Another reason why Keynesian economics doesn't work

Let us imagine that this Keynesian idea that government should spend more money in a recession stands. Not that we'd want to give in to the case in general, but let us assume it for the moment. Why might it still not be a good idea to depend upon this tactic? As Larry Elliot explains:

The second drawback is that the investment – even assuming it happens – will take time to arrive. Every EU country has sent in a list of pet projects and these will have to be assessed by a panel of experts before a final list can be drawn up. This is a recipe for bureaucratic delay and the customary horse-trading as each country demands its share of the action. It is unlikely work will begin on a single project until 2016, when what Europe needs is an immediate boost to demand.

That could come in three ways. It could come from a more meaningful push from the centre, perhaps through the European Investment Bank. It could come from nation states if they were given more budgetary leeway by Brussels to run bigger deficits until growth has returned. And it could come from the European Central Bank through a quantitative easing process. The latter is by far the most likely and will dwarf in size what the commission has just announced.

Government, most especially at the EU level, is simply such a lumbering and inefficient giant that it's not possible for it to get such fiscal stimulus moving in the required timescale. Very much like the American experience of insisting that there were all sorts of "shovel ready" projects out there, then finding that government rules mean that nothing is ever shovel ready. There's always a year or more of paperwork to fill out before anything can be done.

With us still accepting the basic premise, that the deficit should widen, that there should be a greater gap between tax revenues and government expenditure in a recession, perhaps we should be looking for something that acts near immediately instead of increased spending? Like, say, an automatic reduction in national insurance payments in a recession? Like, umm, Keynes himself said would be a good idea?

Markets make us better people

One of the most common objections to market-based societies is that they erode non-market motivations to doing good. Critics, with this objection, say that although markets can in some areas latch onto greed and turn it to society's benefit in some areas ("It is not from the benevolence of the butcher, the brewer, or the baker, that we can expect our dinner, but from their regard to their own interest") they can also pervert and corrupt existing motivations in domains where markets are inappropriate. Consider blood donations: many argue that if you start paying for blood donations then people will stop seeing them as a good deed but as a market activity, and lose their 'intrinsic motivation' to give blood. Overall you might get less blood, or less good blood than before, even though you're now spending money to get it. Back in 2012, Harvard communitarian political philosopher Michael Sandel (famous for his online lectures), wrote a hugely popular book What Money Can't Buy: The Moral Limits of Markets making roughly these arguments (read a wonderful review here).

These questions are discussed widely, but what's weird is they tend to be tackled mainly with a priori thought experiment arguments like mine about blood, above, and anecdotes, even though they are empirical questions. We can actually test whether you get less or worse blood when you pay for it! (You don't) We can test whether people are less pro-social when you add extra market institutions!

A new paper by Björn Bartling, Roberto Weber and Lan Yao, "Do Markets Erode Social Responsibility?", in the Quarterly Journal of Economics tries to do as much:

This paper studies whether concerns for social responsibility persist in repeated market interaction. We develop a laboratory product market, in which socially responsible behavior by firms and consumers involves incurring additional production costs to mitigate potential negative externalities imposed on individuals otherwise uninvolved with the market.

The data from Study 1, conducted in Switzerland, show, first, that there is a non-trivial share of socially responsible products supplied and demanded in all our market conditions, and that—importantly—the market share of the fair product is stable over time in all conditions.

Second, the socially responsible product, which costs more to produce, sells at a price premium that persists with market experience. In most cases, this price premium increases over time, suggesting that consumers’ willingness to pay for socially responsible products is not eliminated with repeated market interaction. Third, we show that individual-level market behavior is consistent with a preference for positive social impact, though such concerns are heterogeneous.

In other words: markets do not erode existing pro-social motivation; they complement it.

Pay is determined by your best alternative job

Economic theory tells us that we really ought to be paid our marginal productivity. And no one at all believes that that actually happens in detail. However, we can take a step back to a point which even Karl Marx got, which is that your pay will reflect the demand for labour. More specifically, the better the alternatives you have the more your pay is going to go up. And here's a nice little story from the Frozen North to illustrate that:

There’s been a lot of attention paid to how Canada’s oil boom has helped make gasoline cheaper. What many people may not realize is that the boom is also driving up the prices they pay for burgers and steaks.

