New ASI paper: The real problem was nominal

The edited text of Prof. Scott Sumner's 2014 Adam Smith Lecture, "The Real Problem Was Nominal" explaining how central banks caused the great recession, has been published as a new ASI report this morning.

Prof. Scott Sumner, who inspired the US programme of QE3 and was dubbed ‘the blogger who saved the US economy’ by The Atlantic, explains how central banks—not bankers—caused the 2007-8 crash. He goes on further, showing how the European Central Bank is repeating the mistakes the Fed and the Bank of England made in the dark days. And he argues that they can solve the slump and prevent future crises with a market-based, rule-based, stability-focused monetary policy of targeting the level of  nominal GDP.

Here is a link to the full pdf.

Killing the myth of the anomie of modern life once and for all

An interesting little paper regarding the rise of most of the population up out of blue collar jobs into white collar ones. Or, as we might also put it, from proletariat to bourgeiosie:

Rising individualism in the United States over the last 150 years is mainly associated with a societal shift toward more white-collar occupations, according to new research published in Psychological Science, a journal of the Association for Psychological Science. The study, which looked at various cultural indicators -- including word usage in books, trends in baby names, and shifts in family structure -- suggests that a shift toward greater individualism is systematically correlated with socioeconomic trends, but not with trends in urbanization or environmental demands such as frequency of diseases or disasters.

"Across many markers of individualism, social class was the only factor that systematically preceded changes in individualism over time, tentatively suggesting a causal relationship between them," explains psychological scientist and study author Igor Grossmann of the University of Waterloo.

Both Adam Smith and Karl Marx warned about the problems of the "excessive" division of labour. Smith pointed out that the man who performed the same boring task again and again might become brutalised to the point of being a beast. And Marx certainly railed against the boredom of industrial work: what later became known as anomie. The interesting thing about this finding is that it's telling us that the death of those industrial jobs in the boring factories is actually the cure for this.

"We were surprised that only one of the six tested cultural psychological theories was any good for statistically predicting changes in US individualism over time," says Grossmann. "The only theoretical claim that we found systematic support for is the one suggesting that the rise in individualism is due to societal changes in social class, from blue collar to white collar occupations."

So as we all move from those factory jobs into service ones we seem to all be getting richer, that's certainly the experience of the past century. Plus we all seem to be gaining greater liberty to live our lives as we would wish (that is indeed the same thing as individuality). Plus, of course, we all get to do indoor work with no heavy lifting.

Difficult to see what is wrong with this really. But perhaps the most important point is that that anomie is decreasing, that brutalism that was warned against. The good old days really are right now.

To examine the views of Richard Murphy once again

Apologies for scaring everyone with that little photograph. But it is necessary, as we occasionally do, to examine the views of the country's leading tax expert once again. Yes, it's Richard Murphy time:

It’s hard to see how someone can set out the case that markets have totally failed and yet believe they can still deliver, but he does.

And he is wrong. His description of what is wrong is fair. His suggestion that this can continue is absurd. This is a system on the brink of falling over. If he can’t see that I strongly suggest you do not follow his advice. I do suggest that you think about what will happen when he has to realise how mistaken he is, because the scenario of falling labour returns and capital sitting idle doing nothing cannot persist. Change has to happen.

And right now only the state can break the log jam.

He's making the mistake that Adam Smith warned us against when he talked of consumption being the only and sole purpose of production. The contention that Murphy is making there is that neither labour nor capital (and it is emphasised in the piece he links to) have any pricing power at present. Therefore profits aren't particularly going anywhere and nor are wages. This isn't actually a failure of markets.The absence of pricing power among producers (and both labour and capital are indeed, in this case, to be considered as the producers) is actually one of those things that we assume when we construct our models of how free markets should work.

And so who benefits from this? Well, the only other people around are us chickens out in that marketplace, the consumers. And if labour and capital, the producers, aren't benefitting all that much from the current structure then it must be us as those consumers that are getting all the benefit of the onward march of technology. That is, the consumer surplus is increasing while what we must pay is not. And please do note that it must be us the consumers benefitting. There just ain't nobody else out there.

