Facebook's $5 billion fine shows us that the Efficient Markets Hypothesis is right
It must be difficult trying to struggle through a discussion of a story without having the basic intellectual tools to understand how the story works. Which is the pickle that John Naughton finds himself in here in The Observer. Facebook gets fined $5 billion over data breaches and the share price goes up? Clearly, something is wrong with something, somewhere!
If you want a measure of the problem society will have in controlling the tech giants, then ponder this: as it has become clear that the US Federal Trade Commission is about to impose a fine of $5bn (£4bn) on Facebook for violating a decree governing privacy breaches, the company’s share price went up!
This is a landmark moment. It’s the biggest ever fine imposed by the FTC, the body set up to police American capitalism. And $5bn is a lot of money in anybody’s language. Anybody’s but Facebook’s. It represents just a month of revenues and the stock market knew it. Facebook’s capitalisation went up $6bn with the news. This was a fine that actually increased Mark Zuckerberg’s personal wealth.
The bit that’s gone wrong is Naughton - and to be fair, many others - not grasping that the Efficient Markets Hypothesis is actually correct. At least that semi-strong version, which says that all publicly available information will already be in market prices.
So, what has happened here? We’ve long known that Facebook is going to get fined over the Cambridge Analytica stuff. Facebook even told us that it had $3 billion stashed away in its accounts to pay such a fine. Market participants knew all of this. It was all already in the share price.
So, what happens when the fine is actually announced? That there’s going to be a fine of billions is something already in the price. That the fine isn’t the maximum that it could be removes some uncertainty. Thus the price moves up.
For, recall what the basic message of that EMH is. Only new information moves markets. Old information is already included in those prices. We think it’s fairly important that if you want to write about how markets work then you have a grasp of how markets work. Sadly, not all agree with what we regard as an entirely uncontentious insistence.
Storming the Bastille
It was on the famous quatorze juillet in 1789, 230 years ago today, that the mob stormed the Bastille fortress prison in Paris, an event taken to mark the beginning of the French Revolution, and celebrated every subsequent July 14th. It was more symbolic than real, although there was some purpose to it. France's Third Estate (the people) first stormed the Hôtel des Invalides seeking the 30,000 muskets held there. Unfortunately for the mob, the Hôtel's commandant had moved their 250 barrels of gunpowder to the Bastille a few days earlier.
The mob turned its attention to the Bastille, with nearly a thousand of them gathering outside to demand its surrender and the release of its gunpowder. The Bastille had a few defending troops of its own, plus 32 Swiss regular guards of the Salis-Samade Regiment as reinforcements. It also had 18 eight-pound guns and 12 smaller pieces mounted on its walls. Its governor, Bernard-René de Launay, refused to surrender.
After a lengthy fight during which 98 attackers and one defender were killed, the mob seized control. The governor was dragged to the Hôtel de Ville, and after much abuse, was stabbed many times to his death, and his head paraded on a spike. The three officers of the permanent Bastille garrison were also killed by the crowd, and two of the invalides of the garrison were lynched, plus two of the Swiss regulars. The mob then went and killed the prévôt dès marchands (mayor).
The Bastille's prisoners were released – all seven of them. They were four forgers, a madman imprisoned at his family's request, someone who'd tried to kill Louis XV thirty years previously, and a Count imprisoned by his father. The mob missed a much bigger catch, the Marquis de Sade, who'd left 10 days earlier. It was not a great haul, but the act was symbolic and fuelled the Revolution.
The sad record of that Revolution is written in blood and terror, as ever more extremist and radical groups practised ever more atrocities. It devoured its own, as revolutions do, with the majority of those guillotined being ordinary French men and women rather than aristocrats. The Reign of Terror came and went, as Robespierre and Saint Just were swept away in its carnage. The mob regularly rampaged the streets, getting its own way until one day a young army officer called Napoleon gave them "a whiff of grapeshot" at point blank range. Then they stopped.