Surging energy investment in Prairie Provinces, home to most of the nation’s farms and cattle ranches, has boosted domestic crude output to a record and sent pump prices to a three-year low. That’s led to jobs on drilling rigs or pipe crews paying two-thirds more than those in livestock, luring cowboys and beef-plant workers to the oil patch.

By cowboy there they really mean more what we English might call a cowman, rather than some Bill Cody type. But it's obvious what is happening. There's no more to do out on the prairie than just oversee the creation of cowpats and that's driving up the wages of those who are there. It's the very same process that leads to a hairdresser making very much more money in the UK than one in China does: the pay of hairdressers is not determined directly by the productivity with comb and scissors, rather by the pay on offer in the next alternative job.

This doesn't mean that the economic theory is wrong though: only that it operates in a rather clunky manner and so is something that gets tended towards rather than an equilibrium state at which we all always exist. As higher productivity jobs appear then they will tempt away some of the labour force. And so all wages tend towards the productivity of the work being done.

At which point we might have a little snark about the UK. There's a lot of complaining going on that the jobs being created these days aren't very well paid, something which is true. But it's also true that the highest productivity jobs in the UK have for some decades been those in wholesale finance in The City. Which is exactly the sector that those same complainants are determined should shrink.

Just like oil wells push up wages for cowboys, so does shutting down highly paid jobs in banking reduce other wages in the same economy.

The plain truth about plain packaging

I suppose you have to try policies out before you conclude whether they've worked or not. But now we've tried out plain packaging and it didn't work according to its own aims, can we maybe give up on it? A new paper from scholars at the RMIT in Melbourne, aptly entitled "The Plain Truth about Plain Packaging: An Econometric Analysis of the Australian 2011 Tobacco Plain Packaging Act", and the first proper study of the scheme, brings the news.

Ronald Coase famously argued that if you tortured the data long enough they would confess. In this paper we have tortured the data, but there has been no confession. At best, we can determine the plain packaging policy introduced in December 2012 has not reduced household expenditure of tobacco once we control for price effects, or the long-term decline of tobacco expenditure, or even the latent attributes of the data.

To the contrary, we are able to find a suggestion that household expenditure of tobacco has, ceteris paribus, increased. In our forecasting exercise the actual data come close to breaking through the 80 per cent confidence interval. While we do not want to over-emphasise these results, we do conclude that any evidence to suggest that the plain packaging policy has reduced household expenditure on tobacco is simply lacking.

Of course, the ASI had already been suggesting this is the result we would find based on simpler analyses; and don't forget that it is not a costless policy. If smokers derive extra pleasure when they smoke from getting their cigarettes from attractive branded packets then this is a benefit of branded packets, not a cost. And note that underage or young smokers, typically short of cash, tend to smoke cheaper cigarettes—Richmonds and Mayfair were my friends' choices when they were 14.

Funnily enough, this paper's release coincides with new evidence from the Office for National Statistics that e-cigs do not bring non-smokers into the tobacco fold.

E-cigarettes are almost exclusively used by smokers and ex-smokers. Almost none of those who had never smoked cigarettes were e-cigarette users.

Not really a surprise. But then even if e-cig users did include some who had never smoked before, this doesn't imply that they moved from (safe) e-cigs to (dangerous) cigarettes. What's more e-cigs have a number of benefits, that I tried to sum up when the EU tobacco directive came up in April, as part of a case that the anti-smoking crackdown has gone too far.

1.  Nicotine has many substantial positive effects

2. Smokers overestimate the dangers of smoking

3. Passive smoking may not be dangerous (at least to women)

4. Smoking is social, enjoyable, creates identity and meaning, and relieves boredom

5. Lifetime health expenditure is lowest for smokers

(If I was writing today I might add 6. Smoking substantially reduces Parkinson's Disease risk, especially if you do it lots and don't stop and this is true for other diseases as well).

The point is not that we should all start smoking, although there is actually a good case that nicotine is a nootropic—see the first link above—it is more that smoking has substantial benefits to the individual (as well as the noted health costs), and relatively low net costs to society, especially when you factor in the huge amount smokers pay through tobacco taxes. When we turn 'smoking' into 'smoking e-cigs' the costs evaporate, probably entirely, and the benefits remain.

