Economic Nonsense: 28. Capitalism brought about the financial crisis and should be replaced

Opinions differ on the causes of the financial crisis; some economists suggest it happened because of a combination of several causes. In the US sub-prime mortgages were involved, in that mortgages had been given to some who were poor repayment risks. When these were bundled into other securities, an unknown risk was being marketed, with some institutions heavily over-extended with potentially bad debts. It should be pointed out that it was US government policy to extend home ownership to low income people. The two agencies Freddie Mac and Fannie Mae were both encouraged to do this. The process of 'red-lining,' drawing lines around city zones inside which no mortgages would be given, was outlawed. It might also be noted that most of those who received mortgages, including low income people, continued to pay their mortgages payments and successfully became home owners. Only a tiny proportion were defaulters. It was the unquantifiable nature of the risk that caused problems.

Others have pointed out that the Federal Reserve Bank made a policy of cheap credit. They did this to weather crises and prevent economic downturns. The Bank of England did some of the same. When money was cheap, so was risk, and the message encouraged financial institutions to undertake riskier ventures. It was as if all the traffic lights were stuck on green, and everyone pressed ahead at speed.

The lesson is that governments and central banks were at fault, as were reckless traders taking huge risks to bring greater returns. It was not capitalism itself that brought about the crisis, but rather the inappropriate behaviour of some of the parties involved, including government. Neither was it regulation. With the possible exception of the pharmaceutical industry, the financial sector was among the most tightly regulated in the world. It was unsuitable regulation that sent the wrong messages and brought about wrong behaviour.

Capitalism has not been replaced and almost certainly will not be replaced, in that no-one has found a better way of generating wealth or of improving living standards over the long term. It experiences shocks and crises from time to time, and it is partly a learning process. After each crisis it is modified to prevent the same happening again. But there may well be new and different crises in the future, and new ways will have to be found to deal with them.

Everything is consistent with the gender difference model

I think science works by proposing models and checking if data falsifies them. A popular model of gender in labour markets is that women and men are on average the same, but that they face discriminatory institutions and employers which lead to them having different outcomes.

Lots of data, on its face, seems to contradict this model: papers suggest that a man and a woman with the same job have the same pay; women earn (very slightly) more than men aged 20-40; women get promoted more aggressively than men if they don't leave the workforce; that women don't seem to rate discrimination the most important thing blocking their progress themselves.

But the model can be modified: let's say men and women are cultured by society into doing different jobs, that qualified women aren't promoted equally; that women earn more but only because they do more education; that so many women are pressured out that the ones remaining are actually much better than the remaining men so they are still under-promoted; that women don't want to speak out or that discrimination is hidden so they don't notice it.

But I wonder whether the model can contort itself enough to fit around these stylised facts:

• Srivastava & Sherman (2015) find that employees working under female managers do not experience smaller gender wage gaps.
• Charles (2011) finds that more gender egalitarian countries often have more sex-segregated occupations.
• Cech (2013) finds that both men and women enter fields that fit with their self-expressed characteristics, net of their beliefs about gender (i.e. even after taking those beliefs into account and controlling for them).
• Charles & Bradley (2009) found that people's curricular field choices are more sex-typed in more developed, egalitarian countries.
• Ceci, Ginther, Kahn & Williams (2014) found (among a huge number of other things) that the higher the average quantitative GRE score in a field, the fewer women were awarded PhDs in it.
• A 2015 ILO report found that women rate direct firm discrimination among the least important barriers in the way of their success in management.
• Gagliarducci & Paserman (2014) found that female-managed firms did worse on practically every measure, but that this was just because they managed different kinds of firms to men.
• Lippa, Collaer & Peters (2010) found that the more gender equal a country, the bigger the gap in mental rotational tasks (a key measure of visuospatial skills) between girls and boys.
• McGee, McGee & Pan (2014) found that male-female differences in competitiveness explain more of the gender wage gap in the NLSY97 (national longitudinal survey of youth that started in 1997) than in the NLSY79.
• Bertrand, Black, Jensen & Lleras-Muney (2014) found that the Norwegian law requiring all publicly traded firms' boards to be 40% or more female had no knock-on effects for women in general.
• Finally Schmitt, Realo, Voracek & Alli (2008) found that men and women differ across the world in personality, but most in developed countries where women have more rights and freedoms.

