Markets are actually quite good at regulation

The ASI blog reader may not be surprised to discover that some regulations have unintended consequences that, instead of solving a given problem, make the situation worse. This isn't necessarily always true—though it might be, it's an empirical question—but it seems that regulatory fair disclosure laws, intended to make executives disclose more bad info about their firms, are another one of these. A new paper "What Induces CEOs to Provide Timely Disclosure of Bad News: Regulation or Contracting?" (pdf) by Stephen P. Baginski, John L. Campbell, Lisa A. Hinson & David S. Koo finds that regulatory fair disclosure laws lead to executives systematically guessing more pessimistically about the future. But the laws fail to stop executives delaying the release of bad news.

By contrast, they find that contracts including provisions for 'golden parachute' payments get rid of the career concerns which incentivise repressing bad news, and get around the asymmetric information problem that would exist in their absence.

Prior research finds that career concerns encourage managers to withhold bad news in the hopes that subsequent events will turn in their favor, and that government regulation (i.e., Regulation Fair Disclosure, or “Reg FD”) eliminates this problem.

In this study, we re-examine the effectiveness of government regulation at mitigating the delay of bad news, and consider the effectiveness of a contracting mechanism that accomplishes the same goal. We provide two main findings.

First, recent studies show that Reg FD changed the way managers provide forecasts in two fundamental ways: (1) managers are more likely to issue a range forecast that is pessimistically biased rather than a neutral point estimate, and (2) managers are more likely to issue forecasts at the same time as earnings announcements.

We show that when design choices do not reflect these changes in manager behavior, the extent to which regulation induces timely disclosure of bad news is overstated.

Second, we identify a compensation contract (i.e., ex-ante severance pay agreements) that firms use to explicitly reduce their CEO’s career concerns, and thus should encourage more timely disclosure of bad news. We find that if managers are promised a sufficiently large payment in the event of a dismissal, they no longer delay the disclosure of bad news relative to good news.

Overall, we find that managers continue to delay the disclosure of bad news after Reg FD, and that if firms provide compensation contracts to reduce their managers’ career concerns, this asymmetric release of information is eliminated.

Just like obscure traditions, market practices that look arbitrary, weird, or irrational are often one of the ways market institutions create a successful and rational economic order. Regulators need to be very careful before tinkering with them.

Finnish politics just got interesting

We think it's fairly obvious that over the past decade the most successful economy in the eurozone has been that of Germany. And we also think it's fairly obvious why this has been so, the so-called Hartz IV reforms. Which appears to be very much what the new Finnish likely Prime Minister believes in:

A millionaire former telecoms executive touted as a technocrat capable of rescuing Finland from economic slump won Sunday's parliamentary election, but he will likely need coalition support from a second-placed eurosceptic party critical of any more Greek bailouts.

Opposition Centre Party leader Juha Sipila, who advocates a wage freeze and spending cuts to regain Finland's competitiveness, beat pro-EU and pro-NATO Prime Minister Alexander Stubb after four years of policy stagnation and a bickering coalition.

Hartz IV looked at Germany's labour costs and concluded that they were too high for the productivity levels in the country. This therefore meant unemployment for some, low economic growth for all. The answer to this was to change the relationship between the costs of labour and the production from that labour.

It's worth nothing that this is one area of economics where there is no difference between the different schools. All will agree that involuntary unemployment is the result of wages being higher than the market clearing level. The arguments all start with why this is so (a supply or demand shock? Capitalist plutocrats screwing everyone? The banks have fallen over?) and then continue on into what should be done about it (raise demand in the economy? Increase educational levels? Lower wages?).

Dependent on the details of what is happening, something which is an empirical, not theoretical, question one of all of them could be happening, could be the right solution, at any one time. Germany then and apparently Finland now mapped it out and decided that it really was simply the general wage level that was too high. That was managed down in Germany and a decade of comparative success has followed (yes, we do have to limit ourselves to the eurozone economies in that comparison, given the burdens of the single currency). Here's hoping that the Finns have the analysis right this time and that the same solution works again.

Aren't these free market things just great?

Two little stories that caught our eye:

Morrisons is trialling a halal pick and mix counter at 10 stores, offering gelatine-free sweets to Muslim customers.

The selection of 36 sweets includes liquorice sticks, cola bottles, jelly beans, gummy bears and sugared lips - all guaranteed to be free of non-halal animal products or alcohol-based colourings and flavourings.

The lust for profits to be made by satisfying consumer desires leads to ever more product differentiation, even to sweeties that those who take their religion seriously can have.

And:

On May 12 it will be 10 years since Malcolm Glazer completed his hostile takeover of Manchester United, loading the business as he did so with the biggest debt in football history. At that moment, a group of United supporters turned their backs on the club they had long followed and decided to establish one of their own. FC United of Manchester they called it, a name now written large across the front of the main stand at Broadhurst Park, the club’s new home. As gestures go, this could not be more substantive.

