Peru: an argument for competition in currencies

If only we had introduced the Hard Euro, as the UK Prime Minister at the time, John Major, had suggested! Sadly his proposal came just too late, as the EU Euro enthusiasts were already pressing ahead with their own plans to create a single, Euro, currency that would replace domestic currencies such as the Frank, Mark, Lire and of course Drachma. John Major’s idea can be seen working perfectly well here in Peru, which I have been visiting for the Mont Pelerin Society conference in Lima. Being close to the US in terms of trade, and reasonably close – well, in the same hemisphere – in terms of geography, and having a border with Ecuador, which uses the US Dollar as its currency, US dollars circulate quite freely here, alongside the domestic currency, Soles.

Dollars are most obvious in the capital and in tourist areas, and indeed the ATM cash machines at the banks will dispense them in everyday quantities. They are commonly accepted, particularly for larger transactions.

The result is that there is a competition between currencies, Dollars and Soles – just as Hayek proposed in the 1970s and as Robert Miller outlined, in a recent Adam Smith Institute paper ‘What Hayek Would Do’.

The effects are interesting. Because of the prevalence of Dollar usage, there are limits to the extent that the monetary authorities in Peru can overextend and devalue Soles. They know that if their currency loses its value, more and more transactions will be done in Dollars. We used to think that there would need to be a difference of perhaps 5% or more (and perhaps a widespread feeling that the gap would widen) between the value of competing currencies in order for people to shift from one to the other: which made a lot of people say that competition in currency would not work, because it would lead to big wrenches from one currency to another.

But the opposite seems to be the case. As one currency loses a bit of value, more and more people make their transactions in the other. The marginal differences in people’s currency use is enough to keep up the pressure on the domestic authorities. And the authorities know that they have no influence on the value of the Dollar – the value of which might, at any point, become inappropriate to local economic conditions – so the last thing they want is people rushing to take out Dollar loans and relying too heavily on Dollars, since then the authorities would lose all control over monetary conditions.

Equally, the public are pretty savvy about their finances. Announcements from the Federal Reserve in Washington lead to radio chat shows in which people debate whether they should be taking out mortgages in Dollars rather than Soles. Just the sort of competition that Hayek might have hoped for – no big wrenches, just lots of individual decisions made at the margin.

Wouldn’t that be nice in Europe? A currency that had to prove its worth to people by being at least as good, and maybe slightly more solid, than their own, and which people could choose (or not) if they desired. Indeed, even in non-Euro countries like the UK, it would be rather refreshing for people to have the choice over which currency they used. It might have moderated the reckless expansions of the early 2000s and made the post-2008 adjustment very much quicker and less painful.

Bonkers '£ campaign' back again

Nutty import-exporter and top Labour party donor John Mills is back with 'the £ campaign'—his wacky attempt to try and ignore all we know about economics and magically devalue the pound to make the UK wealthier. I enjoyed the email he sent me this morning:

The reason why we have such a large government deficit is not because of government extravagance but because we have a balance of payments deficit of approximately the same size. As the Bulletin explains, one is very largely a mirror image of the other. In these circumstances, cutting expenditure or increasing taxation will not reduce the deficit. Instead the impact will be to tip the economy into recession, while welfare expenditure goes up, the tax take falls, and the deficit stays the same size as it was before.

The solution to getting government finances in order is to get the balance of payments deficit down by rebalancing the economy towards export and import substitution led growth. Nothing else will work, which is why we ask you to support the policy changes which we need make to ensure that we can pay our way in the world. As the attached Bulletin explains, When we no longer have a huge foreign payments deficit the government’s financing problems will simply melt away without the need for any austerity policies.

John Mills fits the mould of a rich businessman that gets ahold of one economic concept and just runs with it. Thankfully the Treasury and Bank of England, for all of their faults, are not crazy and Mills is unlikely to actually affect policy.

Devaluation does sometimes work—John Mills is not completely wrong—but not at all for the reasons he suggests. Devaluation works because it's a good way of generating inflation when you're in a slump to clear markets held up by sticky wages. That's in a world of fixed exchange rates.

But in a world of floating exchange rates you can't just decide to change your exchange rate, you have to do something to get there. We could get the Bank of England to target a cheaper pound, but this is exactly the same as getting it to target higher inflation. The way it will get to a cheaper pound is by buying up loads of foreign currency with newly-printed pounds.