As Smith pointed out, this is not a failure of markets. This is actually what we want, what we desire. That consumption being more important than the production. And yes, that lack of pricing power among the producers, that very point we make in our models about free markets, is exactly what delivers to us this desired goal.

Perhaps Murphy would find tax an easier subject than economics?

Big government reduces growth

This probably doesn't come as much of a surprise to readers here, but a raft of new papers add to the evidence that bigger government leads to lower growth. It comes by the way of a rejoinder to a comment on a paper by Andreas Bergh and Magnus Henrekson. The rejoinder, entitled "Government Size and Growth: A Rejoinder" finds:

In our 2011 survey of the literature in the Journal of Economic Surveys on the effect of government size on economic growth in wealthy countries we find a relatively consistent pattern: An increase in government size by 10 percentage points is associated with a 0.5 to 1 percentage point lower annual growth rate. This conclusion is questioned by Colombier (2014). In this rejoinder we present a rebuttal of Colombier’s argument based on a detailed scrutiny of his own statistical evidence and regression results. Furthermore, we note that several new papers that have appeared since our original article was published give support to our main conclusion.

They handily review the new papers that they believe support their conclusions:

Oto-Peralías and Romero-Ávila (2013) confirm a negative growth effect of government size and finds that the effect is stronger in countries with lower institutional quality.

Berggren et al. (2014) finds that government legitimacy exacerbates the negative growth effect of government size in the long run. Afonso and Jalles (2013) find that the adverse impact on growth from government size can be mitigated using fiscal rules such as the Stability and Growth Pact in the EU.

Afonso and Jalles (2014) confirm that government revenue has a negative impact on growth in the OECD, a result they find to be driven by taxes on income. On the expenditure side, they find adverse growth effects from public sector wages, interest payments, subsidies and government consumption, while spending on education and health boosts growth.

Notably, the survey by Gemmell and Au (2013) manages to miss our survey published two years before, as well as some of the key papers in the field, but still arrives at the consensus view, that there are negative output effects from higher tax rates (but positive growth effects from some categories of public expenditures).

More surprising than all of this is the fact that this debate is still raging so fiercely.

So who did cook Adam Smith's dinner then?

The portrait of Adam Smith’s mother above has been published here with the kind permission of her owner Rory Cunningham

Much excitement over in Grauniadland as a new book comes out talking about why that economically rational man so beloved of us neoliberals could not ever be the economically rational woman. Because, you know, women do all that caring and cleaning and stuff for love, not for reasons of calculated rational self-interest:

But a polemical and entertaining new book by journalist Katrine Marçal suggests that Economic Man has another major shortcoming: he’s not, and never could be, a woman.

Hmm. The book's blurb says:

It is not from the benevolence of the butcher, the brewer, or the baker, that we can expect our dinner, but from their regard to their own interest When Adam Smith wrote that all our actions stem from self-interest and the world turns because of financial gain he brought to life 'economic man'. Selfish and cynical, economic man has dominated our thinking ever since and his influence has spread from the market to how we shop, work and date. But every night Adam Smith's mother served him his dinner, not out of self-interest but out of love. Today, our economics focuses on self-interest and excludes all other motivations. It disregards the unpaid work of mothering, caring, cleaning and cooking. It insists that if women are paid less, then that's because their labour is worth less - how could it be otherwise? Economics has told us a story about how the world works and we have swallowed it, hook, line and sinker. Now it's time to change the story. In this courageous look at the mess we're in, Katrine Marcal tackles the biggest myth of our time and invites us to kick out economic man once and for all.

The contention is entirely poppycock of course. For we can only make sense of gender roles and how they have changed within that very concept of economic rationality. The work of Gary Becker explores this world, where the decision to form a family for example, is explained in those rational economic terms. In a world reliant upon human muscle power to feed itself (ie, all of history until the tractor) there was obviously going to be a gender divide in who did what. And as the biologists tell us it really does take two to raise a family (historically one agricultural labourer could produce enough in a year to feed 1.7 to 2.3 people in total). So many other things about men and women only make sense if there is a division of labour (as Smith repeatedly pointed out, this is the basis of wealth creation) and trade in the subsequent produce. "Hunter Gatherer" as a decription of pre-agriculture societies is in itself a gender distinction of roles on the grounds of comparative advantage (which is all about David Ricardo).