When the new stadium opens officially on May 29 with a friendly game against Benfica, the 5,000‑capacity stadium, with its enormous terrace, its myriad community spaces and the area earmarked for a microbrewery to produce the club’s own ale, will surely be directing a belligerent architectural two fingers at the Glazer regime.

Don't like the capitalist plutocrats taking over "your" club? Great, start a new one, why not?

All without the intervention of a single bureaucrat.

We do not, by the way, insist that free markets solve each and every problem to perfection. Only that they work remarkably well across wide swathes of life. Which is why were so attached to them really, just because they do produce what people seem to want for the least effort.

Economic Nonsense: 50. Capitalism is unstable, subject to periodic crises, and should be replaced

Capitalism is not a fixed thing, but rather a process which develops and changes in response to changing conditions, and especially changing technology.  To say it is unstable is basically to say that it changes.  It is not by its nature stable.  The capitalism of the 21st century is very different from that which prevailed at the beginning of the 19th century.  It evolves as circumstances change, adapting itself to cope with the new realities that present themselves.

It is certainly subject to periodic crises.  The business cycle has long characterized it, with economists divided as to its ultimate causes.  Periods of growth are followed by periods of a sluggish or even contracting economy, with some observers suggesting that this is a good thing, helping to weed out underperforming businesses and redirect their capital to newer and more successful ones.

Over and above this cyclical behaviour, there are occasional crises that seem to threaten the whole basis of the capitalist economy.  The Great Depression was one such period, and the 2008 recession was another.  Critics look for some alternative that lacks these wild and damaging fluctuations.  No-one has yet produced a better system.  For all its flaws, capitalism is the best way humans have found to generate wealth and to allocate resources.  Even including its great crises, it has still produced steady average growth in developed economies for the best part of two centuries.  In less developed economies it has recently produced growth and wealth on an unprecedented scale.

Capitalism learns from these crises.  It adjusts itself.  Governments learn from the mistakes that led to them, and devise new rules to prevent the same happening again.  Capitalism develops and adjusts, renewing itself each time.

When the 2008 crisis came, critics prematurely celebrated capitalism's decline and wondered what might follow it.  The answer was capitalism, modified to prevent countries repeating the mistakes of the past.  It is certainly imperfect.  Most institutions made by humans are subject to the frailty and imperfection of humanity.  But they can improve by learning from their mistakes and adapting, and this is what capitalism does and why it endures.

Economic Nonsense: 49. Government was wrong to use austerity to deal with the 2008 financial crisis

Gordon Brown as Chancellor and Prime Minister spent money profusely, believing that he could spend the British people's money more appropriately than they could spend it themselves, and by a political desire to have a large section of the populace on state largesse and thus supportive of a party that promised big spending.  The result was to make the UK hugely indebted, with an annual deficit that required borrowing to sustain that spending and increase the debt year by year.

The coalition government that followed him took action to reduce the deficit by a reduction in government spending.  This was the so-called 'austerity' package, although some critics claimed it was more talk than substance, with reductions in the increase in the debt, rather than in the debt itself.

Crucially, though, the policy was not only one of austerity.  It was accompanied by quantitative easing (QE), or increasing the money supply to reduce the more baneful effects of austerity.  Latterday Keynesians claim that government should have increased its spending to stimulate demand instead of decreasing it to tackle the deficit.  Their critics in turn suggest that it is not demand by government that sustains real economic growth, but investment by businesses in anticipation of future private demand.

The United States followed a similar policy of reduced spending combined with QE, whereas the eurozone countries led by a cautious Germany did not.  They imposed austerity on the over-extended countries of Southern Europe, but without the QE used in the UK and the US.

Britain and America experienced significant economic growth after a few flat years, whereas the eurozone countries did not.  Anti-austerity campaigners have suggested that the recovery is weak, perhaps "not even real," but the evidence does not support this.  The empirical result suggests that the combination of austerity and quantitative easing has worked, but that the eurozone policy did not.  Significantly, the QE countries did not suffer the big rise in inflation which some critics predicted.  In 2015, the eurozone countries announced their own quantitative easing, some 7 years after the UK and US did so.

The conclusion has to be that government was right to use austerity and quantitative easing to deal with the crisis.  They did not repeat the mistakes that turned a recession into the Great Depression of the 1930s.

Economic Nonsense: 48. Labour Unions are essential to improve wages and conditions for workers

It is actually improved productivity, not labour unions, that has improved the rewards of labour.  People earned less money in former times because productivity was low.  People were paid according to the worth of their input into the production process.  When each worker contributed little, they were low paid.  As technology and production methods improved, so did the worth of each worker's input, and wages increased accordingly.

