Whoda thunk it? A free market in banking means more competition!
Some economists, especially economic historians, have really consistently interesting CVs. You'll look at their publication list because you're interested in their work on the US experience of free banking, and you'll end up finding interesting papers on genetic and cultural diversity on economic growth. Prof. Philipp Ager at the University of Southern Denmark turns out to be one of these types. I came across Prof. Ager November 2013 working paper with Fabrizio Spargoli: "Bank Deregulation, Competition and Economic Growth: The US Free Banking Experience" (pdf) which has a very interesting finding that although US free banking led to more bank failures it also led to more competition and probably higher growth.
We exploit the introduction of free banking laws in US states during the 1837-1863 period to examine the impact of removing barriers to bank entry on bank competition and economic growth. As governments were not concerned about systemic stability in this period, we are able to isolate the effects of bank competition from those of state implicit guarantees.
We find that the introduction of free banking laws stimulated the creation of new banks and led to more bank failures. Our empirical evidence indicates that states adopting free banking laws experienced an increase in output per capita compared to the states that retained state bank chartering policies.
We argue that the fiercer bank competition following the introduction of free banking laws might have spurred economic growth by (1) increasing the money stock and the availability of credit; (2) leading to efficiency gains in the banking market. Our findings suggest that the more frequent bank failures occurring in a competitive banking market do not harm long-run economic growth in a system without public safety nets.
This is particularly interesting, because it suggests that even in a free banking system with fairly important regulations, free banking may outperform the alternative.
As Larry White details on the new blog alt-m most histories of US free banking miss out that many of the major distortions and problems in the US experience stemmed from regulatory interventions—especially restrictions on what kinds of collateral banks could accept and tight restrictions on branching, making banks much more vulnerable to idiosyncratic local risks.
My real issue here is not deciding what side is correct. Basically all of the thoughtful work concludes that free banking is better than the tightly restricted banking we have had outside of a few historical experiences. The 'evidence' I see against consists of stuff like this Philly Fed paper, i.e. nonsense.
My real issue is why this evidence isn't breaking through? Why are so many smart, knowledgeable people opposed to free banking? Why is the ruling tendency now towards practically outlawing bank/debt finance altogether in favour of steps toward equity financing everything? I don't have a good answer.
UK poverty is rising we're told: they're wrong
We're told today that poverty is rising in the UK. Apparently the baby eaters have decided to push into destitution yet ever more of the inhabitants of this sceptered isle. On the grounds, presumably, that they just hate poor people. This is not in fact true and this report doesn't show anything like that happening either:
Poverty in the UK is increasing after two years of heavy welfare cuts have helped to push hundreds of thousands of people below the breadline, according to an independent study of the coalition government’s record.
Although middle-earners saw incomes rise marginally after 2013, policies including the bedroom tax and below-inflation benefits rises have reduced incomes for the poorest, pitching an estimated 760,000 into poverty since the last official figures were produced, according to the New Policy Institute (NPI) thinktank.
The report itself can be found here. The reason the statement is incorrect is because they haven't looked at poverty at all. There is, by any historical or global standard of measurement, no poverty in the UK today. There is, of course, inequality, and this is what they are measuring. That number of people are, by their calculations, now getting under 60% of median income. That is, they are looking at relative poverty, not poverty.
Which is, of course, why inequality was renamed relative poverty (and the relative almost always immediately dropped) so that the terminally aggrieved would have something to complain about still. After all, how can you go on shouting about the horrors that capitalism afflicts on the poor when capitalism has abolished poverty?
Change the definition and carry on shouting, obviously.
Well, yes, this is what happens in recessions
Interesting new figures out from the TUC:
The coalition government has presided over the worst five-year period for living standards since modern records began more than half a century ago, according to the Trades Union Congress.
In an analysis based on data from the Office for National Statistics, the TUC said the 2010-2014 period was unique in seeing a drop in real household disposable incomes.
