Facepalm

It worries me sometimes, the things people say:

You know that domestic oil-and-gas boom that’s been sweeping the country for the past few years, turning places like Williston, N.D., into Sin City? Well, the party’s winding down — or maybe it was never that ragin’ in the first place. Oil and gas shale assets, possibly overvalued to begin with, are plunging in price thanks to an oversaturated market and wells whose production hasn’t always lived up to expectations.

The first and most obvious contradiction here is how we can have an oversaturated market and also production that hasn't lived up to expectations. One rather precludes the other really.

But a much greater worry is that they're assuming that a falling price for oil and gas assets is a bad thing. When of course the reality is entirely the opposite: it's just absolutely great. An oversupplied market leading to falling prices for the productive assets means that, well, it means that the market is being oversupplied. Which in turn must mean that consumers are getting their fuel more cheaply: very much the point of the exercise, that we can make things cheaper for consumers.

It's also true that if our new technology, applied to these new assets, led to a rise in the price of those assets then we thought that we would need lots of those assets to apply the technology to. A falling price shows that we now realise that we need fewer assets to supply market demand. That is, that fracking is even more successful and wondrous than we at first thought. Which really isn't a sign that the party's over. Rather, given that consumer welfare is our concern, it's a sign that it's only going to get better.

What Keynes got right and wrong about investment

This is a fascinating paper about the performance of Keynes as an investor. It looks at the performance of the one of the King's College investment funds over the couple of decades that Keynes has total control over the investment allocation. There's one thing that he got absolutely correct. The basic investment strategy of the time was to be in bonds, government securities and so on. Keynes saw that stocks were likely to be a better bet over time: as indeed they have been since then. So a gold star for that.

It's the other point being made about his investment strategy which I think is more important. He started out by looking at the macroeconomy. Trying to time investments on the basis of the ebb and flow of the economy as a whole. And in doing so he managed to underperform the market significantly. As ever when money is involved the loss of it forced him to reconsider his approach. At which point he became what we would today call a "value investor". Damn what the economy is doing as a whole and look at what specific companies in specific sectors are managing to achieve. Or, given that stock markets are forward looking, what they're likely to achieve.

Over the entire time period Keynes was very successful in investing these funds. But it was the gains from the second form of investing that made up for the losses of the first. And here's what really amuses me about this story. Keynes is, of course, regarded as one of the great macroeconomists. Indeed, he defined the way in which most macroeconomists currently attempt to describe the world around us.

But in order to be a successful investor Keynes had to stop being a macroeconomist and look instead to the microeconomics of what was going on. And I think there's an interesting little lesson for us all there. Micro is much more important than macro perhaps?

How Milton Friedman actually won

I think this little piece from Noapinion manages to get this entirely and completely the wrong way around.

I can only imagine how Friedman must be turning in his grave. His academic legacy is probably what he would have wanted...but his political legacy has been to be conflated with some of his most bitter intellectual opponents, to have their ideas ascribed to him, and to have his own ideas reviled by the people on his own side of the political spectrum.

The specific arguments that Friedman made and which are now not liked much by the right in the US are:

Friedman's ideas are pretty close to the mainstream New Keynesian idea of the macroeconomy - the kind of thing promoted by Mike Woodford, Smets and Wouters, Greg Mankiw, and Miles Kimball. New Keynesian models use consumption smoothing, monetary policy rules, and a NAIRU with a downward-sloping short-run Phillips curve - all Friedman ideas. And in New Keynesian models, monetary policy reigns supreme; only at the zero lower bound is monetary policy possibly ineffective. That's a very Friedman idea too. Furthermore, as mentioned above, the policy of Quantitative Easing - which takes us beyond the New Keynesian framework - was what Friedman explicitly suggested for Japan.

This isn't a failure of a political legacy: this is success! To be able to convince your "own side" of the sensibleness of your policy prescriptions is all very gratifying. But it's hardly victory: victory is persuading everyone, so that your ideas become simply part of the mainstream of generally held opinion. That every central bank (except the benighted ECB of course) greeted the recent financial crisis with QE is a glorious victory for the Friedmanite idea that what the Fed really screwed up in 1931-38 was the money supply as laid out in A Monetary History of the United States. That the entire world marches to your drum beat is victory, not failure to be mourned.

On a very much smaller scale we here at the ASI think the same way. Sure, it was Red Ken who brought in the London Congestion Charge: but the idea was nurtured here for years. We don't care who implemented it, it's a great idea, one of ours (and Alan Walters') and we do indeed dance that little victory jig when we think of it. Far from Friedman turning in his grave he'd be celebrating how what was once one of his more outre ideas is now the political mainstream. He won in short.

