Err, yes, that's why we use markets

Via Left Outside we get this from the Brad Delong:

7) There is a valid “great stagnation” worry, but it is overwhelmingly one of institution design rather than of innovation exhaustion.And here we reach what I regard as the big issue. In the future we are going to want to spend a greater share of our incomes and attention in areas where the market system works less well: information goods, public goods, increasing-returns goods, pensions, health care, education. The market works less well in these areas. But our alternative modes of collective organization, product take some bureaucracy, not exactly cover themselves with glory in these areas either. Thus I suspect that not innovation exhaustion but rather institution design will be our big problem in keeping the pace of true economic growth going into the long-run future.

Leave aside whether this is actually true or not, that markets work less well in these other areas. I tend to think that this is incorrect, what we actually have is some areas where we don't allow markets to work because certain prejudices lead to people thinking they won't work. But as I say, leave that aside and think about what we should be doing if the second part is true. That our real problem is going to be institution design. What do we do then?

We use markets of course.

For we don't know what will be the best institutional form to solve a particular one or a set of problems. Therefore we need to experiment with different designs. Which means that we want to set up thoise expoerimental designs, alloow them to compete with each other and then see which solves the problem better. That is, a market in institutional forms.

And this is of course what we have been doing for some centuries now. We seem to have found out that a capitalist heirarchy is the best (best we have at least) method of producing whippet flanges, a rather socialist form of partnership is the best method of coralling the lawyers who deal with the legal complexities of whippet flanges and so on. For one way of looking at a market is that it is a space for experimentation, along with a method of divining which is the most successful of those experiments. Thus, if we're not sure of the best way to do something we should want to use a market to aid us.

We who call ourselves free marketeers are really only arguing one thing on top of this. Yes, we know, no market is ever truly free and we'd be entirely happy to say that we don't want to explore all possible organisational methods again. I would certainly not want to see chattel slavery on our list of experimental forms and institutions again. What we do mean by free though is freer: we simply want the experimental space to be as large as possible so that as many as possible alternatives are tested.

Chart of the week: French economic sentiment a cause for concern

Summary: French economic sentiment highlights causes for concern

What the chart shows: The chart shows the European Commission’s Economic Sentiment index for France and Germany

Why the chart is important: Recent French data highlight that France is in danger of missing out on the euro area recovery – such as it is. Some numbers are improving, eg unemployment and household consumption of manufactured good. But this improvement is minimal. Admittedly, so too is the deterioration in other series, eg the economic sentiment index. But it is worrying that the weakness is broadly based – four of the five sub-indices showed falling confidence in November – and also that it is there at all at a time when the rest of the euro area is showing some improvement. France is also very much looking like missing out on the general EA foreign trade improvement. One key problem is that successive French governments did little or nothing to reform the economy over the past ten years. What makes this even more worrying is that the current government is, if anything, undoing even the small reforms that have been implemented, hinting that French growth will underperform that of other EA countries over the medium-term as well.

Now just what would we do without the Resolution Foundation?

This might be my favourite research finding of recent times. It comes from the Resolution Foundation who are worrying themselves over the incidence and persistence of low pay in the UK economy. Specifically, they're interested in working out who starts on low pay (less than two thirds of median hourly wage) and then manages to escape said low pay. At which point they tell us this:

Moving onto a higher wage remains a huge challenge for the low paid. While significant numbers do manage to move up the pay ladder, there are still far too many who remain trapped at the bottom, or who fall back onto low pay having escaped momentarily. Furthermore, many low paid workers struggle to earn more unless they switch occupations, sectors or in some cases move from small to large organisations.

Well fancy that.

One of the examples they use is of cleaners. And their research finding is that people who remain cleaners for a decade do not move up out of low pay but those who do switch lines of work have a better chance of escaping that low pay.

You could knock me down with a wet flounder at this point I tell you.

You mean that people who remain in low skill low productivity jobs don't start to earn higher wages while those who move to higher skill higher productivity jobs do indeed earn more? Are we going to have to rewrite the textbooks here or something?

Or should we accept this as the most mind-garglingly obvious point about how wages are determined in a market economy? Your choice but what a hole the absence of the Resolution Foundation would put in our understanding of the world around us, eh?

UK growth: Nice, but unreal

Britain's Chancellor of the Exchequer, George Osborne MP, is smiling like a Cheshire Cat. Today the Office for National Statistics (ONS) said that the last quarter's economic growth in the UK was the strongest in more than three years,  with expansion in services, construction and manufacturing. It is the third quarter in a row that output has grown; in the last quarter of 2012, output fell by 0.3%, but in the first, second and third quarters of 2013 it grew by 0.3%, 0.6% and 0.8%. It seems easily probable that over 2013 as a whole, the UK economy will have grown by a healthy 2%+.

