewhere.

The article mentions “the occupation’s most popular aim, with 74% of students in a poll stating support for disinvesting in the arms trade”. It doesn’t mention their other, unpopular demands (and they were demands, not just aims), and their general unpopularity. Minor criticism of the demonstrators is admitted at the end.

Finally, a hilarious quote from a comment article: “you cannot sell education in a market system. Education is too complex to be priced. Not only does it involve too many different elements and qualities, but it consists of things like truth, falsehood, science, culture, and art. These things cannot be bought and sold in a standard market system, because they cannot be identified as ‘goods’.” Ahahahahaha. What non…sequiturs. Education already is bought and sold. Of course it is not to complex to be priced. Teachers have to earn a living, and charge for their services, as do the writers of books, etc. At the moment most are paid by the state, but there is no reason why they can’t be paid for privately. Indeed, many are. In America, for example, one can get a loan to pay for university education, where the payment is a percentage of all future lifetime earnings. Such schemes are crowded out in the UK by the state.

It is not quite true that “if you try and turn the education system into a market, these things will take on a totally one-dimensional character.” It is true that if university was privately funded, fewer people would study things like philosophy, laudable though they are. For most people, degrees like Management are means to an end, whereas degrees like Philosophy are ends in themselves. If students had to pay for it themselves, most would only choose to do a degree if they thought it would pay for itself through increased earnings. Some would still choose to do more “soft” or “abstract” degrees, for “leisure” purposes. (We pay for leisure.) Probably, fewer people would do degrees overall, and then fewer employers would expect them. And wouldn’t that be more rational?

Finally: Is “journalism by facebook group” the new “journalism by press release”?

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Posted in Politics by Hugo Hadlow | No Comments »

More spending is not the answer

Thursday, January 29th, 2009

Sean Gabb on the car industry bailout:

“We are continually told at present – which is somewhat more than usual – how government spending had created, or will create, so many jobs. Therefore, the immense expansion of the British State since 1997 has created three hundred thousand jobs or whatever. Some deplore this because most of those employed can be expected to vote Labour. Hardly anyone denies there has been a net addition to the number of employed. The same reasoning underlies all discussion of how we are to get through the recession on which we have now started.

The truth is, however, that government spending does not so much create as displace employment. Every pound spent by the Government must first be taken from the people, who cannot then spend it for themselves. If the money is taken is taken through taxes, it exactly reduces the ability of the people to spend or invest it for themselves as they wish, or to save it for transfer, via the banking system, for others to spend or invest as they wish. If the money is borrowed, it again exactly reduces the amount of money that the people can borrow to spend or invest.

It is more complex if the money is printed by the Government – or, more likely nowadays, borrowed from the banks in a fractional reserve system. But if its effects are often hard to trace until after the event, inflation is no less a tax than any other means of providing money to governments. It may reduce the actual purchasing power of money left in the hands of the people. Given the downward pressure on manufacturing costs we have seen during the past generation, inflation will at best reduce the potential purchasing power of money that already exists.

This being so, the argument that government spending creates employment relies on a blindness to the concept of opportunity cost – that every pound spent on paying one salary is a pound less to spend on another salary. Put more simply, it is a case of what Bastiat described as “what is seen and what is not seen”. We see the jobs created by the Government in it “regeneration” projects. We do not see the jobs that would otherwise have been created to supply things that people actually would have bought had the money been left in their own pockets.

For the past six months, the argument has been reinforced by the claim that government spending is needed to make up for a disinclination by others to spend or invest. This being so, it will not be a zero sum game, but will create net employment. There is no doubt that there has been a deflation. People are borrowing less and saving more. The banks have been increasing their financial reserves. But it does not follow from this admission that government spending is needed to make up the deficiency. The fall in spending is not the cause of the problems we face, but is a symptom…“

What a pity the government have forgotten the lesson of Mrs Thatcher: government, like a household, which cannot go on spending more than it brings in:

“Now Mr. President, throughout history clever men—not all of then rascals—but none of them businessmen—have tried to show that the common sense principles of prudent finance don’t really apply to this government or that institution, to this business or to that household. Not so, they always do, and especially to government. In the real world large and persistent government deficits haven’t produced any cornucopia of full employment or rapid growth. On the contrary, we’ve seen country after country with substantial deficits run into serious problems of financial crisis and inflation. And to whom do they then turn? They turn to those countries and institutions who have persevered in prudent policies and just as sound finance is vital for households and government, so also is it the essential principle of international finance.”

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Posted in General, Politics by Hugo Hadlow | No Comments »

Margaret Thatcher quote of the week 1

Thursday, January 22nd, 2009

From the archives…

I visited the Churchill Archives Centre today to take copies of a speech made by Baroness Thatcher to CUCA, on 12th March 1976, when she was Leader of the Opposition.

