Add Solow to Baumol and you’ve really got something

An interesting line from Andrew Sissons about Baumol’s Cost Disease. Maybe it’s not entirely cost? One interesting part of it being this:

Baumol’s version of his “disease” actually combines two effects. The first is the famous finding, outlined above, that productivity gains in one sector lift wages in all sectors. The second, less positive part is that productivity growth will necessarily be slow or stagnant in some parts of the economy — typically the service sector. The combination of these effects, according to Baumol, is that the stagnant sector takes up a larger share of the economy over time, and that it gradually drags down overall productivity growth. Because services get more expensive, we have to spend more on them. Because they then make up a larger share of the economy, the economy gets less productive over time. Sounds bad.

And Baumol’s pessimistic theory matches the empirical data since 1967 (when he first published) pretty well. The rate of productivity growth has slowed down in advanced economies, and the service sector has grown as a share of the economy. The prices of many services have risen, while prices of many manufactures have fallen.

If you’re looking for an explanation as to why growth has slowed down in advanced economies, Baumol provides a simple, almost mechanical explanation, which presents the slowdown as inevitable. Maybe it’s Baumol’s world and we’re just living in it?

As so often we’d not insist that this is everything but we would insist that it’s some part of that everything. If productivity is more difficult to improve in services and we’ve a more service oriented economy then obviously, growth - dependent as it is upon increasing productivity - becomes slower.

We would though go on to point out one more thing. We should add Solow to Baumol:

It is a tautology that economic expansion represents the sum of two sources of growth. On one side are increases in "inputs": growth in employment, in the education level of workers, and in the stock of physical capital (machines, buildings, roads, and so on). On the other side are increases in the output per unit of input; such increases may result from better management or better economic policy, but in the long run are primarily due to increases in knowledge.

The basic idea of growth accounting is to give life to this formula by calculating explicit measures of both.

…..

While the growth of communist economies was the subject of innumerable alarmist books and polemical articles in the 1950s, some economists who looked seriously at the roots of that growth were putting together a picture that differed substantially from most popular assumptions. Communist growth rates were certainly impressive, but not magical. The rapid growth in output could be fully explained by rapid growth in inputs: expansion of employment, increases in education levels, and, above all, massive investment in physical capital. Once those inputs were taken into account, the growth in output was unsurprising--or, to put it differently, the big surprise about Soviet growth was that when closely examined it posed no mystery.

….

How, then, have today's advanced nations been able to achieve sustained growth in per capita income over the past 150 years? The answer is that technological advances have led to a continual increase in total factor productivity a continual rise in national income for each unit of input. In a famous estimate, MIT Professor Robert Solow concluded that technological progress has accounted for 80 percent of the long-term rise in U.S. per capita income, with increased investment in capital explaining only the remaining 20 percent.

Baumol does not tell us that increasing services productivity is impossible, he just says it’s more difficult. We also have that historical evidence, via Solow, that planned economic systems do not increase productivity but market based ones do.

Ah, so therefore we need to have more - and more more - markets in services in order to be able to increase productivity in services. As Sissons points out:

The Baumol effect is like a tide that lifts all boats. It brings higher wages to everyone, sharing the benefits of productivity growth across the economy.

Improving productivity anywhere in the economy increases wages for everyone. Therefore the reason to have markets in healthcare, in trains, in education, the reason to have markets everywhere they can possibly be crammed in, is to make everyone richer by improving labour productivity.

QED.

Tim Worstall

The glory of politics and the water companies

You may have noted that we’re not wholly keen on politics as a method of running things. Here’s a good example of why:

In his first interview since taking up office, he told The Telegraph: “Every single river in England today is polluted... The public quite rightly are furious that they have to worry about letting their kids splash about in the river, for fear of what they might catch, because it’s polluted.”

Mr Reed said he will introduce a new system monitoring sewage spills, which involves independent scrutiny of the data, to stop water companies from “massaging the figures”.

Oversight of pollution doesn’t strike us as a bad idea at all.

Sewage was spilt 464,056 times last year, totalling more than 3.6 million hours, a record high since monitoring began, according to the latest data published by the Environment Agency.

Water companies are permitted to release sewage into rivers and seas during exceptional circumstances, such as extreme wet weather, to stop it backing up into people’s homes.

That’s because monitoring has hugely expanded in recent years - added to the vagaries of weather which has led to a run of those extreme circumstances. But the thing we think should be noted. As far as anyone knows the situation in Scotland is worse, far worse. But the monitoring is far - far - less intense. And as far as it is possible to see the state owned and run Scottish Water is not to be subject to this greater oversight of pollution issues.