The figures are likely to boost confidence, and that itself may stimulate recovery. And a growing economy makes it much easier for the government to balance its books, or at least to reduce its annual borrowing, even if the prospect of actually repaying Britain's record peacetime debt is still remote. And we should remember that, thanks to years of stagnation, the UK economy is still 2.5% smaller than its 2008 peak.

I am not sure I believe the figures – growth estimates are notoriously unreliable and survey data suggest that things are growing a good deal more slowly. But whatever level it is, this growth is the wrong kind of growth. It is not growth based on getting the fundamentals right, and on people actually investing in thriving businesses or selling exports of greater value. Not growth based on 'rebalancing' as the economists and politicians rather obscurely call it. Rather, itt is fake growth based on government and household borrowing, and shoring up what Tom Papworth, in an ASI paper this week, calls 'zombie' businesses that are living of subsidies and low interest rates, rather than contributing much of value to the economy.

House builders, for example, have been boosted by the government's Help to Buy Scheme, and by several other fiddles designed to make mortgages more easily available. Indeed, the days of the 95% mortgage – one of the symptoms of what got us into this mess – are back. That is one reason why construction soared by 2.5% in the third quarter. The services sector expanded at a healthy 0.7% in the quarter. At least part of that is genuine, created by the resurgence of Britain's important financial services industry. But a lot of it is services bought in by a government that spends half the nation's income – and by households that are borrowing more again. When interest rates are rock bottom, borrowing makes perfect sense. Saving, of course, does not. But without savers, there are no funds available for rational investment  in the viable businesses of the future.

It was low interest rates, loose money and excessive borrowing that created the boom-bust cycle that burst in 2008. Is anything different now? Rather than enduring the hangover after the party and picking ourselves up, we have opted to down a few more pain-killing doses of money and credit. We all want the recovery to be true; and we can all think up reasons why it might be. But we wanted the pre-2008 boom to be true, and look what happened then.

We're really not running out of resources you know

Despite what various people like George Monbiot tell us, no, we're really not running out of minerals. He tells us today that:

To service this peculiar form of mental illness, we must wear down the knap of the Earth, ream the surface of the planet with great holes, fleetingly handle the products of that destruction then dump the materials into another hole. A report by the Gaia Foundation reveals an explosive growth in the pace of mining: cobalt production up 165% in 10 years, iron ore by 180%, a 50% increase in nonferrous metals exploration between 2010 and 2011.

So I go and look at the Gaia Foundation report where I am told the following:

As can be seen, the main metals have a remaining lifespan of between 12 and 50-odd years. However, there is no doubt that new technological developments will allow access to new areas in the future, deeper in the ground, and with likely increased consequences for ecosystems and communities – as can be seen with oil and gas. Recycling policies will also largely determine how much reserves are available. One can argue that the huge amounts of metals contained in discarded electronic items constitute reserves in themselves (the so-called “urban mining”). Contrary to fossil fuels, metals are never consumed, they are merely dissipated and they have an endless recyclability.

And this is, to use the precise technical term appropriate here, entire bollocks. For example, they tell us that the mineral reserves of bauxite, the ore from which we extract aluminium, have a remaining life of 27 years. This is true, they do. But this does not mean that bauxite will only last 27 years. For they have entirely misunderstood what mineral reserve means. It is not the amount of a mineral that is left. It is not even the amount of a mineral that we know about that is left. The best definition, in everyday language, of a mineral reserve is the working stock of mines currently in production.

The correct phrase to describe the minerals that we know about, where they are, how we would process them, that we can process them using current technology and at current prices is mineral resources. Please note, this doesn't require new technologies, nor higher prices. This is just the stuff that we know where it is but we've not got around to mining yet. And the really annoying thing is that the Gaia Foundation is indeed using the correct data source, the US Geological Survey, but they seem to have forgotten to read the document properly. After all, it is an entire two pages long:

World Resources: Bauxite resources are estimated to be 55 to 75 billion tons

Or about three hundred years' worth. And even that's not the correct figure of total availability either. As the USGS goes on to point out:

the United States and most other major aluminum-producing countries have essentially inexhaustible subeconomic resources of aluminum in materials other than bauxite.

For example, I could get you alumina (the aluminium oxide that we extract from bauxite) from the fly ash left over from burning coal. And there's even a producer in China that does exactly that.

My apologies but this is something that really does bug me about the ecocatastrophists. They continually use mineral reserves to mean all that is left. That's nonsense: reserves are what is left in the mines we're currently operating. Resources are vastly larger than this and total availability is some orders of magnitude larger than this again. I am unable to identify a single mineral or metal that we have any chance of running out of for the next half a millennium. And I do wish that the environmentalists could grasp this point.