Employers compete for labour to produce goods and services and to make profits.  They have to pay wages that attract enough workers, and compete with other employers to do so.  It is true that unions can use coercive methods to impose higher costs on employers, but this limits total employment in those sectors, and thus opportunities for employment to non-unionized labour.  The US auto industry features somewhat higher wages in unionized car plants, but there are far fewer of them than there are non-union plants.

Although it is improved productivity that brings higher wages, the effect of unions is often to lower productivity through restrictive work agreements that spread work out among more employees.  More employees equals more members paying union dues.

In post war Britain, one group that received among the highest reward increases was the completely non-unionized sector of people who clean homes – the ones who used to be called char-ladies.  The demand for their services from businessmen and women who did not have the time to do it themselves, coupled with declining numbers available to do it, led to huge pay increases.

The fundamental truth is that unions do not increase pay for workers generally.  They can increase pay for their own members, but at the expense of non-members rather than at the expense of employers.  Declining union membership in both the UK and the US has been the result in changes in the type of work being done.  Mass manufacturing has become more automated, meaning higher wages for fewer workers, leaving others to seek non-unionized work elsewhere.  Some goods once produced domestically are now bought more cheaply from countries with non-unionized workforces.  The result is fewer union jobs.  In the UK unionization has increasingly become a feature of public sector workers rather than private industry.

Lies, damned lies, and electioneering statistics: wealth is just accumulating at the top

In my last blog, I lamented the rise of questionable facts in the election campaign, as politicians bid for votes. I used the claim that there is a “tide of privatisation in our NHS” as case study. I now examine the claim that “The last four decades have seen wealth accumulate at the top of society while those at the bottom struggle to get by." The rich are getting richer, but so are the poor

The world is getting better. Just look at three of the key UN measures of poverty and living standards.

• Since 1990 extreme poverty (measured as living on less than $1.25) has more than halved.
• Since 1990 the proportion of people without drinking water has also more than halved.
• Since 1990 child mortality (deaths under the age of 5 per 1000 live births) has – you guessed it - more than halved.

For more on our better world, read Matt Ridley’s classic The Rational Optimist.

What about poverty in Britain? It’s getting better too.

Since 1977 disposable income for the poorest fifth of households in Britain has nearly doubled (even after taking account of inflation and changes in household structures). With the recent turnaround in the economy, and greater incentives to work from welfare reform, the employment rate and average income of the bottom fifth should continue to rise.

Even measures of inequality have been relatively stable since the late 80s.

Income stats hide services the poor can consume from the state

Income statistics only tell some of the story though. The poor are better off than is initially claimed. Firstly, these income statistics and most others, focus on disposable income. They don’t take into account the wide range of services that the poor consume from the state, free at the point of use.

Income statistics are a static snapshot, they don’t capture generational gains

Secondly, income statistics don’t capture individual progress across generations. The young are poor, indebted and have no assets. The middle aged at the peak of their careers are richer, have paid debts off, own property and have made some savings towards retirement. The young will all one day become old and with time, have opportunities to better their lot.

Income statistics don’t reflect the benefits of innovation

Finally, income and wealth don’t reflect the great technological advances of the last four decades. People in Britain are vastly better off today thanks to innovation, particularly driven by the private sector. The poor consume more services as the costs of the basics has fallen as a proportion of income, and have access to new services altogether.

Take computing, which has gone from a luxury good restricted to the super rich and big companies, to being accessible to all. A gigabyte of data storage cost around £200,000 in 1980. Today I was able to find storage on amazon at just 3 pence per gigabyte - cloud services will even give you a load for free. In 1980 we didn’t have mobile phones, today there are 1.3 per person in the UK and 86% of people use the internet. The pace of technology adoption is speeding up too.

An honest debate would reflect on our success and focus on creating more opportunities

Economic Nonsense: 47. The state should pay for university education because it benefits society

University education benefits society in several ways.  A skilled, university-educated workforce can boost economic growth and make society richer than it would have been without them.  Less well-off and less well-educated people benefit from this, just as a rising tide lifts all boats.

The experience of going through university generally produces people who are not only educated in their chosen subjects, but who have been exposed to more cultural influences in the process.  Many people would think a society to be a better one if it contained significant numbers of educated and cultured people.  It provides more opportunities for intellectual stimulation and self-development.

All of this is true to some degree, and benefits society as a whole, but there is little doubt that by far the greatest value of a university education accrues to the person who undertakes it.  There is firstly the personal fulfilment that comes from attaining more of one's potential, but there are more material rewards as well.

Possession of a university degree in the UK increases one's employability.  For those in the workforce, aged 18-65, employment among graduates is 87%, as opposed to 70% for non-graduates.  Median salary is higher, too, with graduates on average earning £9,000 more per year than their non-graduate counterparts.  Over a working life this could top £400,000 of extra salary attributable to the degree.  