We might also look at the work of Amartya Sen and Joe Stiglitz on the Sarkozy Commission. One of the questions they considered is what is the economic value of that unpaid household production that women tend to do? Given that it is undifferentiated labour (while there is that gender divide the specialisation and division rarely extends beyond two people) then it should be valued at the undifferentiated labour rate: minimum wage.

So two of the founding figures of economics address exactly this point, Smith and Ricardo, three Nobel Laureates point out the implications and then some journalist comes along to shout that of course economic rationality doesn't apply to women?

Yes, we'll probably file that under poppycock.

Quite apart from anything else it's impossible to explain the changes in society in the past century without using that structure of economic rationality. Why have fertility levels fallen so much? Because children now generally survive into adulthood, the name of the game is to have grandchildren, thus one needs fewer children to have them. Why have male happiness rates stayed largely static while female ones have fallen as they gain ever more choice over their lives? Because having more choices means that the opportunity cost of making any single one of them rises. Why have female paid working hours risen? Because automation has meant that the gender division of labour based upon muscle power is no longer useful.

You simply cannot explain this modern world without that assumption that we're all, men and women together, acting as economically rational beings to at least some extent. For, as Marx pointed out, the level of technology determines social relations: the inventions of the reasonable cooker, the microwave, the vacuum cleaner, the washing machine, the steam iron and so on quite killed off the servant class just as one example.

Sorry, but the concept that there's a male world which is economically rational and a female one that isn't is simply poppycock. Otherwise we wouldn't be in a world where one female journalist writes about a book by another one instead of them both being tied to the domestic treadmill in that game of producing grandchildren.

Uncertain IP leads to less innovation

We've been debating patents on the blog recently. Charlotte wrote about a really cool experiment that appeared to show that IP limits follow-on innovation.

I previously wrote that the follow-on benefits of innovation were on net positive, because the effect of bringing what would otherwise be business secrets into the open outweighs the cost of firms not being able to build on other firms innovations for free.

A newly published paper takes on another angle: collaboration. Entitled "R&D Collaboration with Uncertain Intellectual Property Rights" (full pdf of 2011 version) and by authors Dirk Czarnitzki, Katrin Hussinger, and Cédric Schneider it argues that firms shy away from working with other businesses when their intellectual property rights are less clear.

Patent pendencies create uncertainty in research and development (R&D) collaboration, which can result in a threat of expropriation of unprotected knowledge, reduced bargaining power and enhanced search costs. We show that—depending of the type of collaboration partner and the size of the company—uncertain intellectual property rights (IPRs) lead to reduced collaboration between firms and can, hence, hinder knowledge production.

Among firms with patent applications the average probability to collaborate with a competitor amounts to 13%. The probability of collaborating with a competitor decreases by 3% points for these firms if the share of pending patents in the patent application stock increases by one standard deviation at the mean. Thus, the average probability of collaborating with firms in the same industry is reduced by about 23% (=3/13), which is a sizeable impact.

Take that, Charlotte!

'Munibonds' and the national debt

Bad news from the Telegraph's daily email:

Local authorities are on the verge of issuing bonds in order to raise revenues and make up for further cuts to their government grant.... The "munibonds" will be issued by a new municipal debt agency, and are backed by 48 local councils and the LGA. Scotland will also acquired the powers to issue its own debt in what have been dubbed "kilt-edged bonds".

Why is it such bad news? Shouldn't government be allowed to borrow, for investment, like the rest of us? Few of us could buy a house from our savings: instead we take out a loan. So why should a local authority – or even a country – not borrow to fund its schools, roads and care homes?