I have put a transcript of the speech at http://www.cuca.org.uk/1976/03/12/margaret-thatcher-speech-to-cuca/, and copies of Baroness Thatcher’s notes at http://www.cuca.org.uk/images/1976/, with kind permission of Baroness Thatcher, The Margaret Thatcher Foundation and the Churchill Archives Centre.

What Baroness Thatcher had to say is relevant today.

More borrowing at home would take us still nearer national stagnation and bankruptcy.

And under Socialism, Britain’s credit overseas is hardly good.

Indeed, if the declining rate of the £ is anything to go by, it is disastrous.

His is a dying Government, creating only uncertainty and confusion, living on borrowed time and borrowed money.

We can visualise the sort of demands our overseas creditors will place on the Government in return for shoring up our economy.

…

Are we going to witness a battle between our overseas creditors, demanding crisis action to safequard their money; and the Left trying to force the Government down the spending road to ruin.

It is a battle which we cannot afford. The Prime Minister must put the country first.

He has heard what the electors of the Wirral and Carshalton have said. They have shouted with a mighty voice. He has failed them, as he has failed the Nation.

He must go—and go now. [applause]

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Posted in General, Politics by Hugo Hadlow | No Comments »

What is Capitalism for?

Monday, January 19th, 2009

by Hugh Burling

The other night I was accused of being a Socialist. In conversation I had pursued the claim that it would be a good idea to encourage ordinary people and high-street banks to make lower-risk investments, such that there would be less risk overall in the system, and that slower growth was a fair price to pay for a steadier market. I made no reference to legal compulsion at any stage. As I understand it, the high-risk investment strategies that were until recently so widespread became so partly due to the popular demand for them. That is, ordinary people wanted higher and higher returns on their savings accounts and their small-scale investments, alongside lower and lower interest charged them on their use of credit cards and borrowing. To meet these demands, win more customers and stay ahead in the finance market, banks (investment, lending and otherwise) encouraged their employees to engage in more sophisticated and risky practices. Some thing or things went wrong and the cards slipped. I beg forgiveness for my primitive understanding and exposition of our financial markets and crisis: I think my comments below will make clear why I don’t take as much interest as some in the minutiae of the operation of our collective greed.

At any rate, the conversation was reduced to the question being asked of me: “Imagining that you trusted the borrower so implicitly that the ‘risk’ of a loan could only be judged as ‘zero’, what would you consider a fair rate of return, when you leant someone your money?”

Once upon a time, the moral engines of our society condemned usury, the lending of money for the lender’s profit. The consequence was the emergence of a complex system of gifting and deviously-worded insurance deals based on bartering. I am no expert on the financial operations of the Knights Templars but I strongly suspect that even their feudal wheelings and dealings were much simpler than usury has become since it was made legal for the majority of the population. We have always had markets and capital. At least, they both seem to go back a long way (see Sean Gabb’s “Market Behaviour in the Ancient World: An Overview of the Debate” (also available as a pdf). Wanting to make a profit from helping other people is probably ‘innate’ to human economic behaviour – at least it is so common that the desire needs to be factored into considering how to motivate people to help each other.

Indeed, the beauty of Capital‘ism’ is that it reveals how a selfish motivation can benefit others. But that beauty does not stem from the selfishness of the motivation. Intellectually (rather than historically or emotionally), we support financial markets because of three truisms: (1) “many people act out of selfish motivations more readily than out of altruistic ones”, (2) “borrowing money is a very efficient way for an individual to be able to begin new enterprises and hence develop new technology, provide more services, and a variety of other things we like to have” and (3) “many incidences of borrowing and lending must occur in order to have all the things we like produced or provided”. Because so many ‘lending transactions’ – the term ‘investment’ assumes that the transaction has a selfish motivation – must be carried out, we need to take account of the selfish motivations of the aforesaid many people. Also because selfish motivations are so popular, we do not expect a majority of entrepreneurs, inventors, artists and so forth to make a living on the feudal basis of patronage (in which they suffered perpetual disadvantage). So what we do is to try and facilitate selfishly motivated lending.

The problem arises when that facilitation changes to expectation, then reliance and finally the inability to imagine that people do, sometimes, want to help other people for reasons other than financial gain, and that alternative motivations are ultimately better, if rarer. This inability leads to a twisting of the truisms. The selfish ‘many’ changes to ‘all’, and usury becomes, in the mind of the public, the only means towards growth rather than merely a very efficient one.

