Covid and the Permanent Income Hypothesis
In a rare display of political bipartisanship, Joe Biden and Donald Trump have been united by their belief that fiscal injections are the sole gospel of salvation for the Covid-19 economy. This idea is derived from the largely untested Keynesian axiom of the ‘consumption function’, that stipulates a universally positive correlation between one's disposable income and their levels of consumption (measured by their personal consumption expenditure).
This thinking flows into the idea that government injections of capital into an insolvent economy is the secret elixir to restimulation. However, many have been sceptical of the efficacy of this idea, none more so than Nobel Laureate economist - Milton Friedman.
Friedman contended that Keynes has misunderstood the relationship between levels of disposable income and consumption, and that such a faulty premise contaminates much of his work. The Chicago school economist argued instead that the true relationship lies between one’s permanent income and their level of consumption. Through this, Friedman theorised an idea called the ‘Permanent Income Hypothesis’, whereby individuals calibrate their levels of spending today by their expected earnings tomorrow; a direct assault upon Keynes’ long-held premise.
The partitions can be clearly observed: Keynes arguing a strong positive relationship between disposable income and consumption, Friedman arguing for one that is much weaker.
Despite numerous micro-experiments over the past decades to prove or disprove either man, there was not any conclusive far-reaching evidence. However, through the actions taken by the United States government of three separate fiscal injections over the past eighteen months, there has been a clear opportunity to judge this gladiatorial feud.
The period modelled in Figure 1 (January 2020 to present), presents the relationship between Disposable Personal Income (DPI) and Personal Consumption Expenditure (PCE). Through observation, the periods of fiscal injection where the US fiscal stimulus bills were enacted, DPI spikes, and correspondingly PCE is shown as largely inelastic. This theme is continued through the weak positive correlation between the two variables. This suggests the past eighteen months confirms a faulty relationship between disposable income and personal consumption, suggesting that over six decades since theorising, Friedman may just be right after all.
While the state-induced economic fallout necessitates adequate compensation, a point eloquently argued in an earlier article of ours, the sheer magnitude of the fiscal stimulus inevitably raises the question whether such money has been worthwhile. Despite spending over $5 trillion, levels of consumption have been measly affected. This futility is tantamount to the government's sheltering of Keynesian dogmatism behind a Maginot Line of state intervention. It is time this line is broken.
Finally, a sensible complaint about business rates
It really does seem to take time for good economics to sink into the collective consciousness. Henry George was making this point a century and a half ago:
The industry groups – representing all sectors of the UK economy from airports to pubs, shops, construction and manufacturing – said the current system served as a tax on investment and could hold back firms from spending on green projects and boosting their operations outside London and large cities.
Their statement urged the chancellor to announce a cut in business rates alongside other reforms to lower the burden on firms, including removing disincentives for green investment.
Under the current system, a company investing in its physical premises by installing solar panels or heat pumps could add to the value of the building, raising its rateable value and therefore the firm’s tax burden.
This is entirely unlike the landlord whining that we complained of a couple of days back.
The value of a building depends upon two things. What the building is, what’s been added to it - this is investment. Then where the building is, the plot of land it occupies - that’s land value. We actively desire to tax that land value whatever the landlords have to say about it. And we don’t want to tax the investments because investment is what makes society richer.
The correct reform to business rates is therefore clear. Make it a land value tax and be done with it.
Dealing with Covid was easy
We don’t say that dealing with Covid was well done but we do insist that it was easy. We’ll also admit to a certain fondness for the Swedish Method - government action on the really big things and leave most of life to the good sense of the population - and also for Jesse Norman (despite an historic contretemps there). For Jesse was, according to reports, the only person within half a mile of the Cabinet who actually asked the important question: “How much is this going to cost?” Not, we hasten to add, in anything so crude as the mere monetary sense, but in the proper one of what is being given up as a cost of this plan?
Tom Chivers starts our point for us:
But the valuable lesson, I think, is not “we should have done X” or “we should have done Y” specifically, but that we should be less confident in our ability to predict highly complex situations. And more than that: we should look at the possible results of being wrong in our attempts to predict those highly complex outcomes.
A reasonable estimate is that there are, currently in London, 1 billion things on sale. Not 1 billion items, but different things, left handed, right handed, brass, steel, tin, half inch, 3 mm screws and on with the combinations of nails and hammers and on to cars and hoovers and…. Karl Marx was astonished that century and a half ago that one could buy 500 different types of hammer in that city.