The French Revolution ended in a dictatorship and a career of European conquest that only ended at Waterloo. It contrasted starkly with the English "Glorious Revolution" that made constitutional government the norm, and the American War of Independence that secured the rights of Englishmen for the American colonists, and embedded them in a constitution.
The Bolshevik Revolution in Russia followed more the French style than the English or American ones. It outdid the French one in blood, terror and oppression, and was no more successful at attaining a decent life for its citizenry afterwards. One lesson is that revolutions which sweep away society to put in its place one derived from abstract principles, are less successful than ones which build up and improve what the past has done, and try to erase such of its failings as they can.
An invalid argument - people won't therefore they must
Everything has its costs, everything has its benefits. The mark of a liberal society being that we get to decide the correct balance for ourselves, of an illiberal that we’re told what to do by someone else’s estimations of that balance.
A corollary of this is that if the people who have to bear those costs, and also to enjoy those benefits, don’t think it’s worth it then we shouldn’t impose them upon them. So it is with emissions in cities. It is urban dwellers who gain the transport from cars, it is urban dwellers who suffer the resultant pollution. Which is what invalidates this insistence here:
Among other weaknesses, the measures cities must employ when left to tackle dirty air on their own are politically contentious, and therefore vulnerable. That’s because they inevitably put the costs of cleaning the air on to individual drivers – who must pay fees or buy better vehicles – rather than on to the car manufacturers whose cheating is the real cause of our toxic pollution.
It’s not hard to imagine a similar reversal happening in London. The new ultra-low emission zone (Ulez) is likely to be a big issue in next year’s mayoral election. And if Sadiq Khan wins and extends it to the North and South Circular roads in 2021 as he intends, it is sure to spark intense opposition from the far larger number of motorists who will then be affected.
It’s those in that area who enjoy those benefits and suffer those costs. If they think that a ban, or limit, isn’t worth it, who are we who are subject to neither cost nor benefit, to force upon them the very policy they are rejecting?
Not what we’re not suggesting, that pollution’s just fine, that nothing should be done etc. Rather, we’re jabbing at the hole in the logic of this particular argument being used. The people who will suffer the policy might not vote for it therefore it must be forced upon them. Our point being that if they don’t want it then that’s the reason it shouldn’t be forced, isn’t it?
Caesar, Kaiser, Tsar, Shah
July 13th, 100BC, saw the birth of Gaius Julius Caesar, a man who would change the world. One of his lasting changes was the introduction of the modern calendar. He replaced the Roman moon-related calendar by one based on the sun, and gave us our year of 365.25 days with an extra day every fourth year. He added three extra months and has July named after him.
It was, of course, his military conquests and political changes that earned him fame. He was at the watershed as the Roman Republic broke down and was transformed into the Roman Empire. Although its apologists spoke grandly of ‘Republican virtues,’ the fact was that the old system that worked for a city could not cope adequately with the vast territory Rome now controlled. In practice, well-born senators appointed each other to the governorships of provinces that they then looted.
The territory under Rome was hugely enlarged by Caesar’s conquests in Gaul and Germany, and he needed land for his veterans. Although well born himself, Caesar backed the popular cause against most of the aristocracy. He was, perhaps, an early populist. Had he left his army at Italy’s frontier, as the rules required, he would have been defenceless against trial and probable execution in Rome. In crossing the Rubicon with his army, he set in motion the events that changed Rome into an empire governed by all-powerful rulers.
When he took control, Caesar set about implementing reforms that would transform Rome. He extended Roman citizenship far beyond Italy’s borders, creating a unified state of its disparate provinces. He centralized its bureaucracy into a single government, and put into effect the land reforms that supported his veterans. He was proclaimed ‘dictator’ for life, and carried out populist reforms that made the common people regard him as their champion. He undermined the wealth and power of Rome’s élite senators, which is why they killed him.
The model of a strong leader with authoritarian powers, backed by a loyal army, is one that has been followed many times since in many places. Napoleon Bonaparte is probably the most famous example. Populists in modern times have to pay lip service, at least, to democratic mandates, although in Venezuela Chavez and Maduro have shown how readily the democratic process can be subverted.