Cracking down on traditional tobacco may have gone too far—but cracking down on ecigs is crazy.

The problem with Pigou Taxes

As regular readers will know (often to their great annoyance) I am a great supporter of Pigou Taxes to deal with externalities: most especially a carbon tax to deal with climate change. More generally around here at the ASI we're all agreed that they're a very useful tool if not quite the perfect one stop solution economists sometimes portray them as. the problem being, well, it's the problem with so many things actually: politics. As an example, here's the latest little populist campaign being floated:

More than 30 MPs of all parties are backing a motion to stop charging Air Passenger Duty on flights for children who are between the ages of two and 11.

They say that families with school-age children already pay a premium for having to travel in the school holidays, and should not have to pay extra punitive taxes.

It's true that APD is set at too high a level which is one problem. The existence of an externality (in this case, emissions from flying) does not mean that that activity should be taxed at some punitive rate. It means that there is a correct level of taxation to apply to it. And it was several rises in APD ago that it was at that correct (Stern Review derived, $80 per tonne CO2-e) level.

So that's the first problem with a Pigou Tax. Give a politician an excuse to tax and he'll over-tax.

But the second problem is illustrated neatly by this current campaign. Assuming that emissions are a problem are those made by children flying any less damaging than those made by adults doing so? Not for any reason that we can see, no. Therefore there shouldn't be an exemption. But it's all too easy for a politician in the run up to an election to miss the point and purpose of such taxation and promise sweeties to the electors.

Politics really is a problem with Pigou Taxes.

However, this doesn't mean that they're contra-indicated, only that we've got to be both careful and precise with them. After all, all other taxes are subject to exactly the same political interference. But providing that we've identified an externality accurately we're at least doing some good with a Pigou Tax: which is more than can be said about taxes upon capital, corporations, incomes or general consumption. And yes, we do need to get the revenue from somewhere.

Do we really want Theresa May to decide who speaks at universities?

We already have a burgeoning anti-free speech movement coming organically from politically active students so perhaps it shouldn't be surprising that Theresa May wants to chip in as well, seeking the power to pick and choose who gets to speak at UK universities.

New powers for the home secretary to order universities to ban extremist speakers from their campuses are to be included in the counter-terrorism bill to be published on Wednesday, Theresa May has announced.

The bill will also place a statutory duty on schools, colleges, prisons and local councils to help prevent people from being drawn into terrorism, the home secretary said.

She said universities would have to show that they have put in place policies to deal with extremist speakers.

“The organisations subject to the duty will have to take into account guidance issued by the home secretary. Where organisations consistently fail, ministers will be able to issue directions to them “which will be enforceable by court orders”, May announced.

Since we already have laws against inciting violence, presumably these laws will not really help crack down on terrorism advocacy which says 'go and blow people up'; to be useful at all to courts and the government it must have a wider remit. Thus, it seems like more marginal 'extremist' figures will be targeted; not just Muslim clerics the government doesn't like, but perhaps pick up artists deemed to advocate violence against women, or perhaps anti-abortion campaigners (note what the UCSB professor called the poster-holding campaigner).

Practically every political viewpoint of today would have been judged inconceivably radical and/or extremist to almost anyone from 17th Century England. The benefits of free speech come from the free exchange of ideas, a process which often weeds out bad ideas and leaves good ones alive. To guarantee we enjoy their continued benefits we have to stand against even the smallest, least objectionable infringements made—wherever they come from. Even ugly speech must be protected if we are to enjoy these prudential benefits.

Even if free speech ought sometimes to be curtailed in general, to make some areas 'safe spaces' for unprivileged groups who would otherwise be made very uncomfortable, it seems like universities are one place where we are best placed to let it run wild—you would think that they are bastions of smart, open-minded free inquiry.

Theresa May surely realises from her struggles with the European Court of Human Rights that laws can have unintended consequences. It is surprising that she seems so unworried about handing future Home Secretaries the right to decide what speech goes on in our universities.

It's the minimum wage that's keeping youngsters out of work

From the Independent: 

The young are the new poor

The Independent - Cahal Milmo

A study by the Joseph Rowntree Foundation has warned that young adults and employed people are now more likely than pensioners to be living in poverty in Britain because of the surge in insecure work and zero hours contracts.