To end the suspense, the answer I gave to the question was “nothing”. If one could spare the money, and one sufficiently trusted the borrower to return it to one before one needed it, there would be no point in one asking for interest. Nothing would have been lost. Of course, the lender would have gained nothing either. My accuser was flabbergasted at the idea of performing a transaction without the aim of capital gain, hence his accusation.

When we advocate a free market, extol the virtues of honest trade and applaud the system which makes the best of our too-often selfish instincts, we must never forget that a compromise is all capitalism is: a compromise with our greed. It is not an ideology, it cannot provide a goal and we should not allow its mathematical doctrines to persuade us that all humans are only ever selfish, simply because we have a clever system for working with the many of us who often are. In short, capitalism is not an ism like the isms that suffix its opponent theories. It is a perpetual jury-rig, not because we once had some pristine, more efficient system or are likely to manufacture a new one, but because we’re basically not good enough to build a proper mast ourselves.

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Posted in General, Politics by Hugh Burling | 7 Comments »

Abolish the Bank of England

Friday, November 14th, 2008

I have an article in this week’s “Varsity Debate”.

The title was “Should the Bank of England have cut the interest rate? Last week, in desperate bid to protect the UK economy from a severe recession, the Bank of England announced its decision to slash interest rates to their lowest level in 50 years.”

I argue that “The decision should not be up to the Bank of England; it should be up to us”, and that the rate should be higher, not lower, because the natural rate would be higher. As Jock Bruce-Gardyne said, “There is no economic problem that cannot be solved by a stiff rise in interest rates”.

The problem with a government set interest rate is that it disconnects the ratio between investment & consumption, and people’s true time preferences. When the government sets any price, they disconnect the relationship between demand and supply. If a price is set above the market equilibrium, more people supply the good, but fewer people demand it, creating a surplus (and an illegal “black market” selling the good at the true price). If a price is set below the market equilibrium, more people demand it, but fewer people supply it, creating a shortage. The only situation when the same amount is produced as is demanded, is when the price is allowed to be set by the market. That is the only way resources can be allocated efficiently. And this applies not just to markets for food, or furniture, but to markets for currency and for credit. An interest rate is a price like any other.

A government interest rate disconnects the relationship between investors and savers. However, a low government interest rate does not create a shortage of capital, because not only does the govenment set the price, it enters the market as a lender, and it controls the currency. The low rate means that far fewer people save for the future, but investors can still borrow even more money because the government provides it instead of the savers.

Here’s the complete version:

The interest rate is the price people demand for postponing consumption. If you would give up ten apples now for eleven next year, your interest rate is 10%. A free market will naturally find an equilibrium interest rate. If you would be willing to lend at lower than the market rate, you can lend at the market rate and make a profit. If you are only willing to lend at above the natural rate, no one will borrow from you.

Why can the government lend at below the natural rate? Anyone else who lends their money at below the natural rate will have no shortage of customers looking for a bargain, and will soon have lent all their money. And anyone lending at below the natural rate of interest is making a loss, so no one does it. No one, that is, except the government. The government cannot run out of money, because it can print it. And while an ordinary lender lending at below the natural rate will not have much effect on it, the government can affect it simply because so much of the money in the economy is on loan from the government.

The current interest rate is lower than it would be in a free market. Why does the government lend at below the natural rate? Why does it want to distort the interest rate? A low interest rate encourages more spending now. It is in essence a Keynesian policy, and shares his deep contempt for savings and thrift, because a low interest rate discourages saving and planning for the long term. After all, “in the long run, we are all dead”, so why bother to plan ahead?

Just as spending by the government will cause a short-term boom, cheap lending by the government will encourage more private spending and cause a short-term boom. Most investment is funded by borrowing, and so the more money there is available, the more investments that will be made. The extra investments enabled by extra government money would not be made in a free market: they are the riskiest investments. Government intervention destroys the natural equilibrium between savers and borrowers, causing malinvestment, followed ultimately by correcting recessions when unprofitable investments are liquidated, freeing up capital for new investment.

Make no mistake: this recession is temporary. It is an inevitable correction to bad investments encouraged by government intervention. Long-term economic growth caused by technology will not stop, but the short-term economic growth caused by cheap money must stop eventually.
Further government action, including dropping the interest rate and the resulting inflation from this expansion of the money supply, might stave off recession temporarily, but it cannot stop it forever, and will make it worse. Further government action might be justified to allay the suffering caused by previous government action, though, of course, it would have been better if the economy had been allowed to grow more slowly in the first place, so it didn’t have to recede now. But shock tactics are best: abolish the Bank of England and go straight to a market interest rate. In the long run, we’ll all be better off.