I bet you can make a model that fits, but that doesn't make it plausible.

Economic Nonsense: 27. Outsourcing harms the economy

Outsourcing involves the contracting out of a business process to an outside party, and usually involves something that the business could do, and maybe previously did do, in house. Far from harming the economy, it is usually beneficial, sometimes to an extraordinary degree. It can be domestic outsourcing where firms within the same country provide services to a business under contract, or offshore outsourcing, where part of the activities of a business are performed abroad.

Domestic outsourcing has many advantages. It enables greater specialization, in that it allows a firm to concentrate on its core function, and to have certain functions performed by outside firms that specialize in those areas. By specializing they often acquire the expertise to perform the activity better than the firm could have done itself, and at a competitive price. The firm itself need not meet the capital and overhead costs of performing the activity in-house, but simply pay for the services from others.

Offshore outsourcing is usually done to achieve cost savings. It enables a firm to employ lower cost foreign labour, and thus achieve lower prices for its own products. Many electronic devices such as mobile phones and music players have their assembly outsourced to cheaper countries. This enables the goods to be sold more cheaply in advanced economies, saving customers money to spend on other things. It thus boosts economic activity and makes both countries richer. The poorer country has its workers enter the global labour market and be paid wages, while the richer country receives lower cost goods.

Outsourcing can be beneficial to government when it uses the services of outside contractors to perform some of its functions. Ministers and civil servants are not necessarily (and not usually) particularly good at business, so it can make sense to hire outsiders who are better at it and who have a record of experience at it.

High top tax rates drive away inventors

There are plenty of reasons we might want moderately high top tax rates. If we do them cleverly (e.g. taxing consumption, not income, and definitely not capital or transactions) they can raise the revenue we may need for redistribution and goods everyone seems to believe only the government can provide, while not causing too many efficiency costs.

But there are also lots of reasons we might not want tax rates to go up too high. Eventually we pass the top of the Laffer Curve (it probably peaks when marginal rates + national insurance + benefit withdrawal + the tax rate effects of VAT + so on are roughly 60%, so about now) so we can cut rates and raise revenue—everyone benefits. Higher taxes means lower growth.

Another is that today's top 1% most skilled people are less rooted than ever before, and seem willing to work in Hong Kong, New York, Geneva, Paris, Los Angeles or wherever things are better. This means that changes in top tax rates can have substantial impacts. A new paper shows that this applies not just to bankers (witness the flood of French financiers to London) but also to top inventors.

"Taxation and the International Mobility of Inventors" (pdf), from Ufuk Akcigit, Salom Baslandze and Stefanie Stantcheva, finds that:

This paper studies the effect of top tax rates on inventors’ mobility since 1977. We put special emphasis on “superstar” inventors, those with the most and most valuable patents. We use panel data on inventors from the United States and European Patent Offices to track inventors’ locations over time and combine it with international effective top tax rate data. We construct a detailed set of proxies for inventors’ counterfactual incomes in each possible destination country including, among others, measures of patent quality and technological fit with each potential destination. We find that superstar top 1% inventors are significantly affected by top tax rates when deciding where to locate.

The elasticity of the number of domestic inventors to the net-of-tax rate is relatively small, between 0.04 and 0.06, while the elasticity of the number of foreign inventors is much larger, around 1.3. The elasticities to top net-of-tax rates decline as one moves down the quality distribution of inventors. Inventors who work in multinational companies are more likely to take advantage of tax differentials. On the other hand, if the company of an inventor has a higher share of its research activity in a given country, the inventor is less sensitive to the tax rate in that country.

The paper comes with some fascinating charts, showing just how many useful patents come from the most productive inventors.

It seems pretty reasonable that there are benefits to the UK of having productive inventors in the UK rather than elsewhere—although it may not come out as a net benefit to the world unless there are network benefits to the kinds of big agglomerations of research activity that are building up around Oxford, Cambridge, Manchester and London. But even if that isn't true, it goes to show that people really do respond to incentives.

