Why cannot the British left understand markets?

Forgive me but this is going to be a bit of a rant on one of my bugbear themes: why is it that the British left simply cannot understand markets? Here we've got Martin Kettle describing one of David Sainsbury's ideas:

As a result, says Sainsbury, in opposition Labour now needs to embrace a new form of political economy – the progressive capitalism of his title – in order to govern better and better understand the future. That means embracing capitalism in two particular ways – the recognition that most assets are privately owned and the understanding that goods and income are best distributed through markets.

Neither of those two things are in fact capitalism. Capitalism does indeed describe a method by which assets (and more particularly, productive ones) are owned but it means that they are owned by hte capitalist, not simply privately. The opposite to private ownership is State ownership. It's entirely possible to have privately owned assets but which are not owned by capitalists as the various flavours of mutual ownership show us. John Lewis and Mondragon by the workers in those companies, the Co Op or building societies by the customers ofr them and so on. Private ownership of assets is not necessarily capitalism.

As to markets, this is where I start to get rather angry with the left. For markets combine nicely with capitalism, this is true, but then markets combine nicely with absolutely method of asset ownership. They are, variously, the calculating engine we must use for nothing else at all can tell us as much about the economy as the prices in markets. They're good, as noted, at the distribution of goods and incomes. But this is nothing at all to do with capitalism per se. Which is, as above, a description of who owns the assets, not how we perform the function of exchange of production.

But why should I get angry at the left for not understanding this point? Because in their hatred of capitalism, desire perhaps for some form of socialism or social democracy, they manage to throw the market baby out with the capitalist bathwater. And of the two the markets are vastly more important for our standard of living.

There is a reason why we here at the ASI generally describe ourselves as a "free market" think tank, not a capitalist one. It's because we think those markets are more important than who owns the assets. And I for one really do wish that the left in Britain could understand that that market system is essential in any form of complex economy, yes, even the more equal one they say they want to create. So, please, could they get with the program and stop railing against markets, whatever it is they want to shout about the capitalists?

There's a because missing in The Guardian's analysis of tax evasion

When different regions are compared, Europe comes out the worst in terms of the size of its black market and the total amount of tax it loses as a result. As a region though, Europe also has the highest tax rates in the world. Out of 36 countries looked at, Europeans averaged a tax rate that was 39% of their GDP, compared to a world average of 28%. The lowest rates were found among 39 African countries which had taxes that represented around 17% of their GDP.

Sigh.

That "also" needs to be replaced with a "because".

The more tax you try to squeeze out of people then the more people are going to try dodging the tax you're squeezing out of them. The higher the tax rates then the more tax evasion there will be.

There's more we can say about these figures too: here they're talking about tax evasion, not tax avoidance. Evasion is the illegal stuff and it's almost entirely the activity of individuals: large companies simply do not involve themselves in illegal shenannigans. This is about the VATless builder's non-invoice, absolutely nothing at all to do with offshore or the multinationals. Or perhaps the dole claimer working a few hours cash in hand: the sort of thing that is never going to be wiped out by any system of economic management or taxation at all. The question thus becomes well, how much of this do we want to try and wipe out?

And there we come up against the other side of the problem. Our aim isn't in fact to extract the maximal amount of tax from the economy. It is, rather, to allow, encourage even, the maximum utility of the populace. We want everyone to be as happy as they can be without bursting with joy at the sheer pleasure of it all. Which means that we've got to measure the utility of reducing tax evasion against the disutility of the methods we use to do so. For example, we could be extreme and state that paying someone may only happen when an armed agent of the State is in the room. If the correct tax is not applied at that moment then the agent will shoot everyone. Yes, absurd and extreme: but it makes the point about disutility of certain methods of reducing tax evasion. Less extreme or absurd, we could ban cash altogether and everything must be done by electronic card. The trail there being auditable and the taxman would certainly catch many more than they do now. But there's a certain disutility to that too.

In the end we come to a reasonable conclusion: that there's an acceptable level of tax evasion considering the foul things we might have to do to reduce that level. Other values, such as liberty and freedom, come into play against that desire for revenue. Whether we're at the right level now is another matter of course: but that is where we must start the debate. What will attempting to collect more revenue do to other values we hold dear?