The difference between this capitalism and this free market stuff

I've a long piece elsewhere looking at the effect of WalMart on the US economy. The basic contention is that the consumer surplus of the company (and possibly Big Box stores in general) is vastly larger than the amount that the owners of the original company have managed to keep for themselves:

The entrepreneurs end up with a lot less of the wealth created than the consumers do. 30 years worth of $300 billion a year in consumer savings is some $9 trillion. In return the (inheritors of) the original entrepreneur has got $100 billion. And yes, to make the point again, that capital value of $100 billion is the net present value of all of the profits they’ll make far off into that future.

Now where I come from (so different that we call it maths not math) our math system tells us that $9 trillion is a rather larger number than $100 billion.

The more sophisticated point that I want to make here is that this is a good example of the different effects that can come from capitalism and from free markets.

In a purely capitalist system, one that did not allow competition, there could still be that same value created: but the distribution of it would be very different indeed. Without any competition at all it would all accrue to the entrepreneurs (although we might possibly expect some goodly portion to leak through to the production labour dependent upon the level of unionisation). With competition however we find that others note the new technology (and yes, WalMart is really just a new technology for retailing) and copy it as best they can. This leads to this very different split of the benefits: the vast majority now accrues to the consumer. For the various people using this new technology must continually cut their prices as the others using this same new technology do so.

Which is, of course, where we want the benefit to be accruing, to the man and woman in the street, this is the point and purpose of the economy. To make the average person as rich as we possibly can.

Which gives us our subtle point. Capitalism might well be a useful way of harnessing greed to encourage people to invest, to produce and roll out new technologies. But it is those free markets that spread that added value throughout the society. Markets, if you prefer, ameliorate the effects of capitalism: which is why they are so damn important, obviously.

Chart of the week: UK unemployment falling only slowly

Summary: UK unemployment is slowly heading down – but fall likely to speed up

What the chart shows: The chart shows the UK rate of unemployment as a three-month centred moving average

Why is the chart important: Following the lead of a number of other central banks (most recently the Federal Reserve), the Bank of England has now embarked on a course of ‘forward guidance’. This is an attempt to lay out the future course of current monetary policy over a longer period of time. The new Governor of the BoE, Mark Carney, has said that Bank Rate will remain unchanged until unemployment falls to 7% from its current 7.8% level (June 2013). The Bank says this will occur in 2016. In contrast to developments in the United States, UK unemployment has been slow to fall; perhaps because it did not rise by as much during the Great Recession. However, the UK economy is now giving all signs of surprising on the upside. This means that unemployment (which is a lagging, not a leading indicator of activity) is likely to start falling faster. Given that inflation is already above the Bank of England’s target, Bank Rate will almost certainly rise well before 2016.

Where Keynes went wrong in Economic Possibilities For Our Grandchildren

Or if it's too much for you to believe that Keynes could have been wrong at all, where current interpreters of Keynes go wrong in thinking about that essay. For of course, Keynes did indeed say that by around and about now we'd all be so damn rich we'd not need to be working hardly at all. At which point we might wonder why so many of today's Keynesians are worried about part time jobs but that would be just snide and sarcastic. There are indeed people who are wondering where that reduction in work and concommittant increase in leisure has gone. What went wrong with capitalism along the way?

To which the answer is nothing at all. It's just that Keynes didn't explicitly spell out the difference between household and market work. The difference is there, with his story of the charlady and of the upper middle class woman bored to distraction because she has servants to do all that for her. The great reduction in working time has come in the unpaid, household, part of production:

Whenever there is a new study on housework, domesticated creature that I am, I like to put on my pinny and go around – just to check that the premise isn't all dusty. This time, a report says that, while chores used to take 63 hours a week 60 years ago, they now only take about two.

That's where the great change has come in, in domestic technology. It's the one thing that Ha-Joon Chang was actually correct about. We've mechanised a huge amount of human drudge work and thus freed up the distaff side of humanity to do something more interesting with their lives. This has included entry into the world of paid work, of course. But it's also meant an increase in leisure for both men and women over these decades.

Keynes wasn't wrong, it's his current interpreters who have rather missed the point. Working hours are getting shorter, have been so ever since Keynes wrote. It's just that it's household production hours that have become shorter. And we are all indeed gaining greater leisure, just as Keynes predicted we would.