Now note that the billion in London are different from the same billion in Birmingham, both ditto Bradford, all three from Brighton and on.
The economy., that is, is a complex thing. Compared to managing, planning and running that economy dealing with covid was elegant simplicity. Yet having observed the performance - and not just of our own government, many did equally badly - with respect to covid there are those who insist that the economy can be run by dictat. Without all of us falling about with laughter. Or, perhaps, without us all rising up to remonstrate with those who could say something so observably stupid.
Covid was simple compared to the economy. Yet there is still that delusion, despite the very evidence before our eyes, that the more difficult task will be achieved more easily than the simpler, or even better.
We wonder if one of those 500 types of hammer can be described as a cluebat? If not, can someone get on with the invention bit please?
Greetings everyone!
I found out about the Adam Smith Institute in the classical free-market way; page 23 in a book by Owen Jones.
In the revelation of learning about an entire organisation that shares my free-market principles, I was infatuated with the idea of one day becoming part of it. Deciding post-application that Economics is my undergraduate calling, and feeling disillusioned to the prospect of backpacking in Vietnam, the opportunity to spend a year in Westminster at the spearhead of neoliberalism was one I wished to unequivocally pursue.
Following my application being sent over summer, I was notified that I have been successfully shortlisted and called to an interview in Westminster. After making my way across from Euston Station, I was immediately struck by the unbridled passion and enthusiasm permeating throughout the office, and knew in an instant that this is a place I long for. I received the news of my successful application while brewing a cup of tea, and in my euphoria, ran upstairs to inform my mother.
My journey into neoliberalism started with the realisation that the only guarantee for prosperity is enshrined within the framework of free enterprise. Through this, a close friend and I founded a classical-liberal advocacy website called Friedmanomics, in order to create a platform for young people throughout the nation who feel their beliefs in individual liberty have been marginalised. From our humble beginnings in a single History classroom, we now have writers from around twenty different schools nationwide and an active following. I am extremely excited to bring this previous experience to my time at the ASI, and contribute in the fight to restore the invisible hand to the role now occupied by the state’s creeping hand.
My experience so far has surpassed every expectation (as high as they already were). Walking across Westminster Bridge every morning, brushing shoulders with my political idols as I shop at the local Tesco’s, being paid to investigate free-market ideas; for a boy from rural Cheshire with a poster of Margaret Thatcher on his bedroom wall, this is an opportunity of my wildest dreams.
Charles Bromley-Davenport is joining the Adam Smith Institute for the next academic year as a Research Associate
Hello all!
Never one to take the conventional option, I declined my place at a top university to embark upon a gap year. However, unlike many of my peers who take gap years, I am taking a break from formal education to do something more academically challenging.
I have always loved debating controversial issues, taking stances which seem objectionable to my audience but convincing them of their merits. In the homogenous environment of school, the only way to do this was by presenting arguments with which I (and everybody else) fundamentally disagreed. Now however, I look forward to advocating for neoliberal policies and winning round a begrudging population. I believe this is needed in order to make significant progress in transforming the NHS and Social Care. Intensified through the pandemic, the British public are intent on resisting any change to the NHS, making reform contentious despite economic merit.
Coming to politics (relatively) late, my interest is driven by academic curiosity, rather than dogmatic ideology, and I look forward to my opinions and beliefs continuing to be shaped and challenged throughout the year. My current particular interest is exploring immigration policy, and am looking into the Nationality and Borders Bill. After working within the system at a refugee support service I discovered how harsher policy towards asylum seekers often doesn’t deter entry but simply prevents people from becoming economically constructive.
With the Budget just around the corner, both in time and geography, I am excited to critique and challenge it. During the initial stages of the pandemic, I competed in the IEA National Budget Challenge, and Economics Horizons Competition, coming 2nd and 3rd respectively, giving me an insight into the process and trade offs required when creating the budget. It will now be interesting to examine a budget from Johnson’s Government that gives a more long term indication of the economic priorities of the Government, rather than simply short term crisis control.
As someone who brings the political conversation to every party or pub I go to and am frequently told that there is a time and place, I am looking forward to spending the year with people who, like me, believe that it is always the time and place.