T H White, who authored many of “The Making of a President” books in the 1960s and early 1970s, also wrote a play called, "Caesar at the Rubicon" (1968). At its end, Caesar finally crosses the river to head for Rome with his army. His closing line as he does so is, "If men cannot agree on how to rule themselves, someone else must rule them." When societies descend into conflict and chaos, they should know that the eternal Caesar waits at the eternal Rubicon, sitting astride his white horse with his army behind him, and with that old, old sword at his side…
The real Nordic model: higher taxes on low-income workers
Britons have a thing for the Nordic countries – especially so if you’re on the left. In their quest for well-functioning and more socially equitable societies, the Nordics have long played a utopian role for Britain’s left-leaning forces.
This ranges from envy of Sweden’s work-life balance and child care system, to reflections on Norwegian experiences, and grand plans by think-tanks to “win the Nordic model for the UK”, to discussion of Finland’s egalitarian and successful schooling and Denmark’s futurism.
British people often only look at what Nordic governments do on the spending side: expansive social welfare spending, generous benefits and impressive social equity. They hardly ever take a look at the accompanying revenue side.
Comparing Swedish and British governments unveils some interesting differences.
Yes, measures of country-wide income inequality put Sweden among the middle or lower end of its peers, with UK standing out; the Gini-coefficient after taxes and transfers has Sweden at 0.28 while the UK almost tops the EU-chart at 0.35. Similarly, incomes of the highest-paid 10% of British earners clock some 34% of all pre-tax income (progressive taxes put the post-tax figure at 28%), whereas their Swedish equivalents earn only 28% of pre-tax (24% post-tax) income. The much-despised top-1% of British earners receive around 12% of pre-tax income, whereas Sweden’s top-1% earners only get 8%.
Britain also taxes its population less than does Sweden (35% of GDP as opposed to 44%), but comparing the reliance of various kinds of taxes as government revenues makes this even more clear. In the figure below I have mapped out tax revenues as share of GDP in four categories of income; the first two bars from the left are taxes on labour (direct income taxes as well as indirect ones like payroll/national contribution levies) the third taxes on capital and the fourth various consumption taxes.
This shows the taxation differences between Sweden and UK. As we would expect from income tax rates, labour incomes are much more heavily taxed in Sweden than in Britain. They don’t, however, exclusively or even predominantly apply to high-income earners. Sweden holds the European record for the lowest level where incomes are subject to direct taxation, at one-seventh of Britain’s remarkably high Personal Allowance (£12,500). Moreover, the elevated indirect taxes (payroll taxes) apply on even the lowest incomes, greatly contributing to why Sweden has among Europe’s highest cost of labour, while UK is below average on this – something that may explain the 2.5 percentage point lower unemployment rate in Britain.
The UK relies more on capital taxation than Sweden – and this difference is not driven by corporation tax, which in both countries generate revenues of 3% of GDP. Rather, the big difference is that the UK taxes property a lot heavier than does Sweden, whereas Sweden relies on taxes on investment and savings more than does the UK.
Admittedly, comparing tax systems is tricky and relying on revenues as I have here does not show the full picture. For instance, a small open economy like Sweden may not have the ability to heavily taxing certain tax bases since the burden for relocating elsewhere might be small and corporations or individuals would simply up and leave if they deemed taxes to be too extractive; similarly, British tax authorities may have larger leeway in taxing high-value properties in London with no or little behaviour response, and thereby rely more heavily on properties for tax revenue.
Bursting the Nordic utopian bubble, Kristian Niemietz at IEA describes the Nordic economies as
relatively liberal, relatively lightly-regulated market economies, with relatively low levels of state intervention – but they are also, at the same time, economies characterised by high taxes, generous welfare states, and generously funded public services.