The Bill, which will be brought to Parliament in September with a view to getting it on the statute books by Christmas, will also require water companies to install “real-time monitors” at every sewage outlet, with data that can be independently scrutinised by water regulators.

England is close to this anyway. Scotland is nowhere near it. As far as it is possible to see this bill will apply only to England.

Mr Reed said he will introduce further laws aimed at “fundamentally transforming” the water industry.

This will include setting up a “partnership” between the Government and water sector aimed at raising billions of pounds of private sector investment and encouraging water companies to make long-term plans for investment in their infrastructure.

We already have this. OfWat already determines allowable investment levels in the water companies. One of the reasons they don’t invest more is because OfWat won’t let them.

Finally:

“When I was younger, we’d go to the beach and I’d go in the sea and no one worried about it,” Steve Reed recalls. “We’d go to a lake somewhere and I’d go swimming. No one had to think about it twice – you just assumed the water was clean enough to go in and it was.”

He went on to describe how this care-free approach is a far cry from the attitude of families in modern-day Britain.

“Today parents worry about letting their kids in the water for fear of what they might catch. I want to get back to a position where you don’t have to think about that, you just know that the water is clean,” he told The Telegraph.

The water is hugely, vastly, cleaner than it used to be.

As we say, we’re not great fans of politics as a way of running things. For all of the proposals make perfect sense in that political sense. They’re all also close to or over the nonsense line in a real sense. The lack of investment is because the regulator won’t allow it, the water is cleaner than it’s been since the 18th century - and probably the 16th - and the biggest polluter is the state owned company that isn’t subject to either the bill or the increased monitoring.

Lots of action and little to nothing useful being done - you know, politics?

Tim Worstall

We really don’t think this works as a plan

Colin Hines tells The Guardian how it all should work:

Labour could achieve this by redefining growth as the increase in economic activity directed towards rebuilding public services and turbo-charging a green transition in every constituency. This must include retention and recruitment in these sectors through adequate pay levels, and in the process also boosting the businesses connected with them.

We’ll all get rich by building each others’ windmills. At good union rates too.

We think that lacks a certain something as a plan. Quite apart from that little redefinition of growth as being whatever it is that Colin Hines wants rather than what everyone else wants. That little redefinition being a significant logical problem.

There’s a reason we use “at market prices” in our calculations - definition even - of GDP and therefore economic wealth and or growth. For market prices are the best guide we’ve got to how people value the output, the production, from our economic engine. The entire aim is, after all, to increase the self-perceived well being of the populace. We thus have to measure how well we’re doing by using some measure of how well off the populace think they’re being made. The value of production, of their consumption, that is.

Change that valuation to whatever it is that Colin Hines thinks is worthwhile and we end up with an economy that makes Colin Hines rich - he’s getting what he wants - but that might not quite coincide with what the other 66,999,999 people in the country thinks makes them richer. That being, obviously, why we use market prices as our best attempt at an objective valuation of what the populace desires.

Tim Worstall

Mission critical plans with strict conditionality

A useful example of why direction from the top does not work:

It is the latest sign of a wobble over hydrogen, a so-called superfuel that has been championed as a solution to decarbonise everything from transport and heavy industry to home heating and power generation.

Across the West, politicians have pledged to meet ambitious climate targets partly through developing different sources of the fuel, such as “blue” hydrogen made from natural gas, and “green” hydrogen derived through electrolysis of water.

Collectively, they have pledged to produce millions of tonnes of hydrogen in the coming decades – despite there being no proven path to doing so commercially.

If it were possible to produce green hydrogen in volume then pipe it to every house we’d indeed have a glorious solution to climate change. Even better if we could do so economically. That’s proving between hard and impossible. The big problem is not, in fact, in the creation, it’s in the storage and transport.

Well, OK. But politics - in the grip of those mission critical with strict conditionality plans - has demanded that it be done at vast cost. Which just isn’t how technological advance happens.

The envelope of what can be done expands as technology advances - or changes if you prefer. What people want done also changes according to knowledge, fashion and sheer obstinacy. The trick is in matching what can be done with what people want done. This means constant and continual experiment.

That is, not some baby-kisser deciding what will be done, but that mess of markets of everyone trying everything until we see what works.