I used to read eighteenth-century authors and economists like William Cobbett (of Rural Rides) and Adam Smith (of The Wealth of Nations) and chuckle to myself as they went on and on against the idea of the national debt. Much of the huge rise in prosperity of our times, I supposed, had been built on debt, much of it government debt taken out to fund market-enhancing improvements in roads, bridges, airports, schools, hospitals and housing.

Now I think the Cobbetts and Smiths were right and I was wrong. If we could rely on governments to make rational, objective decisions about the overall benefits and costs of infrastructure finance, then there might be a case for allowing them to borrow for public investment. But we cannot rely on governments to be so dispassionate and high-minded. The very power to borrow is itself too much of a temptation pulling them in the opposite direction. Consider, for example:

(1) It is impossible enough to measure the 'public' benefit of government spending, when there is no such thing as the 'public interest' – only a clash of opposing interests. (Think airports, and the convenience for travellers of extra flights and the distress of local residents over traffic and noise.)

(2) The problem is compounded when it is confused by electoral interests. (As Khruschev noted, "politicians will build a bridge, even where there is no river." All the more so, if there is an election coming up.)

(3) With electoral advantage in mind, it is too easy for those who control the public finances to segue from investment to spending. As Chancellor, Gordon Brown, to his credit, said he would confine borrowing to investment projects. But by his reckoning, anything spent on schools or hospitals was 'investment' for the future – even though much of it was patently simply consumption for today.

Such factors help explain why governments have growth so much, and spend money on so many marginal activities. It is too inviting to spend now, earn the applause of the public, and let the next generation, who do not yet have a vote, foot the bill for it all. Public Choice economists call it 'time shifting'. And in that, of course, the public themselves are complicit. With interest groups, from pensioners to patients, demanding more spending on themselves, and politicians happy to borrow, at little cost to themselves, to provide it, how can we ever expect prudence in the public finances.

It is a draconian answer to say that we should stop government borrowing at all. But actually, the eighteenth century thinkers were right.

The inheritance of wealth and social mobility

Many of the papers are covering the new Greg Clark paper showing that social mobility isn't quite as fast as some think. But it has to be said that the paper isn't quite showing what people think it does. It is true that the intergenerational elasticity of wealth inheritance is 0.7-0.75 as the paper defines it. But this isn't quite the same as saying that that wealth is inherited. To understand the point imagine that it is purely wealth itself that is inherited. People now are rich because their forefathers were rich and that's the only reason. OK. But that's not what this paper has proven in the slightest.

What this paper has shown is that the children (and male children only, as they're tracking surnames) of people who die rich are highly likely to die rich. That means that there is a correlation between being the child of a rich man and being a rich man. It does not show that that richness comes from having inherited the wealth.

Consider this example that is used:

Joseph Bazalgette was responsible for building the world's first sewer system in London in the 19th century, the Pepys family tree contains noted diarist Samuel Pepys, and John Bigge was a judge and royal commissioner.

They found that, compared to their relatives in 1850, those living with that surname today are almost certain to have amassed fortunes well beyond the reach of the average Briton.

For example Sir Peter Bazalgette, the great-great-grandson of Sir Joseph, is the founder of Endemol television production company which created Big Brother and Deal or No Deal.

The company was floated on the Dutch stock exchange in 2005. It trebled in value and was sold for £2.5billion in 2007.

There's a number of different options available to us to explain this. That Sir Peter inherited wealth and was thus able to invest in something that was a further success. Someone who had not inherited could not have done this perhaps. Sir Peter inherited a social position that meant he was able to have such an entrepreneurial success. Or Sir Peter had a privileged education that enabled him to do so and so on. But it's also possible that there's an entirely different explanation, that Sir Peter inherited something else that enabled his success.

It is, after all, indubitably true that intelligence is inheritable. The very concept wouldn't have arisen through evolution if that were not true.

We can even tie this in with earlier work by the very same Greg Clark. In a Farewell to Alms he makes the point that what really enabled the Industrial Revolution etc was that those who were wealthier, had those bourgeois values that created higher incomes, had more surviving children than those that didn't. And thus over the centuries those values spread further down the income bands as the descendants overwhelmed (and there's an argument there about whether it was genes or cultural education) the genes of those who did not start out with these views. Essentially his eariler argument is that it was inheritance of being bourgeois that mattered.