This is just quantitative easing where you buy foreign currency not government bonds! And since buying up a given asset doesn't actually signal different investor preferences, market actors are just going to 'portfolio balance'—try and hold the same real portfolio they held before. This means that it doesn't matter what asset the Bank of England buys, really! Buying dollars is the same as buying gilts.

So if John Mills is calling for a bit more QE, maybe that's not a terrible idea—but devaluation will not do what he thinks it will do.

Unite's interesting little report on NHS privatisation and tax

Unite, the union, has released a small little reportette on the tax positions of those firms that either have or are bidding for contracts to deliver health care services to the NHS. The so called "privatisation" of the NHS. Apparently it would be very bad if people who provided these services did not pay lots of tax. You know, in the manner that the NHS itself pays lots of tax. Given that the report is written by Richard Murphy we know that there's going to be logical problems contained within it. It's just that we need to work out which mistake he's made this time rather than wonder whether there is one. and here's quite a doozy:

If a willingness to pay the right amount of tax, at the right rate, at the right time and in the right place is the best indication that there is of corporate social responsibility then there is, unfortunately, little evidence from the ten companies surveyed to produce this report that many of the suppliers of private services to the NHS are committed to this ideal.

Admittedly, this conclusion is not helped by the fact that eight of these ten companies are at present making losses, and so pay little or no tax at present, and may not do so for some time to come.

The error, of course, being failing to consider the implications of those providers making losses. Those providers are expending more resources to deliver health care than the NHS pays for delivering said health care. This must be so, this is the source of those losses. That is, the NHS is getting more health care than it is paying for: the taxpayer is getting more health care than it is paying for.

Quite how this is something we should object to is unknown. But then this is a feature of Murphy reports, the assumption that we're supposed to be outraged at the taxpayer getting a good deal.

Economic Nonsense: 33. Things like healthcare and education are too important to be privately provided

Healthcare and education are not only important; they are vital.  Most of us would prefer to live in a society that so organized itself that these services were accessible to all its citizens.  This is not, however, the same as saying that they should be produced and delivered by the state.  

When the state goes into the mass production of services it tends to put them into the political domain, where they can be influenced by ideological or interest groups.  Politicians can manipulate them to secure electoral advantage.  They can be effectively captured by producer groups such as teachers' or healthcare workers' unions, to the detriment the citizens who consume them and the taxpayers who fund them.

When the state does mass-produce services, they tend to be standardized.  It is easier to have a one-size-fits-all output than one that caters for individual preferences and allows a variety of choices.  The private sector, by contrast, tends to find different niches being filled by a variety of producers, allowing consumers to choose the level and quality that suits them.

The state can fund education without producing it by giving people vouchers to cover the education of their child, or by routing the funding to the school of their choice, as is done in Sweden.  This leaves the schools independent and in control of the education they offer.  Healthcare can similarly be financed through insurance or refunds, without the state having to own hospitals and employ nurses.  Again, countries that do this tend to have more variety and choice.

Education in state-run comprehensive schools is not very good.  There are some good ones, but a great number that fail their parents and children by leaving them ill-equipped for life.  Healthcare in state-run hospitals varies hugely in quality, with recurrent exposés of inadequate care or neglect. 

Funding for state-produced schooling and healthcare depends on what politicians think taxpayers will tolerate.  Their output does not depend on what customers want.  Far from being too important to be privately provided, healthcare and education are too important to be publicly provided.

Battle against the union blob

It is not surprising that teaching unions are objecting to the proposed 2% pay rise for England’s top teachers. Unions have long protested against performance-based pay for teachers and now they pose another barrier to the School Teachers Review Body. In the STRB's latest submission (pdf) to the government, highlighted is the need for a wages increase to encourage the desired competition in the teaching profession.

Arguments against pay incentives are that they encourage ‘teaching to the test’ and orchestrated cheating by teachers and schools. Performance gains are accepted to exist but said to be short-lived. While the long-term benefits, they say, are non-existent and there may even be damage done in the long-run.

But the latest research examining their impact on pupils demonstrates the opposite as being true. Pay for performance schemes are becoming increasingly implemented and contemplated in many developed and developing countries and have re-emerged at the top of the policy agenda in the U.S. They are not just a brilliant way of distinguishing the strivers from the shirkers in schooling systems. Such schemes are reaping good long-term labour market outcomes, too.