Oh, and one more very important thing. Assume we accept these estimates of tax evasion: this does not mean that we would ever be able to collect it all. For simply by bringing all into the tax net some of that economic activity would not happen at all. Economics does happen at the margin and so it would be the marginal transactions that did not happen. Which means that we can state without fear of contradiction that reducing tax evasion might make the State richer, up to a point at least, but it will absolutely certainly make everyone in aggregate poorer. For simply to tax currently untaxed economic activity is to reduce the amount of said economic activity.

It's because of socialism you fools

This is a classic headline from The Guardian:

Venezuela food shortages: 'No one can explain why a rich country has no food'

Absolutely anyojne can tell you why a potentially rich country like Venezuela has no food: it's the socialism you fools!

Of course, given that the Guardianistas are all currently weeping with joy over the Miliboy's propsals to bring back socialism and price controls we'd perhaps not expect them to note this particular point but that just means that we'll have to do it for them.

For Oliveros, an additional cause for the shortage of basic food staples is the decrease in agricultural production resulting from seized companies and land expropriations. "More than 3m hectares were expropriated during 2004-2010. That and overvalued exchange rate destroyed agriculture. It's cheaper to import than it is to produce. That's a perverse model that kills off any productivity," he says.

Well quite, stealing the land from people who are farming it so that it then doesn't get farmed isn't going to increase food production. But there's a much more basic point that we should make as well. Governments fixing prices can have one of two effects. If prices are set too high then we get the vast wine lakes and butter mountains of the old EEC. And if prices are fixed below market rates then we get shortages. Of course it's impossible for government to get the price just right for it lacks the information to be able to do so: and even if it had it there's no point in fixing prices at what would be the market rate anyway.

And we can go a stage deeper too. Perhaps it's true that some people in Britain find electricity too expensive, perhaps some people in Venezuela are too poor to be able to afford a decent diet. If those are situations that you want to try and remedy then the solution is to give those people more money to purchase those things on the market. What you don't do is go and screw up a functioning market through price contols or any other regulatory nightmares so that no one has access to those desirable things.

A point that rather puts the kibosh on "predistribution" really.

You know that ever longer working hours thing? It's wrong

It's a common meme, a trope, that we're all working ever more hours for The Man. Further, that we should all lighten up, stop sticking our nose to the grindstone and get a work life balance. Now my normal answer to this is that looking only at paid working hours is very misleading. We nered to also include unpaid hours in household production and as those have been falling swiftly for a century or so now we are all indeed enjoying more leisure.

But as it turns out that qualification isn't even needed. Have a look at this:

Oh. We're all working shorter hours in 2012 than we were in 1990. So we are indeed doing what economists think we would be doing which is taking more of our increasing wealth in hte form of leisure rather than materials goods and or services.

The "ever longer working hours" story is simply wrong, flat out so.

The empathy that John Donne and Adam Smith had in common

Both John Donne and Adam Smith expressed the view that we empathize with our fellow men and women.  Donne said that "any mans death diminishes me, because I am involved in Mankinde."  A century and a half later in his Theory of Moral Sentiments Smith wrote, "How selfish soever man may be supposed, there are evidently some principles in his nature, which interest him in the fortunes of others, and render their happiness necessary to him, though he derives nothing from it, except the pleasure of seeing it."

Smith referred to this as a 'sympathy' for others, though in modern parlance we might call it an 'empathy' with our fellow human beings.  I share that feeling that Donne and Smith expressed.  I am not saying it is how people do feel, or how they should feel, although it may be either or both of those.  I am simply saying that it is how I feel.  I identify with other people in some respect simply because they are human.  I feel a kinship with them and an awareness that they are in some degree like myself.  It is not an empathy felt equally with all of them because its force declines with distance.  It is experienced most strongly with friends and family, then with those in my community, and it diminishes like the slope of a hill as it recedes from the summit towards those farther away.  But it never reaches zero, and I am with Donne and Smith in recognizing it for every human being.