Fiona Townsley is joining the Adam Smith Institute for the next academic year as a Research Associate
Sir Simon insists that we're all terribly naughty peasants
Travel was the great beneficiary of the leisure society. Only now are we appreciating its cost, not just in pollution but in the need for ever more extravagant infrastructure. Cities sprawl when they should be densified. Communities have become fragmented. British government policy still encourages car-intensive settlement in countryside while urban land lies derelict.
It is an uncomfortable fact that most people outside London do most of their motorised travel by car. The answer to CO2 emissions is not to shift passengers from one mode of transport to another. It is to attack demand head on by discouraging casual hyper-mobility. The external cost of such mobility to society and the climate is the real challenge. It cannot make sense to predict demand for transport and then supply its delivery. We must slowly move towards limiting it.
The aim of having an economy - heck, of having a civilisation - is that folks get more of what folks want. That utility is maximised. There is, of course, that problem of third party costs imposed on others by our gaining our wishes. To which, as every good little economist knows, the answer is a Pigou Tax. If everyone is charged, within the market price suitably adjusted, the full costs of their actions then we gain the optimal amount of that thing. Optimal in the sense that we are thereby maximising human utility.
At which point something interesting from the IMF. Buried in their report on how fossil fuels are subsidised by $6 trillion, that £11 million a minute number, is what the petrol and diesel prices should be if all those third party costs were to be included in prices. On page 18. The UK charges just about the right price. It’s certainly within pennies per litre. This includes all costs too - not just climate change emissions but local pollution, congestion, accidents, road damage and even the idea that not paying full VAT is a subsidy.
We Brits, even if others elsewhere don’t fully enjoy this privilege, are paying the costs of our desires. We are already at that fully worked out and priced optimal utility maximisation. Yea, including the damages to others a century after us as the ice caps melt into the oceans.
But still we travel too much according to Sir Simon, our mere desires and willingness to carry the costs of meeting them counts as nothing. It might be unfair to characterise his views in this manner but still - the complaint seems to be that us damn peasants just won’t stay put where we’re supposed to be. That’s unfair perhaps but how unfair is that?
Casual hyper-mobility? That the proles are able to visit the other side of the hill without having to walk up it?
It's the how, not the how much, that needs the attention
A certain coordination in demands upon the taxpayer wallet here:
From climate change to health, spending on research pays for itself
So, therefore, government should spend more on research.
To be a science and tech superpower we need to invest more
So, therefore, government should spend more on research.
These calls coming separately from the head of the Royal Society and of the National Centre for Universities and Business. The representatives of those who would get to go spend any more government money allocated to research. Well, as the rumoured not-to-be-a-lady once said, they would, wouldn’t they?
The problem with the call being that they‘re concentrating upon how much money is to be spent. That’s their target, a rise to some specified level of GDP. Which isn’t what we’re interested at all. We want to know what is the output and that’s not something directly linked to that level of input. As they both point out, showing that the UK does put in less than many other countries but also gets more out.
So, any sensible analysis must start from the point that we are more efficient. So, why are we? Our own inclination being to suggest that as we do less of this inefficient government spending in this area therefore our system is overall more efficient. If that is the answer - note we only suggest it - then increasing the government portion of spending simply reduces our overall efficiency.
This is before we get to the logical problem here. The argument in favour of government spending is that such knowledge is a public good. Very difficult to make a profit from therefore the private sector doesn’t do enough of it. But if that’s true then it doesn’t matter which government does it, because it’s the production of a public good anyway. The argument being tried on here, that government must do the spending and also that it must be our government that does, fails in its own logical confusion.
Special interest groups and their begging bowls will be ever with us but that doesn’t mean we’ve got to listen to their pleadings.
The nation's being gaslit over business rates
It is a standard economic analysis that it is landlords who carry the burden of business rates, not tenants. There are libraries packed with proofs of this, Henry George is by no means the only person to have noted it.
Yet we have continued insistences from tenants that they must be freed from the burden of having to pay such business rates. Why?
In a letter to Rishi Sunak, the Chancellor, 21 business figures from companies including MossBros and The Entertainer said that action is vital to prevent a disaster.
Mr Sunak is expected to announce the delayed results of a review of the rates system in autumn, with speculation growing that it could be unveiled in his Budget later this month.