The reason for this is the minimum wage, which also explains why we have nearly 1m youngsters out of work entirely.

While the minimum wage for young people does not seem high – £5.13 an hour for 18-20-year-olds, and £3.79 for under-18s – the fact is that many young people do not provide that much value to an employer. Indeed, when National Insurance and other costs are added, the value of an unskilled young person is often negative. Young people have to learn the habits of work, turning up on time each day, the skills needed in the job, and 'soft' skills such as how to get along in a team with colleagues, how to deal with customers, how to react when things go wrong, and so on. It may take many years of training and job experience to lean these skills.

That is why for centuries we have had apprenticeships in which young people earn very little but learn a trade. But minimum wages – plus the heavy burden of workplace regulation which makes it very difficult to let someone go once they have been hired, however inappropriate they turn out to be – make employers more reluctant to take on people with few or no skills and experience.

The result is that minimum wages hurt those they are supposed to help. Employers do not take on young people, or those without skills, or those nearing retirement, or people with poor social or language skills, or ex-prisoners, or people with mental health issues, because their business cannot carry the cost of giving them the support and training they need to become more productive than the cost of employing them.

Welcome Sophie and Nick!

Sophie Sandor and Nick Partington are joining the ASI as gap-year employees for six months. We asked them to write this post to introduce themselves to our readers.

Sophie:

As I almost enter my third week with the Adam Smith Institute, I welcome myself as one of two new gap year students evolving in a world-leading think tank. And how thrilling it is to be here; immersed in the works of my favourite thinkers and a family of ambitious, intelligent minds. It really is the dream.

Crafting ideas that have changed our world before and will change it again. And if you love a challenge - even greater is the fun for the views we advocate are not the most popular or acceptable. Like our relationship with what we consume: we are not always attracted to the healthiest options. We are a consistent rebellion against common thought.

In my time so far I've witnessed eager 6th form students gather for our annual Independent Seminar on the Open Society, celebrated the 25th Anniversary of the Fall of the Berlin Wall with former European leaders and met and worked with a plethora of inspiring, hard-working individuals. I could not be more excited for my imminent future here and look forward to writing more about my educational and economy ideas.

Nick:

Having finished my A Levels in History, Politics, and Economics, not excited by the prospect of ‘finding myself’ while pretending to help build an orphanage in Mongolia, I decided to eschew ‘gap yah’ clichés and apply for the Adam Smith Institute’s gap year internship programme. Few places are as keen to engage with pre-undergraduate students as the ASI, and I am delighted to have been selected.

Being sceptical of what Jeremy Bentham called the “rhetorical nonsense” of natural rights theory, I admire places like the ASI which provide compelling justifications for a wide-ranging liberal programme quite apart from the vague philosophical assertions so often invoked by others. More than anything, I admire the ASI for so often saying the unpopular thing and holding the counterintuitive line against public opinion on so many issues. There are few institutions with the status of the ASI which approach consensus with such irreverence.

At the same time, the ASI makes prominent what I see as another powerful justification for free markets and the minimal state. For me, that classically liberal social and economic policy benefits those worst off in society is extremely important, and too rarely emphasised in circles on the liberal right (with one notable exception being Matt Zwolinski and the other Bleeding Heart Libertarians). Framed in this way, proposals such as freedom of movement across borders, sometimes dismissed by those otherwise passionate about reducing the coercion of the state, become powerful tools for ameliorating suffering in the most deprived areas of the world.

Working with and learning from the ASI's employees, all of whom do fascinating work on policy, is a rare opportunity. Added to that are the various things which come about from working in Westminster and being able to live in London for the duration of the position. I am looking forward to taking advantage of these while I am here because, perhaps unsurprisingly, there aren’t many Institute for Economic Affairs events on the flat tax in rural Northumberland.

Also, during my time at the ASI, I am hoping to write further about how and when ideas of meritocracy, debates in libertarian political philosophy, and utilitarianism can (and should) affect politics and policy research.