Gordon Brown was recently asked if he regretted his boast, “No more boom and bust”. He replied, “I actually said, ‘No more Tory boom and bust’”. He did indeed say this, once, so he’s not lying. But, of course, he said it without the “Tory” on many occasions. The implication is that Labour boom and bust is fine. This is the kind of drivel Brown is now reduced to spouting.

Brown is often lauded for removing government interest rate from control by politicians and handing it to the Bank of England’s Monetary Policy Committee. This has certainly removed the ability of governments to slash interest rates before an election, causing a boom, with the bust only following after they have been re-elected. However, when it was made independent, the Bank of England was charged with controlling inflation. This has enabled Brown to carry on spending massively while being able to absolve himself of responsibility for inflation.

The interest rate certainly shouldn’t be controlled by politicians. But neither should it be controlled by appointed “experts”. It should be controlled by us. Then it will reflect people’s true time preferences, enabling us to allocate resources efficiently. To prevent politicians for meddling again in the future, we should abolish legal tender laws and go back to free banking, with competing currencies, so that no one will be able to get away with inflating them. In the meantime, any increase in the government rate is welcome. We need a return to a natural interest rate. We need to return to a truly free market.

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Posted in Politics by Hugo Hadlow | No Comments »

The Gender Pay Gap

Thursday, November 13th, 2008

I have an article in this week’s TCS, “No longer any need to mind the gap”. Here’s the complete version:

Women earn approximately 17.2% per hour less than men, on average. The Fawcett Society’s “No Pay Day” claims that this means, from October 30th, all women are working for free. A speaker in a recent Union debate said that “women earn £569 per month less than men”, and that there is probably a pay gap at the University because more bedders are women and more professors are men. Well, yes.

The 1970 Equal Pay Act says that two workers doing the same jobs to the same standard should get paid the same. This is sensible. So why, forty years later, does the pay gap still exist? Is the remaining gap really the result of sexism?

I used to believe it was. But it turns out that if you control for things like part-time work, and men and women being more likely to do different jobs, the gap disappears.

For example, some jobs done more by men have disadvantages that are reflected by higher pay. Men are more likely to work outside in all weathers and work unsocial hours. “Women’s jobs” are less risky in two ways: men are much more likely to be made redundant, and suffer much higher rates of industrial injury. Women have shorter commuting times to work, and take more time off. Women report greater job satisfaction than men.

More women work part-time than men. It costs more to train two workers than one, so part-time workers cost an employer more per hour than full-time, and this is reflected in lower hourly pay. This shows up in the overall pay gap, but doesn’t indicate sexism.

More women than men do certain jobs, and vice versa. This is the result of different average preferences. For example, 36% of male managers work more than 48 hours a week, but only 18% of female managers do. Women with careers are 4.5 times more likely than men to say they preferred to work fewer than 40 hours per week. In one study, men tended to place more importance on “being successful in my line of work” and “inventing or creating something that will have an impact”, while women tended to place more importance “having strong friendships”, “living close to parents and relatives”, and “having a meaningful spiritual life.” But amongst men and women doing the same jobs, the gap can disappear, or even be negative. Female investment bankers and dieticians, for example, earn significantly more on average than male ones.

In many couples, the female partner often spends more time looking after the children, which would reduce her overall lifetime earnings. That is why there is no pay gap amongst the young. In the UK, the median pay gap between 22 and 29-year olds was less than 1% in 2007. A US government study found the gap between men and childless women between the ages of 27 and 33 was about 2%. Middle-aged women who remain single earn more than middle-aged single men. Lesbians and gays earn more than heterosexuals.

If you look at the figures more closely, you find not only is sexism not necessary to explain anything, but that there are some things which cannot be explained by sexism. On average, Bangladeshi women in the UK earn about 26.8% more than Bangladeshi men, and Black Caribbean women 1.5% more. This hardly indicates sexism.

I’m no apologist for sexism; it’s stupid and inefficient, and sexist employers who don’t hire the best person for the job are losing out themselves. And surely sexism does still exist in the workplace. But too often widespread sexism is inferred from simplistic econometric analysis with no other evidence. And, as I hope I’ve shown, this inference is misguided. A study by economist June O’Neill, former director of the Congressional Budget Office, found that women earn 98% of what men do when controlled for experience, education, and number of years on the job.

I’ve been talking a lot about averages. Of course, many women do jobs which are mostly done by men, and many women get paid more. Really, there is now so much variation in the lifestyles and economic behaviour of men and women that simple comparisons of average male and female pay etc are increasingly irrelevant.

The data do not indicate sexism, and those who claim they do are guilty of “cherry picking” data (a scientific cardinal sin), not comparing like with like, and selective reporting of the facts. They focus on the “headline” figure and don’t look any further.