We're going to have an awful lot of shouting in the next week or two about this new paper. And we're prefectly willing to agree with the concept (no, this does not mean we think it necessarily true, just that we're willing to take it as a working assumption and see where it goes) that something or other is being inherited leading to the same sorts of people getting to the top in each subsequent generation. But everyone's going to have to be extremely careful in trying to tease out exactly what it is that is being inherited.

From the information we've got here it's not immediately obvious that it is wealth itself that is being inherited. After all, as the paper itself notes, there's been many different taxation regimes upon both wealth and income over the hundreds of years they study. If it were purely cash that made the difference then the results would not be so consistent over this time. And if it's something else that is being inherited then even 100% death duties aren't going to make much, if any, difference.

To be serious about inequality for a moment

The Office of National Statistics has just released figures on incomes in the UK. Giving us that interesting little chart above. Do note that that is income of those who are in the tax system. And also that it does not include the impact of the benefits system. So this doesn't include subsidy to housing or anything like that. And then have a look at the global rich list. Where you can plug in an income and the country to which it refers and see where that income in that country puts you on that global rich list. The reason you must add the source country is because they are calculating using PPP adjusted currency rates. That is, they're taking account of how much things cost in each country. So this isn't really a comparison of incomes, it's a comparison of living standards.

And here's the astonishing thing. That bottom 1% lifestyle in the UK is still among the top 20% globally. The UK minimum wage puts you well into the top 10% (almost top 5% in fact). And a little over median wage puts you into the global top 1%.

To repeat, this is not assuming that things are cheaper in other countries. This is after we convert to the prices you're paying at Morrisons.

We've nothing at all against those who would campaign about either poverty or inequality. But we would like to take this little opportunity to remind all that by any historical or global standard we here in the UK, yes even the relatively poor by local standards, are living pretty high on that income scale. And that feeds in to what we think is the important point about what we might want to do about inequality or poverty. Let's concentrate on that global picture, not gaze at our own navels. Encouraging poor country growth wit the aim of abolishing absolute poverty seems to be so much more productive to us than worrying about whatever gap there might be between the top 20%, top 10% and top 1% of the global income distribution.

Reading Owen Jones at the moment is really rather amusing

His basic contention seems to be that Syriza's election victory in Greece is a rerun of the fight against the Nazis and this time the left must win. Very slightly overblown that comparison.

Syriza’s posters declared: “Hope is coming”. Its election must represent that everywhere, including in Britain, where YouGov polling reveals huge popularity for a stance against austerity and the power of big business. A game of high stakes indeed: one that, if lost, will mean countless more years of economic nightmare.

This rerun of the 1930s can be ended – this time by the democratic left, rather than by the fascist and the genocidal right. The era of Merkel and the machine men can be ended – but it is up to all of us to act, and to act quickly.

Quite what style he would use to discuss anything actually important is difficult to imagine.

He has, of course, also got the economics of this entirely wrong. Greece's problems do not really stem from "austerity". They stem from membership of the euro. The harrowing internal deflation the country has been undergoing are the result of their not being able to conduct a devaluation of the currency. And far from it being us "neoliberals" arguing that such deflation is necessary we've all been shouting that the devaluation would have been a better idea. Indeed, the absolutely standard IMF (for which read, in Jones' language, neoliberal, Washington Consensus, right wing etc etc) solution to Greece's problems would have been a loan package, some modest budget constraints and a devaluation.

It's not going to work out well, of course it isn't. Partly because it's difficult to see who is going to win that argument over the debt and partly because the actual domestic economic policies of Syriza are so barkingly mad. But before Britain's leftists start cheering this victory over the forces of reaction they'd do well to understand exactly what we all have been saying these years. If the standard, orthodox, economic policies had been followed the Greek situation would never have arisen in the first place. Sure, they borrowed too much, that happens quite a lot. But the deflation would have been replaced by that devaluation and it would all just be a dim memory by now.