Research (pdf) published last month by Victor Lavy looks at a study conducted a decade and a half ago in Israel to determine if there are improvements to future education enrolment, earnings and probability of claiming unemployment benefits. 

The study is the first of its kind to follow students from high-school to adulthood to examine the impact of a teachers’ pay for performance scheme on long-run life outcomes. It found:

A decade after the end of the intervention, treated students are 4.3 percentage points more likely to enrol in a university and to complete an additional 0.17 years of university schooling, a 60 percent increase relative to the control group mean. The road to higher university enrolment and completed years of schooling was paved by the overall improvement in high school matriculation outcomes due to the teachers’ intervention.

So merit-based pay actually improves students' lifetime well-being, judging by school attainment, annual earnings and welfare-dependency, as well as recognising the hardworking, high-flying teachers and making it a more attractive profession.

If we could achieve a similar flexibility in what the best teachers can be paid in the UK, like proposed in the STRB's report, it would mitigate the pressures being faced by schools experiencing increasingly competitive graduate labour markets, tightening budgets and demographics driving up pupil numbers.

A difficulty in recruiting NQTs and experienced classroom teachers in this country has been identified by head teacher unions. A key cause being that salary progression is faster for able graduates in other professions, with the opportunity to reach higher levels of earning as their careers progress, than for the teaching profession.

Ideologically-driven unions are the main enemy of change as they still make it difficult to get rid of timeserving teachers and are hostile to the ambitious reformers in schools and policy-making. It is time to start thinking about the market value of teachers’ talents and penetrate the dogmatic ‘blob’ that the old hat education establishment represents.

There's gold in them thar sewage plants!

Quite the little story as it seems that the good old British sewage system could be a source of all sorts of lovely metals:

Although the prospect of digging through human excrement hunting for the gleam of gold may seem unpalatable, the figures show it could be a surprisingly lucrative enterprise.

An eight year study by the US Geological Survey found that levels of precious metals in faeces was comparable with those found in some commercial mines.

In fact, mining all of Britain’s excretions could produce waste metals which are worth around £510 million a year.

All most interesting and proof that where there's muck there's brass. However, as usual in these sorts of things, that's not quite the whole story.

In the minerals and mining world the crucial distinction is between dirt and ore. Dirt is, well, you know, dirt. It's made up, like all dirt is, of different elements. Sometimes, and here's the crucial definitional difference, that mixture of elements is sufficiently lopsided in favour of one of more elements that it is commercially viable to process it. That makes it ore: dirt is not commercially viable to process, ore is.

So, as an example, the North Sea contains some trillions of pounds worth of gold. And, last time anyone ran the numbers, it would cost some tens of trillions to process the North Sea. The North Sea is therefore dirt, not ore. And so it is with our human sewage. Yes, there would be a revenue stream from processing the metals out. And the cost of doing this would be higher than the revenue.

Meaning that sewage is in fact dirt. Which is roughly where we came in, isn't it?

Economic Nonsense: 32. Economies of scale mean that bigger is better

It can be true up to a point that bigger is better, and there can be economies of scale. It does vary, however, depending on the type of activity. In manufacturing, for example, larger orders for components or raw materials can yield bigger discounts. In service industries, however, bigger might mean less personal and therefore less attractive to customers. It is simply not true that bigger necessarily means better. Several different studies have put an upper limit of about 150 employees as the optimum size. Above that level relationships become more difficult and absenteeism can rise while productivity can fall. It is noticeable that some large organizations split themselves into smaller, semi-autonomous units in order to keep each one inside the threshold of manageability.

New firms are constantly entering the market and nearly always start small. Many succeed by taking business away from larger, more established firms that are slower to respond to changing tastes and needs and changing market conditions. Small firms create the overwhelming majority of new jobs in the UK. Small tends to be more adaptable, more nimble, and quicker to change. When firms grow large they can grow complacent, even sclerotic, with a bureaucracy that finds it difficult to change course. In larger units people often find it more difficult to relate to each other and to co-operate effectively.

If bigger necessarily meant better, firms would continue to grow. This does not tend to happen in practice. They expand to a size they feel comfortable with.