Re-examining London's misnamed green belt

The momentum is building up for a change in London's housing policy after the election. The ASI published "The Green Noose" by Tom Papworth in January, showing that over a third of protected Green Belt land is devoted to intensive farming, by no means pretty to look at or environmentally friendly, and which in fact generates net environmental costs. In February London First published "The Green Belt - A Place for Londoners?" giving the facts and figures on London's land, and showing that only 26% of London's Green Belt consists of environmentally protected land, parks, and public access land. They similarly showed that only 27.6% of London is covered by buildings, roads, paths and railways.

In today's City AM Mark Boleat, policy chairman at the City of London Corporation, makes similar points, quoting the London First report, and pointing out that "a full 60% of the Green Belt is private agricultural land."

The research done by bodies such as the Adam Smith Institute and London First contradicts the popular image of the Green Belt as green and pleasant land. Far from the daisy-strewn meadows and woods teeming with wildlife that the term suggests, much Green Belt land is farmland, with monoculture fields by no means friendly to wildlife or accessible to people.

The first step in re-evaluation might be to classify Green Belt land into the different types that comprise it. There is genuinely green land, the fields and woods that everyone likes. There is damaged or brownfield land, partly made up of abandoned buildings, gravel pits and the like. And there is farmland, much of which is not environmentally friendly.

The government that takes office after May's election could take the initiative to redress a chronic shortage of housing where it is needed by allowing building to take place on land of types two and three, while leaving the genuinely green land preserved. The opposition will be much diminished if it is understood that only damaged, distressed or intensively farmed land will be affected. And more to the point, the extra houses will bring down the costs of housing and make it available to more people.

ASI's Budget 2015 wishlist: A tax code that actually makes sense

Nobody designing the UK’s tax code from scratch would come up with one like the system we have now. Our taxes are complicated and inefficient and divert capital away from productive investments that would boost economic growth. This year, we’re hoping for a Budget that reforms the tax code in line with the best economics out there, reforming the worst taxes and cutting the tax burden on investment and the working poor: VAT: broaden the base and use the money to help the poor

The huge number of exemptions to VAT make the tax so inefficient that if we raised the rate to 20% on every good we could compensate every household and still have a few billion pounds left over. If, instead, we raised every good to the 20% flat rate, but compensated only households earning less than median income, we'd have billions left over to reduce the deficit. The money raised should be given back to people on low pay through tax credits and to create a higher national insurance contributions threshold, which would increase the incentive to work on the other end.

Capital Gains Tax: abolish it outright to boost growth

Capital Gains Tax (CGT) is an extremely inefficient tax on capital that reduces overall investment and raises just £5bn annually. CGT reduces investment, 'locks-in' capital to less productive investments and can be avoided by not investing in assets that will rise in price, so it is distortionary and ends up directing investment away from riskier assets like start-up business debt. Scrapping CGT would not cost a lot (and could be paid for with the money left over from the VAT broadening, above), and would boost investment and growth, boosting wages across the board.

Business rates & council tax: revalue with a view to eventually merge

Business rates & council tax are in theory some of the least bad taxes on the books. As long as the values they are levied on are kept up-to-date, they reduce economic activity much less than most taxes. But in the modern world house prices and land prices move rapidly and not uniformly. The North is currently being hammered—paying business rates far higher than their property deserves—the South is winning out with unfairly cheap payments. Council tax is even worse: the band system is out-of-date and should be replaced with a fluid penny in the pound system like rates, while the revaluation long postponed from 1993 should be done now and then kept constantly up-to-date. If Zoopla can get good estimates of property values then surely HMT can too. Eventually the two systems should be merged at the same rate, so that housing and business both go where they are most in demand.

For further comments or to arrange an interview, contact Kate Andrews, Head of Communications, at kate@old.adamsmith.org | 07584 778207.

Economic Nonsense: 26. People lack the knowledge and ability to serve their own interests

There is an implicit assumption behind this claim that someone else does have the knowledge and ability to serve people's interests better than they can do so themselves. This is dubious, to say the least. People know more about their own character, about their circumstances and priorities and the things that they value. They also care more, for the most part, than others do. It is true that people are sometimes ignorant of such things as the consequences of their lifestyle choices, but information is freely available in the media. Scarcely a day passes without news items about the various types of food we eat or the benefits of moderate exercise. In newspapers and on TV, radio and the internet, there are stories about diet and drinking, smoking and exercise. People can pay attention to this information if they wish.