RHDI – a yardstick of living standards that takes account of incomes, benefits, taxes and inflation – was 0.6% lower in the half-decade ending in 2014 than in the five years ending in 2009, when it rose by 6.9%.
We have two responses to this. The first being that it was probably Done It Duncan who pieced this together:
Living standards are a key battleground in the general election campaign and in last month’s budget, George Osborne said on this same measure they would be on course to be higher in 2015 than when the coalition came to power five years earlier. The two measures differ because the chancellor was comparing a forecast with RHDI for the end of this year with RHDI in 2010, while the TUC is comparing an average of RHDI per head between 2010 and 2014 with an average of the previous five years.
We do rather wonder how many tweaks and variations Duncan had to make to his spreadsheet to get a version which showed a fall. However, there's another point to this, which is that yes, this is what happens in recessions. The economy becomes smaller. As a result the incomes of the people of the country fall. That's what all of these words actually mean.
"Living standards fall in recession" is about as startling as the claim "water is wet". So, err, quite what everyone is chuntering on about we're not quite sure. Unless it's an insistence that there shouldn't have been a recession in the first place and we're OK with that idea. Only that we can't bring ourselves to blame the people clearing up after a recession had already happened for the existence of a recession. That blame rather belongs to those who didn't prevent the recession itself we feel.
Woe and thrice woe as the decline of Britain is upon us
So we're told by an academic, must be true 'coz it's science, right? Britain is doomed to decline and fall because, well, actually, because us moderns just aren't up to much:
Britain is experiencing the same decline as Rome in 100BC, with the collapse of civilisation inevitable, a scientist has warned.
Dr Jim Penman, of the RMIT University in Melbourne, believes Britons no longer have the genetic temperament to advance because of decades of peace and a high standard of living.
He claims that the huge success of the Victorian era will not be repeated because people in the UK have lost the biological drive for innovation.
Instead, Britain is existing in a period similar to the decades before the fall of the Roman Republic where social tensions were rife, the gap between the rich and poor was increasing and extremism was growing.
Hmm, well.
We do think that in order to be able to do history well you need to actually know history. At which point a little putting of that huge success of the Victorian order in context is possibly needed. Per capita GDP, from 1700 to 1870, is usually estimated as having at 0.5% or so a year. Our experience of the 20th century was very much better than that. And here we are now, with GDP per capita over the past four years growing by 1.1%, 0.9%, 0.0% and 1.1%. This in the middle of what we all agree is the worst recession of modern times. We generally think that trend growth is 1.5 to 2% for this number.
Or about 3x that 19th century number, just if we keep generally rolling along without too much strain or effort. If this is failure compared to the Victorian success then bring it on we say.
The modest case for nominal income targeting
I think monetary regime options are basically a two-axis question: they go from maximally politically likely and least desirable to maximally desirable and least politically likely. The most politically likely monetary regime is the one we actually have: flexibly targeting CPI inflation at 2% per year. It's not the worst target in the world—it will prevent a great depression—but it allows deep recessions and slow recoveries like those we've been experiencing recently.
The most desirable monetary regime is free banking and private supply of money. But it's the least politically likely despite the evidence it lends itself to both monetary and financial stability. The monetary side of things—typically you see nominal income (total spending) grow stably or stay flat predictably under free banking, and a concomitant lack of harsh demand-side recessions and mass unemployment—suggests that we can find mid-points.
Thus, I spend my time advocating that we target nominal GDP—the total amount of spending/income/output in the economy measured without correcting for inflation—which I view as a spot in the middle. Less desirable than free banking but orders of magnitude more politically feasible and achievable.
There's one very Hayekian reason for this. The basic Taylor Rule framework that New Keynesian-dominated central banks use performs well only if those central banks can make good guesses of the output gap—the difference between actual output and potential. If they have imperfect information, then targeting nominal income works better.