A few decades before writing The Wealth of Nations, Adam Smith concluded that all that was necessary for a successful country were “peace, easy taxes, and a tolerable administration of justice”. Whatever he thought of as ‘easy’ probably differs from what we would think of today. Nevertheless, a quick look into the tax revenues of Sweden and the UK should awaken the dreaming leftie. Spending like Sweden means taxing like Sweden – reduced property taxes, abolish wealth and inheritance taxes, hike taxes on productive investments and, most importantly: almost double tax revenue on even low-income labourers. Much less tempting, I imagine.
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British tax data is taken from Office for Budget Responsibility’s databank; Swedish tax data comes from ESV, The Swedish National Financial Management Authority, and can be easily accessible here.
Josiah Wedgwood, an Industrial Revolution pioneer
One of the most remarkable and successful pioneers of the Industrial Revolution was born on July 12th, 1730. Josiah Wedgwood was born into a family of non-conformist potters, and showed early talent at 9 years old. He survived a bout of smallpox, but it left his leg too weak to work a potter’s wheel, so he turned to design rather than production.
Wedgwood took the trouble to learn chemistry, so that he could understand and refine the techniques of firing and glazing and the properties of clay. He was a friend of Joseph Priestly, a fellow member of the Lunar Society. He developed several unique glazes and new types of pottery, and found popularity for his products with the top nobility, including Queen Charlotte, whose patronage he traded on.
He virtually invented modern mass-produced pottery by industrializing the industry. He used specialized division of labour to produce high quality at low cost, and sold his wares in every European city as well as to the wider world. He produced less costly versions of his top ranges, to supply the growing middle classes of England. He satisfied the new interest in the classical world by producing works based on ancient designs of vases and plates.
Wedgwood is credited with inventing modern marketing, using mail order, a money back guarantee, and travelling salesmen. He even pioneered “buy one, get one free” and free delivery. Like many of his fellows leading the Industrial Revolution, he keenly promoted the idea of improvement, and of a commitment to making the world a better place. He was an avid campaigner for the abolition of slavery.
It was this notion that humanity could improve itself and that the world could become a better place that was a spur driving the Industrial Revolution. Instead of being content to live fulfilled lives, as their grandfathers and great-grandfathers had sought to do, humanity embarked upon that upward curve that we have never left. The Industrial Revolution applied creative technology to doing things better and making things affordable to the masses that had previously been the prerogative of the well-to-do.
We are still living in that world, with creative intellects seeking every day to make it better. Steve Jobs and Elon Musk are the spiritual heirs of Josiah Wedgwood, developing and promoting the new products and processes that will enrich our world with new opportunities. Instead of seeking to obstruct such people, we should be encouraging them to flourish. Instead of obsessing with how to make people more equal, we should be making it easier for them to expand the choices and the chances that they make available to others. Instead of trying to cut down the tall flowers, we should be seeking to have as many flowers grow as tall as they can. Josiah Wedgwood, whom we honour on his birthday, was one of the very tall ones.
We don't agree that government is a luxury good - at this level of income
Paul Johnson, of the IFS, is here saying that government is a luxury, or superior, good:
Even so, with political will we could, if we wanted, raise the level of tax closer to the European average. We can afford to. One approach would be to raise taxes gradually as incomes rise — slowly enough that people are left with more money in their pockets than before, and quickly enough that the state’s budget rises as a fraction of national income. As we get richer not only can we spend more on public services, we can spend more as a fraction of our income on them.
Note what luxury, or superior, means here. It’s a technical term meaning “We spend more of our incomes on this as our incomes rise”. A normal good is something we spend the same portion on, an inferior less. Johnson is indicating that government is that superior good, something we can - and thus he implies should - spend more of our income on as incomes rise.
We disagree.
A further technical point being that pretty much everything is an inferior, normal or superior good at some level of income. It’s all Maslow’s Hierarchy all over again, what we desire changes as we sate one such and then move on to being able to deal with the next want.
We agree entirely that at a certain level of income then government is indeed that luxury good. We don’t need to get far above mere and simple subsistence to want to pay people to keep the levels of Thugs and general dacoity down. We might well be willing to pass more of yet higher incomes through government to create that system of social insurance. But, as with everything in Maslow’s Pyramid such tastes do get sated at some point. And something will gradually switch from being a superior good to a normal and then invert to an inferior. Where, as we get yet richer again, we spend ever less of our continually rising income on it.