Even on more complicated issues such as pensions land life assurance, there is help available from commentators explaining the different options and giving advice. No-one is on their own on such matters because assistance and explanation are freely available from widespread sources.

Sometimes people make choices for short-term gratification at the expense of greater gain in the longer term. In a free country they are allowed to do this. It is possible that some people lack the willpower to sacrifice present comfort for future rewards. This does not give anyone else the authority to take the decisions out of their hands.

Middle class people have notably longer time horizons than their working class counterparts, meaning they are more ready to do things now that will benefit them in the future. They have different priorities, but nothing in this gives them the right to impose their priorities on others. When people make their own decisions about what they do, they are acting as adults, free to take actions and to accept the consequences they bring. When others take those decisions for them and impose their own priorities, they are treating people as children unable to look after themselves.

The myth of owing future generations

If you’re like me you’ve no doubt heard with great frequency the assertion that we owe it to future generations to make huge sacrifices in the present for the sake of the unborn, and that anyone who fails to accede to this maxim is bordering on moral turpitude. I find the argument that we are somehow indebted to our future generations quite absurd. Yes, of course we ought to be responsible citizens, and always be the least wasteful we can be, but the position that we have a moral duty to live as carefully as we can for their sake strikes me as a strange one to take. I think this view fails to consider one key thing – the enormous riches that the unborn will inherit from us. Look at the blood, sweat, toil, imagination and innovation that came from our ancestors to give us the kind of life we have today. As we keep increasing our skills and our ingenuity we bestow ever-greater riches for future generations.

Suppose I have a baby girl in a year's time, and I still live in the UK. Think what that child will inherit on the day of her birth: she enters a world in which she already has rich pickings of food, drinking water, roads, planes, and the luxury of plenty of leisure time. She also has a stable government, property rights, career opportunities, hospitals, entertainment, and thanks to the Internet, she has access to just about every fact that human beings have ever discovered, and to a vast proportion of other minds who she would otherwise have little chance of meeting.

Most importantly, though, she enters a world in which she'll be wealthier than any generation that has ever lived, a world in which she has the lowest chance of being involved in war, and a world in which the free market, science and technology will give her a quality of life unimaginable 250, 100, or even 50 years ago. All this she has inherited from this current generation and everybody's contributions that preceded them. So before people hastily wed themselves to the viewpoint that we are going to burden future generations with a partially ruined planet and legacies from our own carelessness, let's have a reality check and remember how the rich scientific and economic pageant of our past and present is a pageant from which future generations will benefit. When we express it in those terms, all this talk of our owing future generations is shown to be, at best, an exaggeration, and at worst, a laughable misjudgement.

Notice this irony too. Many on the left are always going on about redistributing wealth from the rich to the poor when considering people who are alive. Why, then, do they adopt the opposite approach to people who are going to be much richer than us? When it comes to wealth, prosperity and well-being, just as being born in 2014 is much more of a blessing than being born in 1914 – being born in 2064 or 2114 will (in all likelihood) be much more of a blessing than being born in 2014. Making sacrifices now for the unborn future generations is to transfer wealth from the presently alive poorer group to the unborn richer group – the very opposite of what those on the left support when the groups in question are alive in the present day.

I talked about what a great life my new daughter would be born into if she lived in my home city. I'm aware, of course, that these luxuries are not enjoyed throughout many parts of the world. If she was born in Ethiopia or Somalia the same couldn’t be said of her blessings. But ironically, the answer to this issue is the answer that shows why we should focus primarily on people suffering in the here and now. Efforts and costs expended for future people not yet born are efforts and costs that are potentially taken away from Ethiopians or Somalis now. Unless you think that Ethiopians and Somalis of a few decades time are going to be worse off then present day Ethiopians and Somalis (and if you do you're probably wrong) then deferring future considerations in favour of present day crises is both the right and most logical thing to do.

Because future generations are going to be more prosperous than us, and because it is both unethical and unwise to prioritise unborn prosperous people over present day plighted people. The trade-off between focusing on the present life lived by people of today against the future lives lived by people who are going to be our descendants comes down heavily in favour of focusing on the present life lived by people of today, as the prosperity and advancements enjoyed through the free market and through science continues to lay down the foundation of better well-being for those yet to be born.

