I really don't believe in macroeconomics you know

I've long been making the point that in the long run it's all microeconomics. How the world will look, the wealth of the people, the consumption opportunities, the technologies used, by our grandchildren will have almost nothing at all to do with whatever macroeconomics is practised right now. They will all, however, be hugely dependent upon the microeconomics we practise now. The incentives in the economy to innovate primarily. If we look at the economy over a couple of centuries, for example from Adam Smith's day to our own, seemingly vast macroeconomic events like the Great Depression are little squiggles away from the long term fundamentals.

However, I also am not sure that I believe in much of macroeconomics simply because we so often find people cooking the books. As seems to be happening in Italy: 

Beppe Grillo, leader of the opposition 5-Star Movement, has long hammered on this point. In April, during the post-election interregnum, he’d clamored for “the immediate payment of about €120 billion” that the government and public entities owed the private sector. The government’s refusal to pay its suppliers violates EU rules. But the EU has soft-pedaled the issue, for two very big reasons: payment of arrears would force Italy to sell a truckload of bonds when there might not be any demand; and it would push the deficit way beyond the 3% line in the sand. Thanks to cash accounting, only actual disbursements make it into the deficit figure. Italy has achieved its “austerity” goals by not paying its suppliers. Once again, abracadabra.

Isn't that simply ridiculous? The targets set are because there's a thought that excessive debt (and 130% of GDP can be thought of as that) can lead to a debt spiral: ever more must be borrowed to pay off the old borrowings. This borrowing, above certain limits, must be discouraged, even an insistence on bringing the outstanding stock down.

But having done this everyone then carries on and allows said debtor to continue to borrow. €120 billion is a substantial sum, even when talking about government money, and is somewhere in the 5-10% range of Italy's GDP. That they're running it up in unpaid bills rather than Treasuries makes it no less a set of debts that the Italian taxpayer is going to have to cough up for sooner or later.

Either more debt is a very bad idea and thus all this austerity is a good one, in which case the Italian state cannot be allowed to stiff its creditors. That's just running up the same debt by other means. Or, alternatively, more debt doesn't matter so issue the Treasuries and stop stiffing the trade creditors. But you can only have what the EU is allowing to happen, debt's a very serious matter but keep on running it up all the same if one is being entirely inconsistent.

Which is, as I say, why I'm not sure that I believe very much macroeconomics. They seem to be making it all up as they go along far too much of the time.

The problem with democracy

The public is ignorant about politics and lacks even the basic facts that it would need to make sound judgments about political issues. A new poll by Ipsos-MORI shows just how deep this ignorance is. Among other things, the poll found that:

• 29% of people think we spend more on JSA than pensions, when in fact we spend 15 times more on pensions (£4.9bn vs £74.2bn)
• 26% of people think foreign aid is one of the top 2-3 items government spends most money on, when it actually made up 1.1% of expenditure (£7.9bn) in the 2011/12 financial year.  More people select this as a top item of expenditure than pensions (which cost nearly ten times as much, £74bn) and education in the UK (£51.5bn)
• the public think that 31% of the population are immigrants, when the official figures are 13%. we greatly overestimate the proportion of the population who are Muslims: on average we say 24%, compared with 5% in England and Wales.
• people are most likely to think that capping benefits at £26,000 per household will save most money from a list provided (33% pick this option), over twice the level that select raising the pension age to 66 for both men and women or stopping child benefit when someone in the household earns £50k+.  In fact, capping household benefits is estimated to save £290m, compared with £5bn for raising the pension age and £1.7bn for stopping child benefit for wealthier households.

These are not just little mistakes, they’re absolute howlers.

This ignorance is perfectly rational and understandable. The problem is that these are the people who decide who runs the country. How can you choose the best set of welfare policies – ‘the best’ being what you would choose if you had all the information available – when you know absolutely nothing about welfare? How can you choose which of the two main parties is offering the best immigration policy if you haven’t got a clue about immigration?

Obviously, you can’t. And giving more power to well-informed elites seems even more foolish. Political psychology suggests that that the more information you have about something, the more resistant to new, contradictory information you are – or, in other words, the more dogmatically ideological you are.

That ideology is often dressed up in terminology that sounds neutral but makes significant assumptions about the role of the state and its ability to effectively solve society’s problems. Anyone for some ‘evidence-based policy’?

This is a problem not just for elections, but for any kind of administration of the state that gives experts decision-making power. If they are inherently dogmatic then giving them power may be even worse than putting every policy issue up to a referendum may be the lesser of two evils (while still being very unappealing).