Chart of the week: RBA attempts to talk dollar down, markets push it up

Summary: RBA attempts to talk dollar down, markets push it up

What the chart shows: The chart shows the Australian dollar exchange rate against the US dollar as well as on a trade-weighted basis

Why the chart is important: Over the past few years, central banks have taken a renewed interest in exchange rates. This is partly because of concerns that other central banks may be engaging in what the Brazilian Finance Minister Guido Mantega in 201 called ‘currency warfare’, ie, attempts to drive down their own currencies in order to gain a competitive advantage; and partly because they try to do it themselves. In theory, a central bank can always push down the exchange rate of its currency, since it can print and sell unlimited amounts. In practice, it is somewhat more difficult. Over recent months, Governor Stevens of the Reserve Bank of Australia, and other RBA spokesmen, have tried to talk down the Aussie dollar. The currency has come down from 96.7 US cents per Aussie dollar in late October to 91.4 (and from 73.3 to 70.2 in a trade-weighted index). However, and the exchange rate has shown itself more resilient than the RBA would like, showing that there is a limit even to what central banks can do against the market..

The joy of markets

How wonderful to see that the terrible shortage of housing in London is being solved!

Office buildings across Mayfair, Soho and Fitzrovia are being turned back into residential homes in a bid to capitalise on rising property prices. “We have sold over 100 office buildings in Mayfair back into residential use in the past year,” said Peter Wetherell, founder of Mayfair estate agency Wetherell.

“All the period office buildings that have been used as offices for 50 years are being turned back into homes. “It’s the biggest thing going on in central London right now.” The trend has been sparked by rising property prices in the capital, with the average cost of a home in London rising 9.4pc in the year to September, and 24pc further growth forecast for 2014. “The square footage is worth a lot more for residential,” explained Mr Wetherell.

It is of course the change in relative prices which is leading to the change of use. And of course without a price system we'd not be able to determine the relative demand (and the effectiveness of that demand) for the two potential uses of the properties.

A commissar mopst certainly could (and would) decide that those properties in the most desirable area of London should only be for the use of those the commissar approved of, as happened everywhere that commissars allocated property. But even such a lauded and senior functionary would not be able to work out what they should be used for without some method of determining the relative values that the people themselves placed upon the alternative uses.

Or as Hayek pointed out, we have to have the market because it's the only thing capable of being the great calculating engine a to the value that people place on things.

Chart of the week: Inventory build-up a major contributor to US GDP

Summary: Inventory build-up was a major contribution to Q3 GDP

What the chart shows: The chart shows the contribution of the change in inventories to US quarterly annualised GDP growth

Why is the chart important: US Q3 GDP growth was surprisingly strong at 2.8% (quarterly annualised rate; in the UK, we would say 0.7%). A breakdown of the numbers shows that 0.8 percentage points was due to an accelerated inventory build-up. This was almost certainly was involuntary. Over time, the contribution of inventories change to output growth tends to cancel out. While a positive contribution for three consecutive quarters or longer is not unheard of, it is rare. Bear in mind that what matters is not the absolute change in inventories, but the change in the change. In other words, a slower pace of inventory accumulation means a drag on GDP growth. The conclusion is that the current quarter and probably the next as well, will see a possibly substantial deduction from growth due to inventories.

The Trading Dead: The zombie firms that threaten Britain's recovery, and what to do about them

Zombie firms threaten to cause a “lost decade” of economic stagnation – new Adam Smith Institute report

• Up to 108,000 “zombie firms” threaten to cause a “lost decade” of stagnant growth and productivity
• Corporate insolvencies are unusually low, suggesting that zombie firms are holding up capital and labour that could be used productively elsewhere
• “If a business can be saved, it is entrepreneurs who are best place to make the changes required” says OpCapita’s CEO Henry Jackson

Over 100,000 “zombie firms” are threatening the UK’s recovery from the Great Recession, according to a new report by the Adam Smith Institute.

Record low interest rates and the willingness of banks to show “forbearance” to unprofitable firms is damaging productivity, undermining competitiveness and preventing workers and money finding its way to the companies of the future.

The Trading Dead: The zombie firms plaguing Britain’s economy, and what to do about them, by Tom Papworth, identifies “zombie firms” as heavily indebted firms that can generate enough revenue to pay down debt interest but not debt principle and are dependent on low interest rates to continue doing so. The paper argues that many of these firms require either insolvency or restructuring for a strong economic recovery to emerge. The report is sponsored by OpCapita, an international private equity partnership that specialises in turnaround through operational change.

The report shows that Britain’s “productivity problem” may be partially due to zombie firms holding up capital and labour in relatively unproductive sectors, raising the costs of entry for new, innovative firms. The two main factors responsible for the zombie phenomenon are low interest rates and bank capital regulations. Low interest rates may be misdirecting money to unproductive zombie firms, and bank capital regulations (such as Basel III) discourage banks from foreclosing on zombie debtors, which would worsen the liability on their balance sheets. This also discourages business lending by banks in general.