This constitutes an overwhelming advantage accruing to the individual who undertakes a university degree.  While there are undoubted benefits to society, those gained by the individual are high and measurable.  They make the loans undertaken to finance university, perhaps £36,000 for a 3-year degree, a very good investment indeed.

When people suggest the state should pay for this, they mean taxpayers should.  It seems strange that a person not equipped to benefit from university, someone who leaves school at 16 to become a bricklayer, for example, should be called upon to pay higher taxes so that someone else, already endowed with more academic and intellectual ability, should benefit from what amounts to a ticket to a higher salary for life.  

Some would call this unfair, and suggest that those who gain the most from university education should finance most of its costs.

Economic Nonsense: 46. Profit is a sign of exploitation

No.  Profit is the reward for investment.  An investor defers gratification and uses their money instead to try to make more money later.  Profit is the compensation he or she receives for doing this.  Part of it takes account of risk, the risk that the investment might not pay off or that the investor might lose the money they put up.  Part of the profit is reward for taking that risk.

The notion of profit as exploitation derives from a mistake made by Karl Marx.  He supposed that value resides in objects, rather than in the mind of the beholder.  Because he thought it resides in objects, he asked how it got there, and answered that value represents the labour it takes to make something.  A price charged above the value of that labour represents "surplus value," and is exploiting the workers who make the object.  Hence comes the notion of profit as exploitation.

In fact people value things differently, which is why they trade.  An object's value to me might represent the other uses I might have made of the money, had I not expended it in producing the object.  If someone values it more than that they will pay a price that includes a profit for me.  Far from being a sign of exploitation, profit serves a valuable human purpose in motivating people to produce goods and services that are of value to their fellow human beings.  It directs us to serve the needs of others in seeking a return for ourselves.  The butcher, the brewer and the baker might seek their own reward in terms of the profit they make, but in doing so they provide others with meat, ale and bread.

Profit is legitimate, and sends signals to others.  If some areas of production show high profits, others are motivated to enter that field themselves and bring extra production onto the market.  The competition with other producers will generally act to restrain or reduce the high profits.

Are EU scared?

One of the greatest fallacies of the Scottish independence referendum was that Scotland was being offered “independence”. Yes, we would have been independent in many respects. But the undisputed plan was to immediately begin re-acceding to the European Union. 

Whatever this meant - from fulfilling requirements to become a member again to no longer being one of the big players (usually meaning France, Germany and the UK) with a greater say than the other nations - we certainly weren’t going to be independent. 

It was not only concerning to witness it seldom questioned by Scottish people that we would be rejoining the EU - despite expecting an in/out EU referendum as part of the UK - but it is concerning, too, that the majority of pro-EU politicians don’t want to reform it or even to achieve a better deal for Britain.

What is more, there is a lot of scaremongering going on as fans of the European project say we couldn’t survive without many of our decisions being taken in Strasbourg. 

A new report authored by Ewen Stewart, Stuart Coster and Brian Monteith seeks to dispel the myths about the UK’s survival without the EU and explains why a Brexit would not bring economic isolation to the UK as scaremongering claims by politicians suggest.

The paper has five arguments to show why often-repeated political claims are intimidating the British electorate into shutting their minds to the possibility of change and preventing a rational debate taking place:

1. In reality, the EU is more dependent on being able to export to our significant market than we are on selling to the European Single Market.

2. There is a real threat to UK employment, influence and broader prosperity if we do decide to remain an EU member.

3. Our future economic well-being depends instead on gaining access and selling to the faster-expanding markets that lie beyond the EU.

4. Employment growth would be even stronger if Britain was free to adopt bilateral arrangements of its own, outside membership of the EU.

5. A growing percentage of cross-border issues and regulatory requirements are determined now by bodies at the global level.

A lot of research is looked into about the UK's performance in comparison to that of the European Union. And the conclusion reached is that British jobs are not dependent on the EU and so this is no reason to leave. Jobs would in fact be gained by leaving the EU.

The UK has performed much more strongly over the last 6 and 12 year time horizons that EU averages while 14 out of our 20 fastest growing markets are with non-EU nations.

We have global links with the Americas, Asia and Africa, as well as the Commonwealth, meaning it is perfectly possible that the UK could have good trading relationships with not just our European neighbours but the rest of the world by enabling trade policy to be determined at home.

The political stability of the UK, the English language and the rule of law coupled with secure property rights and a population that is by far and away the most diverse in Europe mean we will always continue to benefit from global growth.

If the Scottish independence referendum is anything to go by - scaremongering a population about change can make the positive arguments shine and usually backfires. Hopefully it does.