We would, in fact do, argue that this happened some time ago with government. We’ve already more than enough of it. And as incomes rise off into the future - technology does march on - then government should righteously shrink as a portion of GDP. We’ve got enough, we have a social safety net, we’ve got people regulating the things that need to be regulated. Thus we should be spending ever more of our growing incomes on those things which are, at this level of income, luxury or superior goods, reducing our expenditure on those inferiors.
A bit more of that freedom and liberty sounds good to us.
Another way to put this being that we’ve created that rootstock necessary for human flourishing already. Time now for a bit more of that fructifying created by more choice and less government.
Isn't this the truth
Extensive allegations about corruption in South Africa. About which one says:
Several of the Watsons’ other BEE partners became part of the country’s new political elite; there was a revolving door, in these first years of the new government, between political appointments and BEE entrepreneurs. “The minute you have a system where people make money just by the connections they have, rather than the work that they do, the system is ripe for abuse,” says the political economist Moeletsi Mbeki, long a staunch critic of BEE. “It’s a recipe for corruption.”
Quite so, this is true of systems that allocate economic activity, ownership, legal privilege, on the accidents of social position, the school tie network, race, political party membership and so on. All systems have been used at times and all do spiral into that network of corruption. Some worse than others of course but the direction of travel is always the same.
This being a great merit of markets and simple, pure, cash. If people are able to do whatever it is better than the competition - competition which is free of legal constraint from actually competing - then they should be the people doing that thing. Getting the best results does indeed mean that the economy is going as well as it can given technological constraints.
Further, a market economy has its own feedback mechanism. Those who aren’t the best succumb to that competition and are removed from the economic fray.
Another way to put this being that if politicians don’t have the power to choose favourites then we consumers aren’t subject to the inefficiencies and inadequacies of political favourites. Whether that’s a Duke with a Royal Monopoly or the man the President shared a trench with gaining some favour.
If economic privilege is allocated on anything other than efficiency then the inefficient will gain such privilege to the impoverishment of everyone else. This isn’t a good way to run a society.
Legalising cannabis would make our country safer for everyone
It is less than three years since the Adam Smith Institute and Volteface jointly published The Tide Effect, making the argument that the UK should follow the path set down by its Atlantic cousins in taking steps to legalise cannabis. Since then, there has been a tectonic shift in public opinion on the issue. As of October 2018, support among Brits for the legalisation of the sale and possession of cannabis had leapt to nearly six in ten of all Brits, and over two thirds of those between those aged 18 to 24.
This week, the Adam Smith Institute joined forces with Volteface once again on a new paper, entitled The Green Light: How legalising and regulating cannabis will reduce crime, protect children and improve safety. As featured by the Evening Standard, the paper outlines in detail the compelling and growing body of evidence in favour of cannabis legalisation and sets out a series of policy proposals to guide a pro-cannabis government initiative, with reference to existing systems in Canada, Uruguay and the ten US states who have already legalised.
The resounding conclusion from the available evidence is that cannabis legalisation in the UK would be a wholly positive move. Regulation and taxation would reduce underage usage and increase revenue. Staggered taxes would also allow for a passive crackdown on higher potency, potentially more dangerous strains of cannabis, making it safer for everyone. Perhaps most pertinently of all, the report finds that the presence of a robust legal cannabis market would bring about a substantial reduction in criminal violence.
The entire British cannabis sector has been pushed underground by prohibition, which means its illegal profits tend to finance all manner of violent crime. A University College London study estimated the size of the existing illicit cannabis market at around £3 billion, the vast majority of which is likely to feed directly back into criminal activity of various kinds.
Legalisation would reduce significantly the funds criminals are able to draw from cannabis trade. In Colorado, the black market for cannabis had shrunk by over two thirds just five years after its legalisation. Comparable levels of success are easily attainable in the UK, if the government takes a similar route to legalisation. There is no good reason to continue allowing billions in illicit profits to swill around in criminal circles.