The choice we have in a democracy appears to be between open-minded ignoramuses or well-informed ideologues. There is no reason to think that either will choose anything like the ‘right’ policy for any given problem. And, as Jeffrey Friedman has argued, unlike when you buy the ‘wrong’ flavour of ice-cream and can immediately buy a different kind next time, the feedback mechanism in politics is weak and difficult to discern.

The answer may be to recognise these crippling limitations of democracy and, wherever possible, prefer decentralized market mechanisms. We cannot solve the problem of ignorant voters or dogmatic elites in democracy, but we can at least try to take as much power out of their hands as possible.

Recognising that you've really turned into an economics geek: when you interview the kebab shop owner about the merits of clustering

I'm afraid that I must now confess to really having turned into an economics geek. From someone just interested to someone committed. I found myself interviewing the local kebab shop owner on the merits of clustering last week. I think that counts as falling over the edge, don't you?

There's two ways about thinking through the problem of where to site a retail store. One is, obviously, to site yourself where no one else is. You can then enjoy higher prices and margins as there's no competition. Sometimes people go to extremes, like truck money, where the workers are paid in money that can only be used at the company stores. Other times it's the village shop which can, possibly just, make a living by providing the conveniences that it's not worth going to the supermarket for.

Then there's an entirely opposite view: set up in business where everyone around you is doing much the same thing. Bond Street for expensive clothes, Hatton Garden for expensive presents for mistresses, just around the corner in a street whose name I have forgotten for arty and antique pieces. Sure, you're competing against the other people selling to the same clientele. But you're also all where that clientele can find you. The rich man will know where to go and wander about to find that necklace, picture or garter belt for his temporary inamorata. Or, perhaps more realistically, the younger and prettier half of any relationship will know where to spend the money of the other part of it. This is known as "clustering".

When I first moved to Lisbon I asked a friend where I should go to buy furniture: "this street" was the answer. I was a bit confused but that's how Lisbon retail (before the invasion of retail parks and centres) was laid out. Silver on this street, fish on that, furniture on the other. You browsed the shops knowing that all of the interesting places selling what you were looking for were in this area. Which brings me to kebab shops in Usti nad Labem (in the Czech Republic) where I am working now. Just around the corner from where I write is a kebab house. Been going some time, does a roaring trade (the bus stops that lead from the downtown bars to Studentville are just outside) and then a canny entrepreneur opened a new kebab store right next door. One friend here denounced that as cheating: stealing the business created by the first house.

So I asked Shadab (yes, there are hard working Indian entrepreneurs from Bombay doing this in CR just as there are in the UK), the owner of the original shop what had been the effect on his trade. Increased it, definitely. Competition does indeed mean that he gets less money out of any given amount of foot traffic: but competition can also increase foot traffic so that total revenues can rise for both suppliers. When I shouted "clustering!" he knew I was mad: and I of course knew that I had indeed descended into being a proper geek about economics.

Then again, I should have known this already. There's a reason why all the financial types are in The City. There's a value to knowing where all of the different ways of losing money are located, no?

Schools don't need a new curriculum, they need freedom

Today’s announcement of the reforms to the national curriculum have been met with both praise and displeasure from varying sides of the debate, with Anthony Seldon, head master of Wellington College, heralding the new curriculum as giving essential “building blocks” to allow children to progress with more complex ideas, whilst Brian Lightman, general secretary of the Association of School and College Leaders reacted more critically, suggesting that, “unlike previous versions of the national curriculum, which were drafted with a heavy involvement of teachers and school leaders, these proposals have been driven and closely directed by politicians without that professional input."

However, it is not the allegedly more demanding content of the curriculum which is concerning, nor the way in which many regard it as too heavily under the control of politicians rather than teachers themselves, rather, the continued way in which the government forces what it feels is right upon parents and school children, instead of giving them influence over what their own child learns. Not only does this exemplify the overarching nature of government in the UK, but the emphasis this new curriculum puts on force feeding facts to pupils, under the pretence of providing them with “core knowledge”, besides removing any individuality or element of choice, also is likely to reduce interest in the subjects amongst the pupils, as its less independent nature prevents the students from taking the initiative and developing their study into areas which interest them.

Furthermore, this “one size fits all” approach to the curriculum does not take into account those children with special educational needs, who are approximately 20% of the student body in the UK. This only highlights the problems with the inflexibility of the government and this new curriculum, and shows the need for more choice within schools and for parents to allow them to ensure that all children can receive an education appropriate to them.