Err, yes Mr. Naughton, this is entirely the point

John Naughton, over in The Observer, is very worried about, err, capitalists being capitalists. Something of a pity really for someone, let alone a journalist, of his richness in maturity should by now have realised that this is the damn point of it all:

The real lesson of the Uber exposé, though, is that it’s time to discard the rose-tinted spectacles with which we have hitherto viewed these Silicon Valley outfits. For too long, they have been allowed to trade fraudulently on the afterglow of the hippie libertarianism that supposedly infected the early days of the personal computer industry. The billionaire geeks who currently run the giant internet companies may look and talk like a new species of entrepreneur but it would be more prudent to view them as John D Rockefellers in hoodies.

And the economic philosophy that’s embedded in this new digital capitalism is neoliberalism red in tooth and claw, which is why they minimise the number of “ordinary” (ie non-geek) workers on their payrolls, outsource everything they can, despise trade unions, view regulators as barriers to “innovation” and are outraged by the temerity of European institutions that seek to curb their freedoms of action.

Yes, exactly. Companies operate to the benefit of their shareholders. They're also pretty red in tooth and claw when they do so. And if that were all the economy were about then agreed, we consumers might not enjoy the experience all that much. Which is why we do our darndest to make sure that that's not all there is in the economy. The other magic ingredient we look for is competition. This means that we've any number of red in tooth and claw capitalist institutions trying to do the best for their owners and for their owners only. But they can only do this by offering us something that we think is worth it. Their proposition must offer us value: both in the simple sense that no one buys anything at all that they don't think is worth more than they are paying for it and also in the more detailed sense that competition means that the offering must be better than that of those others.

It's competition in the market that tempers that profit lust. Just as it's competition that tempers the inherent inefficiencies and producer capture of formerly monopolistic and non-profit making state services.

On that capitalist side of it this is the very point of the entire system. We want them to be sharp elbowed, nothing but profit seeking, neoliberals. Because only by producing something that we both desire and are willing to pay for can they become those billionaires (geeks or not).

This is not the right time for another pay claim by NHS unions

On Monday, NHS unions plan stoppages 'short of strike action'. It may not feel like it if your hospital treatment has been cancelled or you are lying in a ward with fewer nurses to look after you. The stoppages come after strikes back in October failed to move the government to raise its pay offer for NHS staff. A pay review body recommended a 1% increase for all NHS staff, but the government argues that this is unaffordable and unfair. After all, the 3% 'increment' rise puts more money into the hands of higher-paid NHS workers than lower-paid ones.And some 55% of NHS staff already get an annual 3% rise: so the government is saying that any extra cash for wages should go to the workers who do not get this. So it is proposing a 1% rise for the others, but not an extra 1% on top of the existing 3% increments.

Extending the 1% rise to all NHS workers, says the government, will cost around £300 million. Some 75% of hospitals' budgets is staff costs, so the extra cost that the union proposals would impose on them would mean cutbacks in staff – some 4,000 nurses lost this year, and another 10,000 next year. That could leave hospitals unsafe, risking another Mid-Staffordshire disaster.

Many members of the public would say that NHS staff should count themselves lucky. Average pay in the UK grew just 0.1% last year, and many businesses are hanging on by the skin of their teeth. But NHS pay has been rising since 2012. More than 5,000 nurses were recruited last year, and more midwives too. Public sector pay is generally higher than private sector pay for the same job, even before you count the more secure and higher public sector pensions. Lower paid workers, including those in the NHS, have been helped by the rise in the tax threshold to £10,000. Moreover, the £133 billion NHS budget – some 18% of public spending or over £2,000 per man, woman and child – is ring-fenced, so there is no chance of it falling – unlike the fortunes of most high-street businesses.

And if you want to know how bad things can really get, look at Portugal, which slashed its health budget 17%. Our public finances are not quite in that much of a mess, but things are still tight. The UK has economic growth of 3% but it is still fragile, and there are lots of things that could still spell disaster – a potential crisis in the eurozone, ebola, tension with Russia, you name it. The British government is 1.45trillion in debt, and adding to that debt by another £100 billion a year, despite creaming off 40% of the national income in taxes.

This just is not the right time for another pay claim. And certainly not for another Winter of Discontent (with images of ambulance crews dropping 'non-emergency' cases off in the snow to find their way home). The mind shivers. It is clear the government cannot budge, so why don't we all go back to work and try to get Britain out of this mess?