The property tax has long been derided as an outdated measure that penalises bricks and mortar stores at the expense of online rivals which have warehouses in cheaper out of town locations.
The letter said: “There are many views on precisely how the business rates system should be reformed, but on this we are all united: the current business rates system is broken and there must now be fundamental change.
“If there is no genuine reform of the business rates system, the occupation of commercial premises is going to become unaffordable to more businesses.
"There will be more bankruptcies of well-known retail brands, more retrenchment by retailers which do survive, more closures of hospitality venues, more boarded-up shops, fewer start-ups and whole shopping centres abandoned. Many communities are being hit hard, with thousands of jobs being lost each year.”
It’s certainly a stirring call. Despite the fact that it is entirely and wholly wrong. Any reduction in rates would flow through as higher rents to landlords. We even have empirical proof of this, from the changes in business rates in Enterprise Zones those decades back.
So, why are we all being gaslit in this manner?
Melanie Leech, of the British Property Federation, helped organise the letter
BPF, who are they?
The British Property Federation is the voice of the real estate industry in the UK. Our membership reflects the diverse nature of our industry – owners, developers, funders, agents and advisers.
Ah, the insistence upon the change now makes sense. Of course the landlords will be against a system of taxation that bites into their rents. Why the rest of us should take a blind bit of notice of this self-dealing is the question that needs answering now.
Spotting the invisible hand out there in the wild
Adam Smith’s actual use of “invisible hand” in Wealth of Nations was as follows:
Every individual... neither intends to promote the public interest, nor knows how much he is promoting it... he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention.
The background discussion is about the difference between the foreign and domestic trades. The argument being that the foreign trade produces more profit than the domestic, more more profit than the extra risk. Yet some do just prefer the domestic trade. Since domestic investment benefits the domestic economy this is the invisible hand. It’s an observation about a foible of humans, that their risk calculation is not necessarily entirely calculated.
One implication of this is about portfolio allocation:
British savers have been urged to expand their horizons and buy overseas stocks as their penchant for domestic companies has held back returns.
“Home bias” among Britons has been waning but the average investor still holds more than a quarter of their pension or Isa in UK companies. This is despite the global market’s total return of 78pc over the past five years, compared with just 22pc from London’s blue-chip FTSE 100 index.
The average investor’s exposure to the UK has almost halved over the past decade, from 42pc of their portfolio in 2010 to 26pc in 2020, according to the Investment Association, a trade body for the fund industry.
245 years and counting since first publication and we’re still catching up with the truths laid out for us. But then that’s true of so much of what’s in that book, isn’t it?
On the subject of the British sausage
The defining point of the British sausage is not quite as Jim Hacker put it:
Hacker: By the end of next year we shall be waving goodbye to the good old British sausage and we’ll be forced to accept some foreign muck like salami or bratwurst or something in its place
Sir Bernard Woolley: They can’t stop us eating the British sausage, can they?
Hacker: They can stop us calling it the sausage though. Apparently it’s going to be called the emulsified, high-fat offal tube.
Sir Bernard: And you swallowed it?
The grand distinction of the British sausage is not what the meat is. All sausages are made from whatever scrag ends come to hand. It is that we, being the pragmatic folk we are, note that the yumminess goes to hide in the fat of said scrag ends. We thus add up to 10% rusk, or breadcrumbs, to retain that yumminess through the cooking process.
Which brings us to current events:
The UK is on the cusp of victory in the Sausage War with the EU, after Brussels finally waved the white flag over allowing British bangers to be sold in Northern Ireland at the end of the grace period.
We’re willing to agree that there is a scale to regulation and politics. Some things are better handled at a higher level, for more people at a time, some things at a lower and more locally.
The current situation has the rulers of the remnant-European Union’s 450 million people arguing with the UK’s rulers of 65 million over what type of sausage the 1.8 million in Northern Ireland may have for their breakfast. The 1.8 million not even being a part of the 450 million.
We can’t help but think that there’s something wrong with the scale at which government and regulation is attempting to work here. We do rather lean to the idea that the folks of Northern Ireland are capable of deciding which sausage, if any, they’d like to have for their breakfast. This doesn’t even need to be done collectively, that voluntary cooperation between butcher and consumer would seem to be all that is required.
They have been doing this for some time, after all, there is a reason that the full plate in all its emulsified, fatty, offaly tubular yumminess is called an Ulster Fry.