Fortunately, this new curriculum is not being enforced on the country’s academies, whose independence allows them to better provide for children individually. However, it must not be forgotten that in fact, although the government has less direct control over academies (e.g. they are not subject to the new curriculum) this may be replaced by the influence of the academy’s main sponsor, rather than parents, so they may not be ideal for providing a more independent education.

Whilst academies are not necessarily the only or ideal solution, currently they appear to be the best available option, due to their relative independence. In addition the way in which they specialise in one area of study allows parents to find a school more closely in line with their children’s strengths and weaknesses. On the other hand they have been criticised as being too selective, meaning that schools choose pupils, rather than the other way round, removing their key justification. Therefore, although they are a step in the right direction, more needs to be done to create both a more flexible curriculum and school system, as while they make up over 50% of English secondary schools, they represent only 13% of the overall maintained sector, which badly needs an injection of freedom.

Chart of the week: Portuguese bond yields jump as government falls into disarray

Summary: Spike on Portuguese bond yields show euro crisis not over

What the chart shows: The chart shows the yield on the Portuguese 10-year benchmark government bond; and the difference (‘spread’) between the yield on its German equivalent

Why is the chart important: With the (admittedly significant) exception of the Cypriot crisis earlier this year, the euro area has been relatively calm since ECB President Mario Draghi last summer promised to do ‘whatever it takes’ to save the euro. However, in the first week of July, there was a brief eruption in Portugal, where the Finance Minister resigned due to the country’s failure to reach its fiscal targets; and the Foreign Minister then resigned because he disagreed with the Prime Minister appointing a new Finance Minister who vowed to continue austerity instead of pushing for growth. But Portugal was the ‘troika’s’ star pupil – doing everything asked of it without complaining. Failure to achieve targets raises a question mark over the entire austerity policy pursued in the euro area; and the rise of politicians in a ‘model country’ questioning it means that the days of austerity – already eroded – are likely to be numbered.

Unintended consequences in everything

Home insulation promoted by the government may end up killing old people in their homes, apparently (hat-tip to Chris Snowdon):

Prof Chris Goodier, of Loughborough University's department of civil and building engineering, said it was vital that homes in the UK better insulated to help meet carbon emission targets and save on winter fuel bills.

But he said the risk of overheating had been overlooked in the "big rush to insulate and make homes airtight", particularly as more extreme weather events, including heatwaves, are being predicted for the UK by meteorologists.

"Overheating is like the little boy at the back of the class waving his hand. It is forgotten about because the other challenges are so big,"

This is nothing to sniff about. Back in 2003, a staggering 70,000 people died in heat-related deaths during a Europe-wide heatwave, partially caused by elderly people living in homes designed to withstand cold winters instead of extremely hot summers.

That heatwave was widely attributed to global warming, which the 'Green Deal' home insulation is meant to stop. But this sort of unintended consequence shows the danger of imposing any one 'solution' to problems in complex systems. If the 'solution' causes problems of its own, those problems will be compounded across a much wider area than if different 'solutions' had been allowed to emerge from the bottom up.

Where there are collective action problems like global warming, the simple solutions that adjust incentives and let the market try lots of little things out (like carbon taxes) beat the grand plans of Very Clever People who cannot possibly know the full consequences of their actions. Of course, even things like carbon taxes may have their own unintended consequences too.

The NHS is going to have a £30 billion a year funding gap apparently

Woes, woes unto us, eh?

The long-term crisis in NHS finances will be laid bare next week when the health service reveals it is facing a £30bn hole in its budget – as a prominent Lib Dem peer suggests charging people to see their GPs. Tim Kelsey, NHS England's information director and a former Cabinet Office adviser on data, said the health service faced a £30bn funding gap by 2020. In an interview with Health Service Journal he said: "We are about to run out of cash in a very serious fashion." He said that next week NHS England would be "publishing a call to action". The document – entitled The NHS Belongs to Us All – is expected to make the case for significant changes to the way hospitals operate. "The financial context is, and our analysis will disclose, that by 2020 there will be a £30bn funding gap in the healthcare system." NHS England's predictions appear to be based on work by the Institute for Fiscal Studies. Last year it calculated that if NHS spending was left to continue to soak up resources at its long-term rate and other on-health public spending is kept at 1% a year, then the funding gap would be about £30bn. When contacted NHS England confirmed that it would be publishing a report next week. "We are not in a position to say more at this stage," it said.

I'm not sure that I can take this. It will mean more Polly Toynbee columns about how the NHS is The Wonder Of The World, so fabulous that absolutely no one has ever tried to copy it.