Coming around to the Austrian view of investment and recessions

I don't think it's any surprise to anyone that Madsen and Eamonn, here at the ASI, are rather more Austrian in their view of the world than I am. This is partly just because they are but also because I'm not really sure that I believe in any school of macroeconomics at all. I can see that there are useful things pointed out by all of the different schools: quite happy to accept that the New Keynesians have a point about sticky prices and menu costs, the Marxists aren't entirely wrong to think that class can sometimes matter (which Englishman could reject that basic point?) and so on and on. But I'm also extremely doubtful that any of the various schools manages to capture the full complexity of the economy in the way that, say, the microeconomics of prices and incentives captures activity at that level.

However, this story certainly supports one prime contention of the Austrian story:

Spain's €1bn white elephant airport could be yours for just €100m The first private international airport in Spain that turned into one of the country's biggest white elephants is being sold off for just €100m.

A vast airport built where very few live, fewer go and apparently almost none wish to fly to. This is very much he Austrian story about recessions: the boom times allow monstrosties of this type to be financed and built. A misallocation of capital in fact. And once the system gets sufficiently clogged with such misallocations then recession is going to happen. Further, we'll not return to growth until these misallocations are liquidated and we're back to allocating our capital sensibly, not on these white elephants.

What turns people off this Austrian view is that it almost seems to glory in the bankruptcies which are a necessary part of cleaning up the messes of the previous misallocations. Which isn't quite what is being said: rather that this is a sad necessity which we've got to go through so we might as well recognise that. And as I say, this particular case shows that there's at least one solid truth in that Austrian view.

Demand Matters

Markets are about supply and demand. Scarcely a more banal thing could be said in economics, and yet some of the time it seems like free-market economists look only at supply. Glance over policy recommendations from a free-marketeer and you'll often see only tools for freeing up supply—labour market deregulation, planning reform, a bonfire of the quangos, an end to unbalancing subsidies or tax breaks, liberalisation of trade barriers. These are all fantastic things, which we definitely need. And even through the visor of the AS/AD model, even in a slump, these can make things better both by cutting prices and by raising wealth. But either deliberately or unconsciously, these economists are completely avoiding the demand side.

Is this because there are no doctrinaire libertarian things that can be done on the demand side? I've certainly heard many policies like quantitative easing called "socialism" by fellow travellers, but I'd like to think that my libertarian-leaning friends were more thoughtful than instinctively dismissing ideas they see as ideologically impure out of hand.

And further than that, there are things we can do to make the demand side more libertarian, at least if we don't make the perfect the enemy of the good. School voucher systems are not decried for their "socialism" by libertarians despite the fact that under these systems schools are still paid for and run by the state. Monetary policies that are more free market (and more sensible) than our current one should be looked upon in the same way. It's not the case that anything short of abolishing the central bank is "socialism"—unless we want to completely devalue the word. And even if an intermediate policy were a form of "socialism" or "central planning", the realistic alternative is not a free market in money, but an abysmal central plan!

What are these intermediate policies that free-marketeers seem to be ignoring? Firstly there is nominal income targeting, which relies on markets both to stabilise demand and to allocate that demand among competing industries according to consumer preferences; and secondly counter-cyclical taxes, which rise automatically in good times and fall in bad times. Those are both thoroughly libertarian and entirely focused on demand.

In fact, the two most important libertarian economists of the 20th century—Friedrich A. Hayek and Milton Friedman—both endorsed demand-side policy, in the right circumstances. Friedman blamed the US Great Depression on the Federal Reserve, allowing a massive collapse in the money supply and aggregate demand. Hayek said that after the inevitable collapse of a misallocated capital structure there could also be "secondary deflations", where aggregate demand collapses and there is a costly adjustment period. Both would support monetary policy to deal with this issue—stabilising demand, so as to avoid painful adjustments from big inflationary or deflationary shocks. If money is non-neutral in the boom, why would it be neutral in the downturn?

One response libertarians might make is that Say's Law shows there is nothing we can do about demand. But Say's Law clearly doesn't hold in the short-run, and Austrian economists who rightly critique the assumptions economists often make about equilibria should be absolutely clear of this. In the short-run, a dip in aggregate demand—absent any response from the government, central bank, or hypothetical free banks working together—necessitates a period of deflation. But we know that (at least nominal) wages are sticky-downwards, meaning that calling for an adjustment to the new equilibrium means calling for years of the grave evil of unemployment foisted on millions. Say's Law reasserts itself in the medium- to long-run, and by then the misery and destruction of potential wealth has all already happened.