It has been claimed that large public industries and services, such as Britain's National Health Service, are literally too big to manage and would operate more efficiently if they were broken into smaller, more easily managed units. Experience suggests that schools have better results if their size is measured in hundreds rather than thousands.

While there can be economies of scale when a new firm is growing, there does seem to be a point after which diseconomies of scale outweigh the advantages of size.

Quantitative easing isn't a distortion

Dr. Bill Woolsey—previously the mayor of James Island, South Carolina, but also a lieutenant-colonel in the US Army, Associate Professor of Economics at The Citadel military training school, and market monetarist/free banking blogger of much repute—is one of my favourite economists. He has a unique way of explaining economic concepts in tightly logical and crystal clear fashion and couples it with a civil, friendly tone. His second-last post—Are Open Market Operations Distortionary?—is a classic example. If there is a central bank, he argues, responding to rises in money demand by creating new money through 'open market operations' (buying govt bonds with newly-created money) is not distortionary. Indeed, it would be distortionary not to respond.

Many of my fellow free bankers agree that when banks accommodate changes in the demand to hold their monetary liabilities, the result is equilibrating and nondistortionary.   However, they believe that when a central bank adjusts the quantity of base money to accommodate changes in the demand for it, there is something problematic with the process.   The injection of base money is somehow distortionary.

Now, I don't want to claim that this could never be a problem.   The Fed's policy since 2008 has most certainly become very distortionary--intentionally   Perhaps there should be no surprise that the Fed has attempted to funnel money into housing.    Using government interventions of one sort or another to promote home ownership has been the norm for  nearly a century now.

I will surely grant that the potential for a central bank to create an excess supply of money is much greater than that of private banks issuing any sort of money. My point is simply that to the degree a central bank limits its issue of new money to the amount demanded, there is nothing especially distorting about the process.   It is coordinating.

The proper comparison is not what would happen if the nominal quantity of money remained fixed and there was a deflation of prices and wages.  Nor is the proper comparison to what would have happened if there had never been an increase in the supply of saving.  The proper comparison is what would happen if there was a increase in the supply of saving by purchasing government bonds.

Read the whole thing.

What should we do if Piketty is right?

The biggest non-fiction book release of 2014 was surely Thomas Piketty's Capital in the 21st Century which managed to inspire a frenzy of response from academics, the intelligentsia, and even huge sales. I hope I can fairly reduce his argument to the claim that wealth inequality will widen if the return on capital (r) is higher than the growth rate (g). Recently Matt Rognlie has presented it with what many have seen as a very serious response (pdf) based on the point that more or less the entirety of the widening in the wealth gap since the 1970s has been down to rising land values, themselves based on restrictive planning policies rather than a fundamental mechanism to do with r and g.

Without having got more than 10% through Piketty's book, I'm hardly in a place to weigh up these perspectives, but I was very interested by a new paper from Clemens Fuest, Andreas Peichl and Daniel Waldenström, whose work on corporation tax I already knew well.

Entitled "Piketty's r - g model: wealth inequality and tax policy" (pdf) it finds some evidence for his model being true, then asks 'if it is true, what shall we do?' Well it turns out that we should pretty much follow the ASI's budget wishlist policies!

Increasing the taxation of mobile capital is only possible on a global scale, as suggested by Piketty (2014). Experience with policy coordination in this area suggests that this will not be possible. It therefore seems more promising to try to increase g rather than to decrease r through tax policy.

Some evidence suggests that recurrent taxes on immovable property and consumption taxes (and other property taxes) are the least distortive tax instrument in terms of reducing long-run GDP per capita. Increasing these taxes and using the additional revenue to reduce labour taxes, for instance, would probably stimulate growth and have positive effects on the income distribution.

Tax consumption, tax (the consumption of) land values, reduce distortionary taxes on labour (and, we might add, capital and transactions). If Piketty has as much influence on the Left as it looked like he might then maybe the world's tax systems are in for some major boosts to efficiency!

Logical Fallacies: 20. Argumentum ad numeram

https://www.youtube.com/watch?v=7BUNbDelojg  

The final instalment in Madsen Pirie's series on Logical Fallacies; here he looks at the 'argumentum ad numeram'.

You can pre-order the new edition of Dr. Madsen Pirie's How to Win Every Argument here