Or so says a new paper, "Nominal GDP Targeting and the Taylor Rule on an Even Playing Field" (pdf) by two of my favourite economists, David Beckworth & Josh Hendrickson:
Standard monetary policy analysis built upon the New Keynesian model suggests that an optimal monetary policy rule is one which minimizes a weighted sum of the variance of inflation and the variance of the output gap. As one might expect, the Taylor rule evaluates well under this criteria. Recent calls for nominal GDP targeting therefore must contend with Taylor rule as an alternative approach to monetary policy.
In this paper, we argue that the information requirements placed on a central bank by requiring policymakers to have real-time knowledge of the output gap need to be taken into account when evaluating alternative monetary policy rules. To evaluate the relevance of these informational restrictions, we estimate the parameters of an otherwise standard New Keynesian model with the exception that we assume the central bank has to forecast the output gap using lagged information. We then use the model to simulate data under different monetary policy rules. The monetary policy rule that performs best is the nominal GDP targeting rule.
Previously I've argued that we might call nominal GDP targeting 'Hayek's Rule' because it would achieve his preferred view of macroeconomic stability—a stable flow of payments. But I think we have another reason to call it Hayekian—it emphasises the importance of information-constrained central planners, in this case of money.
Willy Hutton is starting to parody himself
Will Hutton's managed to argue himself into a most interesting little corner. He's been shouting for years that we need companies to be managed for the long term, not just for the short term interests of share traders. OK, not an argument we share (for the price of a share is the net present value of all future income, therefore it is a long term matter) but interesting in a manner. Hutton's also one who shouts about how appalling all this inequality is. And the rich shouldn't be allowed to own everything and other such generally lefty ideas. And then we get to this:
In fairness, part of Tesco’s problem is that Britain’s retailing landscape is being transformed by two different challenges – online shopping and discount retailers Aldi and Lidl, whose market share has doubled in the past five years to more than 10%. Tesco’s grandiose out-of-town hypermarkets are now stranded behemoths no longer attracting, as they once did, shoppers who now prefer to go online. Tesco has recognised the reality, stopped building new stores, closed others and written down the value of its fixed assets by £4.7bn.
But Aldi’s and Lidl’s success is rooted in something more profound than just capitalising on newly cost-conscious, financially pressed consumers. They are privately owned businesses that think long term and whose business purpose, enshrined by the owners, is to focus on a very narrow range of goods they can sell at high volumes and thus price incredibly keenly. British supermarkets, having to please shareholders with no such commitment, can never price so keenly even if they could match Aldi’s and Lidl’s logistical capacity and focus.
He's seriously arguing that it's better for everything to be owned by a few billionaires than it is for all of us, in a rather more minor manner, to be capitalists and owning the businesses of the country through our own savings and or pensions.
How on Earth did anyone nominally on the left end up advocating such oligarchic policies?
An extra reason to dislike deficits and government debt
On Wednesday, in a piece trying to set out the reasonable case for austerity, I made one argument against government deficits—they crowd out the private investment that really raises our living standards over time. I think this is true outside of exceptional circumstances when the economy is in a slump and the central bank is unwilling (or perhaps unable) to rectify the situation. But there is an important reason why raising taxes isn't a simple solution to the problem. Except for lump-sum taxies levied on natural ability (impossible) or existence (unpopular and possibly unfair) the government doesn't have access to any tools for raising money that don't distort the economy. Higher taxes lead to lower economic activity; lower taxes lead to higher economic activity.
If you or I or a firm incurs a debt, we (usually) have to work hard to create wealth to pay it back. That is, increasing private debt does not reduce economic activity. If it's used to fund consumption it's likely to increase it a smidgeon—if it's used to fund investment it's likely to increase it somewhat.
This is different when the government incurs debt. It sells a bond, which on the margin must be slightly more attractive than all other existing investment products, thus creating a bit of extra value for investors/savers. It eventually must pay these back through raising taxes or monetisation. Monetisation is bad, creates inflation or even hyperinflation, and thankfully in developed countries governments do not do this.