Now, we at times have praised the idea of green hydrogen. Largely because of some actual work in the field, one of us has worked at the, ahahaha, coal face. We as a result think it’s still a pretty neat idea. But not in the manner that politics has decided it should be dealt with. Rather, hydrogen might - note the might - be useful as a local and medium term (so, days to weeks) storage system. Electrolysis to storage to fuel cell. Akin to batteries that is. Equally, once we have green hydrogen to Fischer Tropsch it up to such things as jet fuel could make sense. This is not, really not, the same as thinking that we can pipe H2 to every house in the country to run gas stoves or water boilers.

But we also have the necessary humility here. Which is to agree that while it’s all a very neat idea we do require proof of that contention. The only way we’ll gain that proof is it everyone tries everything then we see what works and do more of it.

Markets that is. Not Ministers, bureaucrats or committees demanding vast industrial combines based on a technology that no one knows will work or not.

We’re very sceptical of political ability to do anything. But especially so of the ability to decide upon technology. As here, the system always does seem to plump for what might not, in fact, be possible at all. Whereas the correct idea is to find out what is possible and economic - at which point, of course, no urging, forcing nor subsidy is required as that proof of what is possible and economic is all that is required for general adoption.

That logic is a fundamental problem with the very idea of politics guiding all. That’s before we get to the problem of the plans being pulled from fundaments.

Tim Worstall

We’re really very sure that the point is being missed here

The first point being missed here is that this is theft:

Landowners will receive less in compensation when they are forced to give up land for house building, under a tough new Planning and Infrastructure Bill.

As part of its plan to “get Britain building”, Labour will toughen up the rules around compulsory purchase orders.

It will mean that the amount of compensation paid to landowners will be “fair but not excessive”.

We agree that we are projecting a little here. But there’s long been muttering that compulsory purchase should be at current permitted use prices, not potential permitted use prices. This is, as we say, theft.

For the current market price of a piece of land is both current permitted use and also some element of potential permitted uses. Some estimation of the value if permits were changed times the perceived probability of those permits changing. Options have value - there are vast financial markets worldwide that prove that contention - therefore to pay only current permit value without that potential is theft.

But horrific though theft by the government is this is still missing the point. For what they want to stop having to pay is that uplift in value from gaining planning permission. Which is that missing the point entirely. We all want a system where there is no uplift in value from planning permission. We want so much planning granted that there is no scarcity value to gaining planning. So, wibbles about how to tax - or how not to pay for - the very thing we want to abolish in the first place is to very much miss that point.

Increase the supply of planning so that planning has no value. In short, abolish the Town and Country Planning Act 1947 and successors. Blow it up, proper blow up - kablooie.

Tim Worstall

We’re sure someone promised us joined up government at one time

We also guess that hasn’t arrived as yet.

"I am determined to create wealth for people up and down the country. It is the only way our country can progress, and my government is focused on supporting that aspiration."

So says Sir Keir and jolly good, excellent in fact.

Therefore, and obviously, we’re going to go about increasing the incentives to do the hard work to create wealth. Lower corporation tax, reduce inheritance tax, cut capital gains tax, lower the rate of income taxation and so on. For if we desire people to put in the hard work to create wealth then we would want to increase the incentives to do that hard work then - allow people to keep more of the wealth they create.

We are, aren’t we?

We’re not?

So that Blessed Day of joined up government has not, as yet, arrived then, eh?

Tim Worstall

Farewell, Dr Smith

We don’t know exactly when Adam Smith was born. It was some time in July 1723. But we do know that he died, on this day, in Edinburgh, in 1790.

The story is that he was entertaining friends at his home, Panmure House off the Canongate, as he often did, being a lover of informed and educated conversation. At some point in the evening, he felt unwell, rose and said: “Gentlemen, we will have to resume this conversation in another place.” He died that very night.

Well, not exactly, it was a few days later. But the story is in the right spirit. And Adam Smith’s religious beliefs are a matter of debate; it unlikely he believed in an afterlife anyway. Indeed, though he died seventy years before Darwin’s Origin of Species, from 1759, in his own Theory of Moral Sentiments, he was grasping towards an evolutionary explanation of why human life, in economics, morality and other areas, seems to serve us in generally beneficial ways, without the need for any conscious direction from governments or anyone else. As if directed by an Invisible Hand, he wrote, though he knew there was no conscious entity moving that hand. Or Providence, he suggested. Smith’s mentor David Hume, in the last book of his 1739 A Treatise of Human Nature, was also grasping for an evolutionary explanation, and he was certainly not a believer.