We were all born in the same way.  We all cried, soiled our nappies and took warm comfort in our mother's milk.  We all learned by example and experiment how to make sense of the world, and to make our way in it.  We all seek to better our lot and to care for those who command a special place in our affections.  These experiences and impulses are common to humanity. 

These feelings of a common lot with others of our kind can be erased and overcome, alas with ease, by the fanaticism of a religion or an ideology, and we can be conditioned to regard others as less than human and unworthy of our respect and consideration.  But I think the default condition, expressed by both Donne and Smith, is that of a sense of fellow-feeling with others of our species, and a recognition that they share much in common with ourselves.

News of a distant tragedy moves us, not because we know or will ever meet those involved and affected by it, but because we feel a common sense of identity with them, an identity that derives only from our common humanity.  Donne spoke for himself, as I do, whereas Smith expressed the view that this general ability to project ourselves into the experiences of others "is a matter of fact too obvious to require any instances to prove it."  I believe, like Smith, that this feeling is the basis for the decent treatment of other people and lies at the bedrock of our relationships with others.

Why are insurers willing to make permanent losses on insuring people?

Following on from my blog post of yesterday I've been emailed with an interesting question. I asserted that the very evidence that banks are making losses on current accounts (before we consider the value of the float that is) is evidence that the banking market for current accounts was competitive. I was then asked this follow up question:

"Tim, you say that banks consistently lose money and/or fail to make a decent return, thus perfectly competive. I’ve no reason to doubt you. A query for those who understand these things. Why do some markets consistently lose money for those trying but failing to be ruthless capitalists? Motor insurance is a consistent loser overall, even though there is a captive market. But no one drops out. Professional indemnity insurance for solicitors is another consistent loser, despite a captive market. Whenever someone drops out, some obscure Latvian/Irish insurer comes in, keeping the rates down. Newspapers are another, but they are fun/prestigious/influential. Motor insurance is not. What is it about certain markets that makes capitalists tolerate endless losses?"

The newspaper point is fun: there are those willing to take financial losses for the proximity to power and sheer self importance of being a media magnate. Which leads to the thought that those who tell us of the financial sacrifices they make to be in "public service" might have similar motivations.

The answer to the insurance question though is simple: premiums are not the only revenue stream in an insurance company.

We pay our premiums in and the insurance company only has to pay them out at some point in the future. They thus get to play with that vast pile of cash for some amount of time. What they actually do with it is invest it. What they invest in will depend a little on what type of insurance they're writing, what the likely time scale is before any potential payout. Someone writing car insurance will probably have a more liquid investment (ie, shorter term) portfolio than someone writing earthquake reinsurance (ie, insurance to insurance companies about earthquakes). The reinsurance companies have some of the longest term investment portfolios around, often longer even than pension providers.

These investments of course make a return (well, hopefully they do!). And that's the second source of insurance company income. The returns they get on the money they get to play with inbetween receiving the premiums and having to pay out the losses.

The end result of this in a competitive market is that said insurance companies are going to compete among themselves over the price they will set those premiums at. Given that second income stream it actually makes sense for them to lose money on the underwriting, a loss which is more than compensated for by the investment returns. Indeed, we can take this one step further. Given that income stream from investment returns we have a very simple test for whether an insurance market is in fact competitive or not. If the companies are all making a profit on the simple underwriting then probably not. By this measure the UK car insurance market probably is competitive, the US one not.

There are other points we can make as well. When investment returns fall then we might expect to see insurance prices rise. I don't know whether that has happened recently and if anyone knows do please tell me. Other businesses work in much the same manner. Futures broking say. The actual business of doing the buying and selling is a loss leader for gaining access to the deposits that the customers must leave with the firm (the "margin"). This is invested for the benefit of the firm, not the customer. It was indeed falling returns on bonds and bills (the allowable investments for these firms) that led MF Global to stretch itself into the Euro Sovereign market in search of higher yield. An adventure that ended horribly of course.

Another observation is that the part of Obamacare that insists that medical insurance companies pay out 80% of premiums on actual medical care doesn't matter very much. For no one's bothered to take account of the investment returns from having all that cash while they wait for people to get cancer.