In addition to interrupting illegal income streams, cannabis legalisation has been shown to directly affect rates of various violent crimes. A 2013 study conducted by Norwegian academics in US states in which cannabis has been legalised found a strong correlation between the liberalisation of cannabis legislation and reductions in violent crime. This was especially true of homicides, assaults and robberies, with researchers able to draw causal links between the rapidly diminishing illegal drug market and these kinds of violent criminal activity. Those findings have since been corroborated by another study, this time from the Federal Reserve Bank of Philadelphia in 2017.
By following the Six Point Plan laid out in the Adam Smith Institute’s latest paper, the government can replicate those outcomes here in the UK. This policy is not a stab in the dark; these outcomes are not hypothetical guesswork. Since the British government would be far from the first to legalise cannabis, we can rest assured that major unforeseen catastrophes are unlikely to spring up in the immediate aftermath of the implementation of this policy.
Legalising cannabis is a common-sense decision. Politicians from across the political spectrum have coalesced behind calls for reform to our antiquated drug laws; from the Conservatives to the Liberal Democrats to the Green Party, the number of people who see the harm that the current system of prohibition is inflicting on some of the most vulnerable within our society is growing at an unprecedented rate. Now is the time to act.
When China trades with the world
On July 11th, 1405, an immense armada of Chinese sailing ships set sail from Suzhou under the command of Admiral Zheng He, at the behest of Zhu Di, the Yongle Emperor of the Ming dynasty. There were 317 ships in the fleet, carrying about 28,000 crewmen. Over 60 of the ships were large, roughly 500 feet long, versus the more common Chinese ships of 100-foot length. It was to be the first of seven such voyages into the Indian Ocean by Zheng He, visiting Southeast Asia, Thailand, Arabia and the Middle East, India and the Horn of Africa.
The purpose was trade and exploration, and to assert a Chinese presence. They took gold, silver, porcelain and, of course, silk. They brought back exotic animals such as ostriches, zebras and camels, as well as ivory. There was also a giraffe, which was thought to be a qilin, the mythical Chinese unicorn thought to be symbolic of prosperity and good fortune. This showed heaven's favour on the expedition and the rulers who commissioned it.
It was by no means China's first trading foray. They had sold silk for thousands of years, and the Silk Road was well established about 200 BC when the Han dynasty began. One route went South to India, and other went North through Uzbekistan to the Persian Empire. It carried silk, tea and porcelain, bringing back horses, carpets, glass and precious metals.
Even Zheng He's route had been blazed by merchants and diplomats of the Tang dynasty (618-907) and the Song dynasty (960-1279), who traded to Malaya, India and Sri Lanka, and the Arabian Peninsula, Iraq, Ethiopia and Egypt. Kublai Khan (1260-1294) supported the Silk Road by a postal system, infrastructure, and loans to finance caravans.
Seen in this light, China's new Belt and Road Initiative is a re-establishment of the international trading network that previous Chinese rulers had encouraged. It is strangely named, because the 'Belt' part is the overland routes for road and rail, and the 'Road' part refers to the sea routes. Together they constitute a new Silk Road, perhaps the largest infrastructure project ever undertaken, one that will take years to complete. To facilitate it will be massive construction, including road and railway, a power grid, and intermediate facilities.
It shows that China is determined to re-establish a trading route that will see widespread trade with the world. President Trump might back protectionist policies with tariffs that make Americans pay more for their imported goods, but China is committing itself to the international trade that will enrich its citizens. They know that the future is not self-sufficiency, but specialization, by which people become richer by buying from those who can produce more cheaply, thus leaving them with more to spend on other things.
China's past saw a great trading nation that exchanged goods with distant parts of the world. It is determined that China's future will capture that spirit, and is taking the steps that will facilitate it. This is to be applauded. It will make for a more interconnected world, and as Bastiat observed, when nations send goods across frontiers, they rarely send armies. Trade deals involve negotiation rather than warfare, and negotiated deals don't kill people; they enrich them.