Now unpack what they've actually said there. NHS inflation has been and is higher than the general inflation rate. This is partly because it's a protected State organism and partly because of Baumol's Cost Disease: services become more expensive relative to manufactures over time.

The solution to both of these problems is to introduce markets. Sure, they can be markets where the financing is still done by the State. But you need a variety of suppliers competing with each other for access to that cash stream in order to increase that productivity. This is obviously true of any organisation suffering from bureaucratitis: but it's also implicit in Baumol's writing on innovation. Yes, it's more difficult to increase productivity (and thus lower the inflation rate) in services but this is why services need to be subjected, even more than manufacturing, to the incentives of market competition.

That the NHS is going to suffer, as a result of its higher than general inflation rate, a £30 billion funding shortfall is why the NHS needs to be subjected to market competition. But do note that given that it is being subjected to market competition its higher inflation rate is going to be moderated: thus there won't be the £30 billion shortfall.

If you prefer, that identified shortfall is exactly why the current reforms must go through: because they're designed to beat that shortfall.

Now, if only we could get Polly to grasp this concept....

When the khat is away, the mice will play

The government still hasn’t got the message. On Wednesday I saw that Theresa May has decided to ban khat, a herbal stimulant popular among Somali, Yemeni and Ethiopian communities. This goes against advice from the government’s own Advisory Council on the Misuse of Drugs (ACMD), which claimed there was “insufficient evidence” that khat caused health problems.

I agree with the ACMD that khat should remain legal, but for different reasons. The legal status of recreational drugs should not be decided by their healthiness. They should all be legal. Individuals should be free to harm their own bodies if they wish to do so. The government should be limited to providing information about the risks, providing customer protection through licensing and quality control, and helping those who struggle with addiction.

With this new ban, khat will go the way of other recreational drugs. Where there is demand, there will be a supply, regardless of the government’s ban. People who want to buy khat will now have to go through the black market. They will become involved with drug dealers who they would otherwise have no business with. These dealers will be unregulated, of course, so there will be none of the customer protection found in a legal market.

The BBC report says: "Somali groups in the UK had told the ACMD that use of khat was a 'significant social problem' and said it caused medical issues and family breakdowns."

Banning khat will likely exacerbate this problem. People whose khat habit is causing a problem will be less likely to seek help, for fear of being branded a criminal and punished by the state. The real problem is pushing the drug business underground. Dealers are risking years in jail for responding to a legitimate demand, so the incentive to obey other aspects of the law is limited and some have no qualms about cutting the drugs with more harmful substances, or assaulting their customers to keep them obedient.

These dealers would not exist if drugs were legal. I realise that while cigarettes are still legal, there is a significant black market in them. This is mostly due to the huge taxes the government hits them with: 82% of the price of a packet of fags is tax. But when recreational drug users can only get their highs illegally, the black market is much bigger. As ever, the example of alcohol prohibition 1920s USA is illustrative.

Finally, legalising recreational drugs would help the government’s finances as well: the tax revenues would be huge. In 2011/12, the government received £2.8m through taxing khat. That was £13.8m worth of khat - the overall drugs market is estimated at between £2.15bn and £6.54bn. But instead, the government ignores advice it has requested, as it did in the case of ACMD chairman David Nutt in 2009. Nutt himself uses a clever analogy to refute the khat ban. But it seems that the state’s illogical control freak attitude will stubbornly persist.

The government should legalise not only khat, but all other recreational drugs. This would correct the current infringement on liberty, make it easier for addicts to get help, bring in tax revenue, and destroy the black market and related crime.

Making it easier to fire workers really does lower the unemployment rate

We're all used to the idea that making the labour market more flexible, which is a code for making it easier to fire workers, lowers the unemployment rate. I think we've all also seen the counter-argument that this is tosh. It's never quite laid out why it is but it must be so there. Fortunately we've now got some more empirical evidence to bolster our case about flexibility increasing employment:

Using 1981–2009 data for the 50 states, this article examines the relationship between economic freedom and the unemployment rate, the labor force participation rate, and the employment-population ratio. After controlling for a variety of state-level characteristics, the results from most specifications indicate that economic freedom is associated with lower unemployment and with higher labor force participation and employment-population ratios.

The advantage of American data is that the various states are rather closer together in their overall culture than are the (fewer) countries of Europe. It's thus easier to see the effects of variations in economic freedom without having too much confounding data. But there we have it, greater economy freedom, including those hiring and firing laws, leads to lower unemployment. We should thus be deconstructing some of our own wasteful regulations and laws around this point in order to lower our own unemployment rate.