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Posted in Politics by Hugo Hadlow | No Comments »

“You can’t spend your way out of a recession”

Thursday, October 23rd, 2008

I have an article in The Cambridge Student.

“most of the ads for sub-prime loans had dried up before the recent bail-out bill. As soon as that went through, the volume for these ads went up 10 times. Whatever the government did to ‘fix’ the problem ain’t working because all they did was just give everyone who didn’t make money the first time around another shot at the craps table.” (A commentator from the US advertising industry)

Do politicians never learn? The government are going to attempt to spend their way out of the recession. Again.

The Chancellor, Alistair Darling, invoked Keynes as he revealed plans to spend billions to kick-start the economy.

But just as the Great Depression was caused and exacerbated by government action (distortion of the interest rate and Britain’s decision to return to the Gold Standard at a ludicrously non-market rate caused overinvestment, debt and inflation, and Roosevelt’s New Deal slowed the recovery), government action is going to exacerbate this new problem.

Keynes’ theory was that initial government spending can lead to a greater increase in the national income. Imagine the government spends a large amount of money. The people they pay this money to might save a little of it, but spend the rest. They then pay it to other people, who save a little more and spend the rest. So the same money gets spent several times. However, it is obvious that while government spending causes this “multiplier” effect, it also causes an anti-multiplier effect. Had the government not taxed and spent that money, people would have spent it themselves anyway.

In fact, the inevitable inefficiency in the tax system, let alone the public sector in general, means government spending actively harms the economy. If the last ten years have taught us anything, it’s that increases in government spending are rarely accompanied by corresponding increases in productivity. Labour increased spending on the NHS by £43 billion in five years, and then slowed the rate of spending only slightly. But a report by the Office for National Statistics in April 2008 showed that productivity had actually fallen by 10 per cent over the previous 10 years. For example, the new GP contracts encouraged many doctors, perfectly rationally, to work shorter hours.

And “priming the pump” often means big civil engineering projects, which are capital-intensive and so less productive of jobs than private-sector small businesses.

So “priming the pump” of the economy is not a sound argument for government spending.

Even ignoring the fact that Keynes’ ideas are mostly discredited, there simply isn’t any money to spend. Keynesian “pump priming” requires the government to save in the good years and spend in the bad. But Labour has increased government debt each year by about £30 billion plus an undeclared £80 billion. Total government debt is now about £1.8 trillion, or £74,000 per household.

Personal debt is at record levels. Our national household savings ratio is negative, meaning we aren’t actually saving anything at all. Businesses are being hit by the credit crunch because they aren’t sitting on big piles of cash. Increasing taxation won’t increase government receipts; in fact, it would probably decrease them.

The only way the government can raise the money is to take on more debt. And that’s just future taxation: “mortgaging our children’s future”.

What’s the reason for all this government debt? Simple: too much spending.

Government spending has increased by 50% in real terms since 1997. If spending had only increased with inflation, we’d have been able to abolish income tax, corporation tax, and alcohol duty. That would be really helpful at the moment, both for the economy and people feeling the pinch of rising fuel and food costs. But this government is going to end the same way all Labour governments do: running out of money.

Government spending needs to be capped by law. It should only increase with inflation and population. The government intends to abandon its Golden Rule and its limit on debt. But what we need is a new rule to limit spending.

—

Murray N. Rothbard’s essay, “Keynes, the Man”, is well worth reading.

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Posted in Politics by Hugo Hadlow | No Comments »

Don’t blame markets

Sunday, October 5th, 2008

I have an article in this term’s Berry.

Many people see the current financial crisis as demonstrating the failure of free markets, and the need for increased government regulation. However, as I show, we do not have anything like a free market, and that economic crises are caused by past and current government intervention. To fix things, we don’t need more government intervention, but less. We need to return to free banking. We need what we don’t have: a truly free market.

Here’s the article:

The banking crisis is not a result of market failure. It is the result of two things: the ownership structures of investment banks, and government intervention in the money market.

Most investment banks are owned by dispersed shareholders, and their shares are traded on the stock market. Management is divorced from ownership, with the result that the shareholders can exert little control over fund managers. This separation of ownership from control means that traders are free to gamble with other people’s money. In a growing economy, everyone does well on average and traders enjoy large bonuses. But if investments turn out to be bad, traders face almost no sanction. It is not their money that is lost; the most a trader loses is his job. This leads to excessive risk taking.

Three of the big five Wall Street investment banks have gone under. Yet hedge funds, which before the crisis were thought to be much riskier, have not been hit nearly as hard. This shows that the problem is not with markets, but with the structure of investment banks.