A country can 'grow its way out of debt' but only in the sense that the taxes required to pay the debt off are smaller relative to the size of the economy. £10bn less debt is still £10bn less (plus interest) in taxes. Eventually all debts must be paid off with extra taxes, whether you do them now or later.
These taxes reduce economic activity through their deadweight losses (presuming we're already levying efficiency-increasing optimal Pigovian taxes to fund normal expenditure). This means that extra government debt will lead to less activity than there otherwise would have been some time down the line, over and above its crowding-out effect on investment.
There's an interesting side-point here comparing tax-funded or deficit-funded spending overall. Should we borrow now and tax later or run balanced budgets all the time? This is another question—but my point is that either way we fund spending it's going to be costly.
Markets get around silly regulations
Advocates of free markets often bemoan all the regulation that firms are subjected to under modern neoliberalism. One thing they forget is that this is a sign that capitalism has won, not that it has lost! The debate now is about restraining or editing or improving capitalism, and never about overthrowing it. All the major officially anti-capitalist countries are gone or anti-capitalist only by name and not by nature.
But another thing you often see them overlook is how markets work their way around regulations and can effectively neuter them. Ban one financial instrument and if the instrument served a purpose, and is missed, you will soon see another instrument, technically different but substantively filling the same niche, creating almost as much value as the older one did.
According to a new paper from Stephen McDonald at Newcastle Business School, this also works for car insurance. In its ridiculous Test-Achats decision of 2011 the European Court of Justice decided that insurance firms can no longer use gender/sex as a risk factor to price insurance.
That is: the ECJ recognises that men have more accidents and women have fewer, so male drivers are more costly to insurance firms and society and women drivers are less. And that a random male driver is more likely to be costly to a given insurance firm than a random woman. But despite men driving more recklessly and women driving more safely, the insurance firm cannot use these true facts to price their services more efficiently. The decision was not even driven by identity politics and social justice rhetoric; since barely anyone thinks men are discriminated against.
Thankfully, markets have worked around the issue, and found proxies for gender they can use to eliminate most of the inefficiencies generated by forcing them not to use useful and important information. "Indirect Gender Discrimination and the Test-Achats Ruling: A Field Experiment in the UK Motor Insurance Market" (which Dr. McDonald kindly sent me a pre-publication version of; I hope he doesn't mind me quoting from it) shows us how.
Following the ‘Test-Achats Ruling’ by the European Court of Justice, firms in the European Union can no longer use gender as a risk factor to price insurance contracts. However, the Ruling allows factors correlated to gender to continue to be used, thus raising the possibility of indirect discrimination. This paper examines the effect of the Ruling in the UK motor insurance market where gender-sensitive pricing was previously common.
Using a difference-in-difference-in-differences estimation approach, it is found that gender is no longer used directly to price contracts, but that there is some evidence of indirect discrimination in which occupations are used as a proxy for gender. Specifically, it is found that prices for young (21-year old) drivers become relatively cheaper for those in occupations with a higher proportion of female workers, but increase for occupations usually performed by males. There is no evidence that this occurs for older drivers or that car type is used as a proxy for gender
Good old market mechanisms!
Four basic points on deficits
I'm (probably) going on Scotland 2015 later, to talk about Paul Krugman's views on deficits—i.e. 'do we really need to reduce the deficit?' Now there's no real reason why my economic views and arguments should be trusted over those of a Nobel prizewinner (it's a red herring that his Nobel prize was in the economics of trade; he has a widely-respected macro textbook and a number of widely-cited macro papers). But I do think my points hold water anyway. 1. Krugman is right that we didn't and don't have a debt crisis in the UK. When it comes to debt—like with many other things—I trust the markets. Markets aren't stupid; they aggregate the preferences and information of billions of people.
Look at Greece: it can only sell new debt at a high yield because markets are worried about the existing 200% of GDP they owe. The UK can sell debt very cheaply because the UK's debt level is more or less manageable and the UK has always repaid debts it's incurred, for hundreds of years.