I'd also make a rather more speculative point. Why is it that people don't want to believe this finding? As above, we've known it for a long time but there's a great reluctance to believe it. And I think it's because people really don't understand the job churn in the economy.

If you think that a rise in unemployment of 100,000 means that 100,000 people have been fired then you might well think that making it harder to fire people will lead to a reduction in the number of people in unemployment. But the truth is that this isn't what causes a rise in unemployment at all. There are always 100,000 people getting fired. More than that actually: some 3 million jobs, or 10% of the total, are destroyed in the UK economy each year. That's that destruction part of capitalism. This rate doesn't, particularly, rise in recessions nor fall in booms either. That's a reasonably constant rate at which the economy destroys the things that people do for a living.

What does change in a recession is how many new jobs are being created: thus the balance, between those fired and those hired, changes. The actual unemployment numbers that we see are the end result of this complex process. If unemployment rises by 100,000 in one month it's not the result of 100,000 more people being fired. It's the result of 100,000 of that (roughly) 250,000 who get fired every month not finding a new job. Unemployment isn't best thought of as a result of people being fired therefore: it's a result of people not getting hired.

At which point the economic freedom argument begins to make intuitive sense. The more economic freedom, the less regulation stopping you from doing things, the more things will get tried and done.The less the cost of firing an undesired worker the more of them will be hired: demand curves do indeed work that way. So far so true: my speculation is that those who don't get this point are those who don't really understand why unemployment occurs. It simply isn't because people get fired because people get fired all the time. It's that they don't get rehired at times which is what causes unemployment.

Why an opt out system for kidneys still won't work

Ben had an interesting idea yesterday: let's make organs the property of the State for them to allocate, as the State wishes, after our deaths. Even to the point that those who wanted the corpses of their loved ones buried intact would have to pay the State the value of those organs that would go unused. "Interesting" here includes the meaning of "how do I get a rise out of my readers" and by that measure it was indeed most interesting. However, by another, it's not so much. For the problem with the proposal it that it just won't solve the perceived problem. Not enough people die healthy enough for us to have enough organs to transplant.

Our basic problem is that people die as a result of our being able to perform organ transplants but there aren't enough organs available to perform such transplants. Not enough people carry organ donor cards and some of those that do their families demur when asked at that crucial moment. Thus it seems logical enough that we should move to a different policy in order to save those lives. We should have opt out systems: only those who feel strongly enough about rotting with their kidneys and have indicated that desire should be able to do so. Or even, as Ben intimates, that those who want to rot complete should pay the loss to the person whoi doesn't get the transplant as a result of said desire.

And yes, it's all ghoulish and yes there are considerable civil liberties implications: but we should indeed float such ideas to see where they go. The problem is that even if we did this we still wouldn't have enough organs for transplant. For you've got to die pretty healthy for it to be possible to use said organs: no one with any form of cancer can be used for example. No one with a variety of infectious diseases. By the time anyone's got dementia there's little point in trying to use parts of them and heart disease has its own problems: the process of dying this way can damage the organs that are desired.

Effectively we're left with that small group of people who die in accidents. There are certainly enough people who do to cover the simple number of organs desired even if some parts will be a little too squished (that being the cause of death) to be useful. But once you count in the necessity for blood type matching (and it's a lot more complicated than just O, A or AB etc) and tissue matching that's just not enough people to go around. Even if all organs of the deceased were indeed State property to be allocated: there still aren't enough.

So Ben's solution fails at the first hurdle: whatever the moral implications, it still doesn't work. Cadaveric transplant just isn't enough.

Which leaves us with two options. One would be to increase the number of cadavers. Perhaps abolishing the motorcycle helmet and car seatbelt laws. That would probably help, might even solve the problem. Plus we've the obvious benefit that this is an increase in freedom and liberty.

The other is that we should move to a paid market in live organ transplants. I've pointed this out a number of times before.

In terms of what we can transplant corneas we're fine with under the current system. Kidneys, lungs and livers can all come from live donors (no, really, you take a bit of the lung and a bit of the liver). And I've no problem with it being a very tightly controlled market, State controlled, but in order to get them to come forward we're going to have to offer cash rewards. About the only one we can't deal with at present in this manner is hearts. But then compulsory donation unless a fine is paid wouldn't solve this one either. And once we've solved as best we can this problem, through our paid market, then there's no need to go around thinking about making all corpses State property, is there?