Hedge funds are privately owned, often as partnerships. Fund managers usually invest their own money as well as others’, so they have incentives not to take huge risks. The small size of hedge funds allows managers to assess fund manager performance more closely. It also means that if bad decisions are made, they cannot have such large effects. If a hedge fund goes bust, the effect on the economy is less significant.

Big banks are therefore looking at changing their business structures. UBS is considering splitting its asset-management and investment banking businesses.

The second, bigger problem is government intervention in the lending market.

A simple example is legislation in America which discourages lenders from denying mortgage applications from fear of being accused of racism. The Community Reinvestment Act has coerced lenders into allowing riskier mortgages, ultimately leading to more repossessions when borrowers couldn’t make their repayments.

But the central banking system is a more systemic problem. Governments keep the interest rate artificially low by lending money at a lower rate than the going market rate. A small player wouldn’t have much effect, but because governments can print money, they exert a large enough influence on the market to change the interest rate. After years of inflating the money supply, most of the pounds and dollars in circulation are lent by the central banks. As well as being the cause of inflation, this allows investments in riskier activities which wouldn’t be allocated resources by a free market. It creates bubbles or inflates certain markets, such as the housing market.

The debt bubble that has been built up over the last decade or so is the real cause of the current economic crisis, and central banks are to blame. They provided the cheap money which underpinned the growth of debt. The so-called “Greenspan put” refers to twenty years of US Federal Reserve policy to cut government interest rates aggressively every time drops in market confidence threatened the long economic boom. The 1987 stock market crash; the Gulf War; the Mexican crisis; the Asian crisis; the LTCM debacle; Y2K; the internet bubble burst; 9/11; and now: every time, US rates were slashed. Often, US government interest rates were actually lower than the inflation rate: real interest rates were negative. That is really cheap money.

Investors in the UK and US increasingly believe that when things go bad, the government will inject liquidity until the problem got better. Governments do so every time, and the perception has become firmly embedded in asset pricing in the form of higher valuation, narrower credit spreads, and excess risk taking. The end result has been moral hazard in risk taking and has caused bubbles in equities, credit, real estate, and commodities.

The knowledge that the government will bail out any business distorts the market: it encourages rash decisions in the short term, and in the long term stupefies the market from adjusting to changes in demand and technology.

Ultimately, “capital injections” do not prevent credit crunches. They exacerbate business cycles and makes the crunches bigger when they inevitably do come.

Bad ownership structures are not a long term problem. As long as their shareholders are not bailed out, banks will fix themselves.

But government intervention is a long term problem. Central banks should be abolished. Government should not interfere with the market interest rate. The only way to long-term economic health is to trust the markets.

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Posted in Politics by Hugo Hadlow | No Comments »

Market Crisis and Regulation

Wednesday, October 1st, 2008

The financial sector is in crisis. Lehman Brothers has collapsed, Merrill Lynch sold, Fannie Mae and Freddie Mac nationalised, and AIG looks like it may well go the same way. In the face of such market turmoil, it is to be expected that the old doomsayers are out in force, bemoaning the folly of the free market, and wallowing in the glories of nationalisation as our collective saviour. But such joy is misplaced. The free market is still only partial, and indeed too young to be blamed for the current economic woes.

To use an analogy, imagine that person A and person B have been given a chain saw. Person A has been given an instruction book, reads it, and follows it to the letter. As such they immediately and quickly get started trimming a few bushes.

Person B, on the other hand, has not been given an instruction book. Instead he must work out how to use the chain saw for himself. Because he is an intelligent person (and can learn from the work performed by A) B quickly works out how to use the chain saw. However, because B does not have an instruction book, he is quite happy to cut everything in site, while A checks each section to ensure that he does not attempt to cut something that is too thick for the chain saw.

Very quickly, B is able to take over A, and produces, because he is not stopping and starting, produces a cleaner and more even cut. Unfortunately, B is suddenly stopped in his tracks when he tries to cut something too thick. The chain saw jams; indeed, the chain saw backfires and B loses his grip. B is shaken for a few minutes, but he quickly recovers and starts again. This time he avoids the thick branch.

Soon, A and B find a poll in the bush made of a material neither has come across before. A can find no reference to the poll in his instructions. As such, both A and B decide to try and cut it. They both fail and the chain saws backfire. Afterwards, A is given a new instruction book, listing iron poles as another thing that the chain saw cannot cut through. B is not given any regulation.

Later, A and B come across a pole made of another material neither have come across. With his new instructions, A is told not to cut through anything that he does not recognise. As such, he does not cut it. In contrast, B tries to cut the pole and finds that it is made of rubber and cuts easily. He can then continue, ending up with a clean shaven bush with only a couple of thick branches and iron poles protruding.