2. Krugman is right that (extra) deficit spending can sometimes raise growth. Cutting taxes or raising productive government spending in a recession will raise growth, but only if the central bank is incompetent and (a) has let monetary-macro conditions fall below where they were expected to be; and (b) is unwilling to correct its mistake. Cutting taxes will also enhance efficiency and give the economy a supply-side boost.
3. Krugman is wrong that the UK is and has been suffering from a massive insufficiency of demand and needed to do more expansive fiscal policy. Firstly, fiscal policy is unnecessary or counterproductive when the central bank keeps the nominal economy stable with no monetary spurts or crashes.
The Bank of England lowered its policy rate to 0.5% and kept it there for over six years; it still rests there. It did a £375bn QE programme. Consumer price inflation hit 5.2% twice and stayed above target for five years. Do we really think it was willing to see inflation go even higher, but only if it came from extra fiscal policy?
In New Keynesian models a demand-driven slump is typically identified when you have low or negative growth and low or negative inflation. But we saw high inflation and low or negative growth. This suggests that there was a big supply-side problem—the 'productivity puzzle'—and that demand was not necessarily massively deficient.
4. There are reasons to reduce the deficit other than a possible debt crisis. At the zero lower bound—as Keynesians endlessly tell us—interest rates cannot fall further to induce extra borrowing to invest and consume. In fact, the zero lower bound may or may not exist (lots of European government bonds currently have negative yields). But even if it does exist, 99%+ of assets are not yet at the zero lower bound! This especially includes private firms' debts and equities, which are exactly where private investment comes from. And remember that private investment is how societies get richer.
By all means the government should borrow to fund investment projects that will produce above-market positive returns (although NB that these almost never exist except where the government has effectively outlawed private firms from investing in a given area). But bear in mind that borrowing to funding general government spending comes out of funds that could otherwise be used for private investment. It comes at a cost, even when Bank of England policy rates are near-zero and even when gilt yields are near zero.
So Krugman is right that we don't have a debt crisis (look at markets!); he's right that deficit spending can work (in weird circumstances); but he's wrong that the UK has suffered a massive demand deficit (look at inflation!); and borrowing comes at the expense of private investment (nearly no assets are at the zero lower bound & the zero lower bound may not even exist!)
Do patent-owners 'hold up' further innovation?
One of the standard arguments of the anti-patent crowd is that patents hinder follow-on innovation by making it risky or costly to build on other people's breakthroughs. There is some evidence for this (see this post from my colleague Charlotte).
However, a new paper challenges this general thesis by looking at whether the outcomes it predicts happen in the real world. If it is true that owners of standard-essential patents (SEPs)—those ones that set up a whole standard used across the marketplace and essential for a large number of follow-on innovators—charge over-the-odds fees and prevent follow-on innovation, then it must also be true that:
- Industries where SEPs predominate are ones with relatively stagnant (quality-adjusted) prices, because new entrant innovators have less chance to bid them down through competition
- Court decisions that reduce the power of SEP holders will lead to more innovation in those sectors
The paper, "An Empirical Examination of Patent Hold-Up" (pdf) finds neither of these to be true:
A large literature asserts that standard essential patents (SEPs) allow their owners to “hold up” innovation by charging fees that exceed their incremental contribution to a final product.
We evaluate two central, interrelated predictions of this SEP hold-up hypothesis: (1) SEP-reliant industries should experience more stagnant quality-adjusted prices than similar non-SEP-reliant industries; and (2) court decisions that reduce the excessive power of SEP holders should accelerate innovation in SEP-reliant industries.
We find no empirical support for either prediction. Indeed, SEP-reliant industries have the fastest quality-adjusted price declines in the U.S. economy.
The principle is nicely illustrated in this chart.
At one point there was more or less of a consensus among libertarians that intellectual property was a good kind of property rights. Nowadays you are more likely to see a proto-consensus against copyright at the very least and often patents as well. I think that emerging evidence means we should keep our minds open.