What libertarians are missing is that the relentless focus on supply is leaving them almost completely out of the conversation, and thus leading to worse policy than necessary. If free marketeers were talking about the best things to do on the demand side, as well as on the supply side, then there would be less of the all-eggs-in-one-basket big project spending stimulus, and more diverse market-oriented ways of countering the demand shortfall.

Mark Carney bottles it with baby steps

Mark Carney had the leeway to make radical change here but he's bottled it with baby steps.

The 'Carney rule', promising low interest rates and the possibility of more quantitative easing (QE) until unemployment is low or inflation rises, is definitely an improvement on the current regime. It gives firms clearer guidance on the future stance of policy, removing some of the uncertainty in the world economy today. I expect it to deal with some of today's demand shortage, and more importantly tomorrow's expected demand shortage.

But unemployment and inflation come from both aggregate demand (which the bank can control) and aggregate supply (which it has essentially no control over). Since neither of these numbers distinguish between changes in supply or demand, the Bank is still fumbling in the dark with its guesses over whether a change in inflation comes from demand (which means it should react) or supply (which means it shouldn't). This means firms are still left guessing, and it means that uncertainty still reigns.

What we really need is a truly rule-based system that takes discretion away from nine 'wise men' and uses market forecasts to create real stability. That system is nominal income targeting.

Apparently government does all the innovation around here

We have a new contender for silly economic theory of the year here. Marianna Mazzucato's book on how it's really the State, government, that invents everything and that therefore we must, umm, well, I'm not sure actually. Either allow the state to carry on inventing everything or tax everyone more.

Second, government has also increasingly accepted that it funds the risks, while the private sector reaps the rewards. What is emerging, then, is not a truly symbiotic ecosystem of innovation, but a parasitic one, in which the most lossmaking elements are socialised, while the profitmaking ones are largely privatised.

I've already spluttered and sworn about that one elsewhere. When the state takes 50% of all of the entire economic output of the entire country, evertyhing produced in aggregate by every man woman and child in the nation, quite how we can describe any profit at all as being privatised I'm not sure. But there's a larger error at the heart of the argument:

Conventional economics offers abstract models; conventional wisdom insists the answer lies with private entrepreneurship. In this brilliant book, Mariana Mazzucato, a Sussex university professor of economics who specialises in science and technology, argues that the former is useless and the latter incomplete. Yes, innovation depends on bold entrepreneurship. But the entity that takes the boldest risks and achieves the biggest breakthroughs is not the private sector; it is the much-maligned state.

You can prove pretty much whatever you want in any field if you decide to start by ignoring everything everyone else has found out about that field. And the economist who has done the work in this field, about government and private contributions to invention and innovation, is William Baumol.

His finding being that the state, government, and private industry are equally capable of inventing things. Whizzy new machines, whizzy new ways of doing things. He notes that the Soviets managed to make a satellite and a rocket to get it into space and there's pretty much no economic system more state directed than that Soviet one. However, he then goes on to note that innovation is not the same as invention. Innovation is the process by which these whizzy new things disperse through the society (the take up of new technologies if you like) and also the rate at which people find interesting things to do with this whizzy new invention.

The importance of this being that the innovation side is done vastly better by a private sector, a market based one. Technological adoption is faster, more things are found to be done with the invention and so on.

A perhaps even more potent example is the information and communications revolution. The US National Science Foundation funded the algorithm that drove Google’s search engine. Early funding for Apple came from the US government’s Small Business Investment Company. Moreover, “All the technologies which make the iPhone ‘smart’ are also state-funded ... the internet, wireless networks, the global positioning system, microelectronics, touchscreen displays and the latest voice-activated SIRI personal assistant.” Apple put this together, brilliantly. But it was gathering the fruit of seven decades of state-supported innovation.

Baumol's point is that the private sector could have come up with these technologies, even though it was the State that did. But only the private, or market, sector could have come up with the iPhone. And it is worth noting that absolutely no government anywhere has managed to come up with anything remotely approaching a smartphone. Which is, as I'm sure you'll be fascinated to learn, the technology with the fastest adoption rate globally of any technology ever.

Or, as Baumol didn't quite say, the Soviets did manage to put a satellite up there but 50 years after that they'd still not managed to make a domestic washing machine that worked. And as Ha-Joon Chang rightly observes, the washing machine has done more to reduce the burden of labour, to free women from its shackles, than any other invention. And it did indeed need the private, market based system to do that.