What this is trying to show is that a regulated market is retrospective. With deregulation, banks have been able to make investments they have never been able to try before. Some of these investments, like the metal pole, have proved to be bad. But it is only after the investment was tried that this proved to be the case. As such, the free market has also learnt the lesson.

Nevertheless, some investments, like the graphite pole, were successful. In an ever changing world where regulations are often years behind progress, such investments would not have been realised had it not been for the free market.

Undoubtedly, the current economic crisis derives from banks lending to people who cannot pay them back. The fall-out from this has meant that the liquidity upon which banks depend has contracted. But what should be emphasised is that the free market can now learn from this mistake. As such, person B will not try and cut the thick branch with the chain saw again.

A deregulated market is in its infancy, and people are still learning how to use the freedom it affords. To finish with a final analogy, a child who has been playing virtual rugby for years is finally allowed to play it for real. During his first match he breaks his leg, and mother prevents him from ever playing again. So, he returns to his virtual game. Just imagine the opportunities lost by that child had he been able to learn rugby properly, especially now that he is an overweight couch potato in front of a television screen.

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Posted in Politics by James Arthur Sharpe | No Comments »

Response to two speakers: Simon Heffer and Lord Blackwell

Saturday, May 17th, 2008

Simon Heffer visited CUCA in Lent, resulting in the most attended and best talk of the term. He spoke of the creation of a “client state”, where the Labour Party massively increased the number of tax-funded state jobs in order to increase their voter base. People working in the state sector tend to vote Labour, so Labour’s strategy was clear: make more of them. This is massively costly, but seems to work.

Heffer’s solution is that the Conservative Party should not bother seeking these votes, because they will not vote Conservative anyway. Heffer is a critic of Cameron’s rebranding and apparent change of focus of the party, though has recently said he might consider voting Conservative. (He probably will.) He suggests that Cameron should not adopt policies to try to please everyone including these voters, but should focus on their traditional voter base.

In an article since, “Labour is malignant, not incompetent” (Telegraph, 2nd April 2008), he sees this strategy repeated by Labour with immigration. The Lords Economic Affairs Committee report on “The Economic Impact of Immigration” showed quite clearly that net immigration is not beneficial to the country. This has been obvious for years. The figures show that net immigration does not increase GDP more than it increases population, so has no effect on GDP per person and therefore general well-being. Government responses to this resort to obvious double-speak.

Heffer believes, as do I, that the government has known full well that net immigration is not beneficial, but has pursued it because it knows that immigrants tend to vote Labour. It has put electoral success above the country when it knows they are opposites.

Heffer calls for a radical cut in the amount of money spent by the government, which currently spends over £600 billion per year. Government spending has increased by 50% in real terms while Labour have been in power over the last ten years. As Lord Blackwell pointed out in his talk, the amount of stuff the government needs to provide doesn’t increase every year, so government spending should remain constant. Indeed, this means it should reduce as a percentage of GDP. If the government was spending the same as it was ten years ago, we could have abolished income tax.

Heffer demands tax cuts mostly to save money and free the economy to grow, but he echoes the calls of Sean Gabb for tax cuts to cut the funding to the ruling class – those who draw money and status from the state.

Lord Norman Blackwell visited CUCA yesterday, speaking and taking questions in the Union Dining Room, and then over dinner at Strada. Like me, he is very keen on policy: he worked on policy for Margaret Thatcher and John Major.

He started by talking about how radical some old policies seemed at the time, and how he believes others which seem radical now will be considered common sense in the future. For example, the Post Office used to run the telephone network in this country. As one might expect from a monopoly, the service was shoddy and expensive. If you wanted a telephone, you had to be put on a waiting list, and an engineer had to come to your home and fit one into the wall. You could only buy telephones manufactured by the state, which were very expensive.

People thought that the telecommunications couldn’t be provided by private companies. Now that it is, we know that of course they can.

Later, Lord Blackwell himself presented a report to British Telecom trying to convince them that it was safe for people to have telephone sockets, rather than a telephone hard-wired into the wall. Now, the idea that telephone sockets are dangerous is ludicrous. Then, it seemed radical.

Of course, there is an element of natural monopoly in landline telecomms. It does seem there needs to be some involvement by the state. But it should be as small as possible. As Hayek said, the state needs to create a legal framework in which competition can function. This should be designed to encourage as much competition as possible. Just because a market can’t function without the state, that doesn’t mean the sector should be run entirely by the state.

In the UK, British Telecom runs the lines (and even this is changing), but other companies can run calls on top of them. Much like Network Rail running the train tracks, but other companies running the trains. This is much better than BT doing everything, without having to compete and therefore having no incentive to provide a good, cheap product.