Economic Nonsense: 25. With free markets the poor are left behind

No. It is the poor who benefit most from free markets. The expensive new products that initially only the rich can afford become cheaper as time passes until they fall within what most people can afford. Colour televisions were initially a luxury product for rich people, but there was money to be made so more producers entered the market. The competition spurred firms to develop cheaper methods of production and improvements in quality. Colour TVs are now something that even poor people in rich countries are expected to own. Many consumer goods follow the same trajectory; most recently smartphones have done so. Far from being left behind, the poor are pulled along by the progress that initially caters for the rich.

Free markets offer a great variety, a variety that includes high fashion items for wealthy buyers, but also serviceable and affordable versions for those not so well off. A Bentley is a very fashionable, high quality car with four wheels that enables its owner to get around. A Vauxhall is less fashionable and less high quality, but it has four wheels and enables its owner to get around. The rich eat caviar, while the poor eat the equally nutritious but less fashionable cod roe. The princess and the movie star can wear the latest couturier designed Paris dress; others can await the High Street department store version inspired by it a few weeks later.

On a global scale, the world's poor have made huge gains because of free markets. Hundreds of millions have been lifted from subsistence and starvation because global free markets have enabled them to produce goods or services that sell to people in richer countries. They have not been left behind because globalization has admitted them into markets and allowed them to advance their living standards.

No, Robots aren't taking our jobs

The impact of mechanization on human employment has been a long-held concern. Long before robodoctors, drones and self-service checkouts the Luddites waged war with technology, smashing and burning the labour-saving machines they considered a threat to their livelihoods. Today, people like Tyler Cowen predict that the rise of intelligent machines will result in a society where the top 15%  are fantastically successful and wealthy, but much of the traditional work of the lower and middle-classes is performed by robots and automation. Indeed, a much-cited 2013 study by the Oxford Martin Programme on the Impacts of Future Technology found that 47% of total US employment is at ‘high risk’ of computerization and could be automated within the next few decades. ‘Threatened’ sectors include transport, logistics and office administration, but surprisingly also the service sector, which is currently responsible for many of the new jobs created in developed economies.

Technological progress tends to have two differing effects on employment. At first there is displacement, as workers are substituted for new technology. However, efficiencies gained from automation often reduce prices, increasing real income and the demand for other goods. Companies will move into industries where productivity and demand is high and create new jobs, or use new technology to create new industries. Automation also frees up displaced workers to utilize their skills in other, potentially more fulfilling and creative ways.

Setting aside something like the singularity the economic impact of robots depends on whether they destroy more jobs than they create, and which section of society gains most from the opportunities they bring. At the moment, nobody really has a clue what  future economic impact robots will have. Even a survey of nearly 2,000 experts in robotics and AI found that they were split down the middle in terms of techno-optimism (believing that robots will create more jobs than they replace) and techno-pessimism (that the rise of robots will inevitably adversely effect a significant number of blue and white collar workers).

Until now, there’s actually been very little empirical work done on the economic impact of the use of robots.  However, a new paper — ‘Robots at Work' —from the Centre of Economic Performance at the LSE makes a welcome contribution to the field.

Using data from industries in 17 developed countries between 1993-2007, the report finds that ‘robot densification’ has no statistically significant effect on total hours worked over the period. This suggests that the use of robots has not (on net) resulted in less work opportunities for humans.

It has, however, had significant, and positive, effects elsewhere. The study found that the contribution robots make to economic growth is substantial, at 0.37 of GDP growth, and accounted for one-tenth of aggregate growth over the period. They also raised annual labour productivity by 0.36 points, comparable to steam technology’s boost to British labour productivity between 1850-1910. They also found that robot densification increased both total factor productivity and wages.

Industrial robots were used in under a third of the economy during the study period, and accounted for only around 2.25 percent of capital stock even within robot-using industries. The authors suggest that the likely contribution of robots to future growth is substantial, particularly when considering their potential impact in developing countries.

There is one note of warning, though — whilst the study found no overall impact of robot densification on hours worked, the use of robots did have a negative and close to significant impact on the hours worked by low-skilled workers, and, to a very small extent, those of middle-skilled workers. Presumably time will tell whether this is trend truly worthy of concern, and whether displaced workers are able to find alternative jobs elsewhere. For now, though, this study suggests that robots are tools which assist with and complement our jobs, as opposed to threaten them.