And finally, this is the secret of Warren Buffett's wealth. Yes, he is indeed a very astute investor. But as soon as he'd scraped together enough money to do so the first thing he bought was an insurance company. So his excellence in investing has not been applied to his own money (nor those of his partners) over the decades, but to the multiples of their capital that owning that cash float and investment pool inside an insurance company offers him. He's been using leverage: not by borrowing but by owning the returns from the insurance company premium pile. Oh, and Geico, which Berkshire Hathaway owns, generally does make a profit on car insurance underwriting. But then I've already said that the US car insurance market might not be all that competitive.

The new economics foundation hasn't bothered to understand Adam Smith

You would think that 237 years after publication that those who wish to pronounce on matters economic would have, by now, grasped the simple and basic points that were made by Adam Smith in Wealth of Nations. But apparently not, at least not over at the nef, which is why Giles Wilkes explanation of the acronym, not economics, frankly, is so apposite.

They've a new book out telling us how lovely it would be if we all just worked less and had more leisure. In this they are correct: it would indeed be wondrous if we were able to take more of our increasing wealth as leisure. Which is, of course, what we have been doing for some centuries now as our wealth has increased. We all have a great deal more leisure time than our forefathers (and most especially foremothers), as I've pointed out here and elsewhere many a time.

However, where the wheels come off the organic yurt is that they think that we will increase leisure hours by doing less work in the market and more for ourselves in domestic production. This is, quite frankly, an insane suggestion.

Take two of Adam's points. The first that the sole purpose of all production is consumption. The corollary of this is that we would like production to be efficient: this will maximise potential consumption for any given set of inputs. The second that the division and specialisation of labour increases the efficiency of production. Thus, if we wish to increase the amount that can be consumed for the inputs available then therefore we want to take advantage of the specialisation and division of labour.

The specialisation and division of labour takes place through the market: sadly it's not true that all 7 billion extant human beings are part of this yet (this is why some of them are so darn poor) but a good three to four billion are. That's the number that we can divide and specialise with. This is going to, does lead to, vastly greater efficiency of production than the available split between the two people in my household. Thus by doing more market work and less household production I will maximise the amount of leisure I have for any particular standard of living. Or, if I wish to run it the other way (as we all do at times, some of us do all the time) maximise the standard of living for the number of hours I am prepared to labour and not be at leisure.

The entire thrust of the nef's new little book is that we should, in complete contradiction to the above description of reality, do less market work where we are efficient and more household work where we are less so. So that we must labour more hours for any particular standard of living or, alternatively, have a lower standard of living for any particular amount of leisure we might decide to have.

In one chapter we have a full blown professor no less arguing the following:

Tim Jackson challenges the argument that more labour productivity inevitably leads to more growth and more jobs.

No one has ever said it does: rather, that greater labour productivity allows more leisure for that labour that is being more productive: or, alternatively, a higher standard of living for said labour.

These people a loons.

Mean medians

The US Census Bureau has just released a major publication "Income, Poverty and Health Insurance Coverage in the United States: 2012" that has set much of the US political and economic blogosphere alight. "The incomes of the middle class have stagnated!" they cry, pointing to a statistic that shows the median household income in 2012 down from a real terms peak of $56,080 in 1999 to its pre-recession peak of $55,628 in 2007, to a measly $51,017 last year. That means the median has grown just 3% since 1991, when the last major recession hit the bottom. On the headline measure, incomes are actually below 1989.

I do not doubt that the middle classes (and the poor!) have been hit hard by the recession (although in the UK the story might not work in exactly the same way). But to tell this as a general story of middle-class decline seems to be stretching it massively. I don't just mean because we can now use excellent services like Facebook, Twitter, Google, and so on for free. Having said that, I think Tyler Cowen massively undercounts the importance of free internet services—we now have near-instant, cheap or free access to basically the entirety of human artistic output. A proper measure of consumption or income that included these would give a much more optimistic result.

Still, this isn't my key point. We use median statistics because incomes are very unequally distributed—the US had a Gini coefficient of 0.463 in 2012, while the UK's was 0.32 in 2011-12. A mean (like GDP/capita) does not tell us anything about how gains are distributed, it just tells us how big the gains have been, compared to the size of the population. A median, showing us the middle point, is less easily skewed. But a median can still be extremely misleading under certain circumstances.