The same thing has been done with broadband internet. Can you imagine what our internet would be like if the government still had complete control of telecomms? Atrocious! Things would never have improved so rapidly.

We probably wouldn’t even know what we were missing out on. In Cuba, the state has to stop its subjects from finding out about the standard of living in other countries, so that they don’t know what they’re missing (toasters). What are we missing at the moment that we don’t know we’re missing? We’ll only find back if we stop the state slowing us down.

So telecommunications is one area where those advocating privatisation have been proved right. So are railways. Alex Singleton of the Globalisation Institute addressed CUCA at the Gin & Tonic party at the beginning of term, and he pointed out that by every objective measure, the railways have been improving since Conservative privatisation – the turning point.

Lord Blackwell suggested that healthcare and education are next to be privatised. People don’t know what they’re missing. They don’t know how good things could be.

However, Lord Blackwell didn’t suggest that “privatising” healthcare meant abolishing tax-funded (“free”) healthcare. Abolishing state-run schools doesn’t mean abolishing free education.

He suggested a voucher system. Consider education. The system would require very little change. Instead of being told what school you must go to, you could choose. Instead of only the state being able to set up state-funded schools, anyone could. That’s all.

He suggested not using the word “vouchers”, for two reasons. One, he thought it was as tainted as “privatisation” for many voters. Two, people didn’t know they wanted it, even though they wanted its consequences. If you offer people “choice” in your manifesto, they say “We don’t want a choice of schools. We don’t want to send our child to the next village. We just want to send our child to the local school, and we want it to be good.”

Choice (i.e. competition) doesn’t even need to be exercised to have beneficial effects. You don’t have to take your business from the local pub and drive to the next town. It’s just the fact that you could that means your local pub has to make an effort.

Similarly, if you go to a bad school and a good new one starts up, things won’t just be improved if everyone moves to the good school and the bad school shuts down. In most cases this won’t even be necessary. All that is necessary is that you can move. That is enough to give the old school some incentive to improve.

A similar scheme could be implemented for healthcare.

He suggested rolling out education vouchers in poor areas first. Even though this would mean richer areas wouldn’t get the benefits so quickly, it would demonstrate that the measures were to improve education in poor areas the most. This might help get voters used to them.

“Privatisation” seems radical in the UK at the moment, but it won’t when people see the consequences. We just need to look at the success of the Swedish implementation of vouchers.

People like to claim that there is something special about education and healthcare: that they are “public services” rather than products like any other. This is wrong. They are products like any other. People said the same about telephones.

Lord Blackwell used much libertarian rhetoric, and seemed to consider himself a libertarian. I’m not sure whether I’m a libertarian or not, though I have very strong libertarian sympathies.

I think vouchers are a good idea. But they’re not a libertarian idea. Vouchers roll back the state by allowing the state to pay for, but not run, education and health. They do mean that the state bureaucracy is smaller even if taxes stay the same. But libertarians would not even have taxes to pay for education or healthcare.

It may be that complete abolition of the welfare state is better for the country, especially in the long run. As Andrew Perraut says, “if markets are as massively productive as we libertarians believe and compounding returns to growth in the long term are taken into account, you could probably justify no more than very basic safety nets, for fear of distorting the economy and dramatically lowering everyone’s goods in the future.” But the safety net could include healthcare and education.

In any case, vouchers are better than the current system, and we need them fast.

My commitment to reducing the size of the state is Perraut’s: any taxation reduces economic growth. Some taxation is necessary, but the optimum amount is far lower than it is at present.

Lord Blackwell’s seems to be for a different reason. Statism cows people. It reduces the striving, self-reliant ethic. If people have a problem, it encourages them to expect the state to solve it, rather than solve it themselves. This attitude reduces economic growth because it discourages innovation.

He ended on a quotation that Lady Thatcher looked up while they were working on a speech. It is one of the closing sentences from John Stuart Mill’s “On Liberty”:

“a state which dwarfs its men, in order that they may be more docile instruments in its hands, even for beneficial purposes, will find that with small men, no great thing can really be accomplished.”

Postscript.

Afterwards, over dinner, he talked about the historical consequences of global cooling, including the halt of the expansion of the Roman Empire. This would be an excellent way to write an article aiming to change people’s minds about global warming. The scientific evidence that global warming will stop, rather than being catastropic, is clear. We haven’t had any for over ten years. So take this for granted! Treat global cooling as inevitable, and write an article about its historical consequences and how we must prepare to meet them again.

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Posted in Event reviews, Politics by Hugo Hadlow | No Comments »

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