The report finds that private sector rescue of zombie firms is possible, but only for some. This rescue, in the form of corporate restructuring, must also be done in a decentralised “bottom-up” fashion by individual entrepreneurs and investors such as private equity firms using their local knowledge of specific firms and industries. A government-led drive would likely suffer from chronic inefficiencies.

Tom Papworth, Senior Fellow of the Adam Smith Institute, said “We tend to see zombies as slow moving and faintly laughable works of fiction. Economically, zombies are quite real and hugely damaging, and governments and entrepreneurs cannot simply walk away.

“Zombie firms stop workers and money being redeployed to more productive uses, they prevent new, better firms entering the market, they undermine competitiveness, reduce productivity and slow the growth of the whole economy. Low interest rates and bank forbearance represent a vast and badly targeted attempt to avoid dealing with the recession. Rather than solving our current crisis, they risk dooming the UK to a decade of stagnation.

“Zombie firms need to be confronted with the reality that they are not profitable. With timely interventions by knowledgeable entrepreneurs, many firms can be restructured and saved. But others must be liquidated to allow resources to feed the growth of the future.”

Henry Jackson, CEO of OpCapita and the report’s sponsor, said: “Turnaround specialists are uniquely placed to help Zombie Companies to restructure and return to profitability – a far better outcome than that they continue to limp on indefinitely. And when private equity steps in it is using its expertise and insight to bring the radical changes required for a failing business to survive.”

The report sets out the role of investors in identifying firms that are ripe for restructuring through the seven key aspects of a successful turnaround: crisis stabilisation, new leadership, stakeholder management, strategic focus, critical process improvements, organisational change and financial restructuring.

Henry Jackson concluded:

“If a business can be saved, it is entrepreneurs and turnaround specialists who are best placed to effect the changes required. Private equity firms have the insight and knowledge to do that, and they are prepared to take the risks to get it right. Delivering change in such circumstances is often extremely hard and carries inevitable risk. But genuine improvements in profitability can create long-term sustainable value.”

To arrange an interview with the report's author or for further information, email media@old.adamsmith.org or phone 02072224995. The report can be read in its entirety here.

The myth of Mazzucato's Entrepreneurial State

It's quite extraordinary the way in which Marianna Mazzucato, in her book The Entrepreneurial State, uses the example of the iPhone as proof that it's really the State that is the entrepreneur. Here's Owen Jones taking the argument for a walk:

Clutch your mobile phone close to your bosom, stroke it tenderly, and praise the Fairy Godmother of Free Market Capitalism that you’re not walking around with an obscene brick stuck to your ear, a breadstick aerial reaching towards the heavens. “Imagine what telephones would look like if the public sector had been entrusted with designing and making them,” as an opinion piece in the Telegraph had it this week, reflecting views widely held on the Right. “The smartphone revolution would probably be at least another couple of decades away.”

One tiny little flaw with this dystopic piece of counter-factualism: er, the public sector was entrusted with doing just that. Economics professor Mariana Mazzucato’s The Entrepreneurial State shows how – to take just one example – the Apple iPhone brings together a dazzling array of state-funded innovations: like the touchscreen display, microelectronics, and the global positioning system. The governing ideology of this country is that it is the entrepreneurial private sector that drives human progress. The state is a bureaucratic mess of red tape that just gets in the way. But free market capitalism is a con, a myth. The state is the very backbone of modern British capitalism.

So how many smartphones have been state designed? I know of a tablet being put together in North Korea but can't think of any others. So we do seem to be left with the idea that smartphones were indeed the creation of that private sector entrepreneurialism.

But other than that snark what is actually wrong with the basic argument that is being put forward here? Essentially, it's that those making it don't know their economics.

We distinguish between two things: invention and innovation. The first is thinking up entirely new things: say that GPS system mentioned. It's generally agreed that at this basic level of research and invention that the State and the market actors are equally able. The Soviets did indeed make Sputnik even if 50 years later they still couldn't make a washing machine that anyone with a choice wanted to buy.

The second, innovation, is the same as entrepreneurialism. This is taking said inventions and putting them to new uses. That State certainly never thought that the GPS system would be used to tell me I'm just passing a really great pizza joint but smartphones do indeed do that these days. But that free market did take those series of inventions, combine them in a new and interesting manner and create the technology with the fastest adoption rate ever in the history of our species.

This is all pretty standard stuff and it's been part of William Baumol's work to explain it all to us over the decades. The State can invent but finds it very difficult to innovate, the market can invent just as well but is stonkingly better at innovation. Given that Mazzucato is in fact an economics professor we might hope that she actually knew this before writing her book. Then again, she is as Sussex so perhaps not. Which is why she used the iPhone, a picture perfect example of market innovation, in her argument about state or market invention, an entirely different subject.