One of those circumstances, and an empirically highly relevant one, is when there is mass immigration to a country. According to one official dataset and my simple calculations, legal inward migration to the US was 13m between the 1999 peak and 2011 (inclusive). Presumably illegal migrants aren't counted in the figures, but for completeness we might note they seem to number more than 12m. If we assume that inward migration is typically lower skilled than the US population as a whole (which seems highly plausible), then it's entirely possible that a median falls while every individual in the population becomes much richer. Indeed, this is particularly true if outward migration is largely made of particularly high-skilled people (which also seems plausible). The income per natural concept, developed for a different reason, but relevant, is the number we'd want to check to look at the real trends in incomes when the make-up of the population is changing significantly.

Immigrants to the USA have much higher incomes than they had before. US citizens' incomes also rise, not just because migration boosts their wages but also because of the general effects of economic growth—GDP/capita is significantly up on 1989, 1991 or any of dates picked to generate shocking income statistics. Everyone is better off, but the statistics need not reflect that. Of course, since I haven't picked the statistics apart absolutely conclusively, I can't say for sure that this effect is actually driving the divergence between apparent prosperity for US middle classes and the statistics implying penury. But of course, without that level of digging, neither can the het up US wonks.

Heavens to Betsy, Robert Reich almost gets one right

Unfortunately Robert Reich is not a perfect guide on what not to do as he sometimes almost manages to get things right:

These rules don’t exist in nature; they are human creations. Governments don’t “intrude” on free markets; governments organize and maintain them. Markets aren’t “free” of rules; the rules define them. The interesting question is what the rules should seek to achieve. They can be designed to maximize efficiency (given the current distribution of resources), or growth (depending on what we’re willing to sacrifice to obtain that growth), or fairness (depending on our ideas about a decent society). Or some combination of all three — which aren’t necessarily in competition with one another.

Markets do indeed exist in nature: the male bower bird building a shelter in return for a legover is and exchange in a competitive market whatever else it might be as well. But yes, it is true that the rules define the markets and we can indeed play with the rules to push one or more of those ends. But it's not quite any mixture will do:

Evidence suggests, for example, that if prosperity were more widely shared, we’d have faster growth.

Not really, no. For it would depend upon how we made that properity more widely shared. Higher taxes and more redistribution could well have higher deadweight costs than whatever greater growth more widely shared prosperity might putatively provide us.

But then of course Reich goes so horribly wrong:

Instead, the rules are being made mainly by those with the power and resources to buy the politicians, regulatory heads, and even the courts (and the lawyers who appear before them). As income and wealth have concentrated at the top, so has political clout. And the most important clout is determining the rules of the game. Not incidentally, these are the same people who want you and most others to believe in the fiction of an immutable “free market.” If we want to reduce the savage inequalities and insecurities that are now undermining our economy and democracy, we shouldn’t be deterred by the myth of the “free market.”

Those things described, the buying of influence at the political court, are not free market. Indeed, the solution to those things is to have a free market: one not influenced by politics and thus one in wihch purchasing politicians gains one no advantages. That is, Reich is reliably wrong again in the actions he calls for, for free marketry is the solution for exactly what he is complaining about.

Chart of the week: US balance sheets contract

Summary: US banks’ falling holdings of risk assets could mean trouble

What the chart shows: The chart shows US commercial banks’ holdings of Treasury and Agency securities

Why is the chart important: Two common themes in the aftermath of the Great Recession have been politicians attempting to make banks safer by mandating higher capital ratios; and also attempting to make banks lend more. These are generally mutually contradictory. Current US developments are a case in point. US banks have in the past stocked up on ‘safe’ assets in the form of Treasury and Agency bonds. But, recently, their bond holdings have shrunk, partly because of higher interest rates, which push down the value of bonds. At the same time, banks have been discouraged from buying ‘risk’ assets. Instead, the Fed’s QE enabled banks to pile into cash. But now the Fed is poised to turn off the cash tap. This could threaten current healthy broad money growth; and potentially derail the US recovery.