A few days later, the smoke of a bonfire could be seen rising up from the garden of Panmure House. Smith had ordered that, on his death, all his papers should be burned, apart from one essay on The History of Astronomy. It was not such an uncommon request at the time: people did not want to be judged on their random notes and half-though-out jottings. But we were lucky he spared The History of Astronomy, a remarkable essay in the philosophy of science, advancing a trial-and-error thesis that would not be lost on the twentieth-century author of The Logic of Scientific Discovery, Sir Karl Popper.

Smith was indeed a polymath. As well as the economics for which he is most remembered today, he also wrote and lectured on the use of language, on the arts, on justice, on politics and on moral philosophy. It was The Theory of Moral Sentiments that in 1759 made him internationally famous — and brough him a generous income for life that would give him the freedom to think about economics and write his 1776 masterpiece An Inquiry into the Nature and Causes of the Wealth of Nations.

Today we call that simply The Wealth of Nations. And in it, he shows how the spontaneous order of the free market works. For centuries, people imagined that the only gainers in any economic transaction were those who ended up with the money. But Smith noted that their customers benefited too, by getting goods or services that they valued more than the cash. Indeed, the trade would not happen unless both sides got value from it. So we need to be facilitating free exchange — not thwarting it with protectionist measures against foreign imports or domestic regulations on trade.

This ‘system of natural liberty’, he explained, allowed the spontaneous society to flourish and raised nations from poverty to prosperity. It enabled families to strive to ‘better their condition’. By contrast, regulations and laws were too often laid down by politicians and their business cronies: to promote their own interests, most generally in opposition to the interests of the working poor.

Smith would have regarded a government that controls nearly half the economy, spending nearly half the nation’s GDP —  a concept that he introduced to the world on the very first page of The Wealth of Nations — as the greatest tyranny. Taxes, he thought, were another way in which established interests skew things in their favour and block potential competition. Taxes, he argued, should be as low as possible, should encourage rather than restrict free trade and innovation, and should be simple, understandable and convenient to pay. Unlike today’s.

When economic freedom, tempered by Smith’s moral virtues of prudence, justice, beneficence and self-control, has been allowed to flourish, it has led to the greatest increase of human prosperity. The free trade era of the nineteenth century enriched the world and brought humanity cheap food and manufactures. The globalisation of the twentieth and twenty-first brought nearly all nations into the world trading system and pulled a billion people out of dollar-a-day poverty. 

Adam Smith’s lessons are plain enough. The question is why governments so rarely learn them.

There really is no money left, you know?

Yes, yes, government can just instruct the Bank of England to print more money. But even then there’s no money left.

Labour needs a “growth miracle” if it is to fund its aspirations for public services, economists have warned, ahead of the King’s Speech. Economists have raised doubts over the new Government’s ability to boost the economy and expect a repeat of the slow expansion in growth since the global financial crisis.

We can’t have government buying us lovely new things because all hte money’s already been spent. The promises that have been made to us about pensions, services, depend upon economic growth happening already. They can’t be afforded if there is no growth - if there is growth we can only have what we’ve already been promised.

But it gets worse:

The Resolution Foundation has estimated that Labour’s spending plans commit the party to around £18bn of annual budget cuts over the next parliament. As they stand, these would affect “unprotected” areas of government such as the Department for Work and Pensions, the Ministry of Justice, local councils and higher education – and a funding shortfall for a depleted NHS. Ahead of this week’s king’s speech, when the new government will lay out its legislative agenda, five public sector workers give their verdict on Labour’s approach.

Every single one of them insists that the correct move is to send them lots more money. Hey, that could even be true. But it’s another reason why we can’t have nice new things from government. Any extra money around is simply going to pay those who do what we currently get more.

There’s no money for new things because we need growth to pay for the current promises. Even if we do have growth we’ll not gain new things because we’re going to end up paying the current suppliers more. There really is no money left for new things. To gain new things we’ll have to stop having some other things. We are back in that world where opportunity costs reign.

So, what does government currently do that we’d be happy to do without in order to gain some other new and lovely thing? That’s the world we’re in…..

Tim Worstall

If people don’t grasp the basics then…..

We’re willing to be fair to Will Hutton here. That’s a difficult job but someone’s got to do it. This line comes from the Observer’s subeditor, not Hutton himself - headlines and subheads are written by subs, not journalists or columnists. It does capture, well, the argument Hutton is making but these still aren’t his direct words:

Wealth is a privilege, and with it comes the obligation of paying tax to benefit society

This is, obviously, piffle. For what is being said there is that only by paying tax does wealth benefit society. Which is, obviously, that piffle.

It’s actually true that wealth is the product of having benefitted society. As in the William Nordhaus paper about who gains from entrepreneurial activity. It’s us out here, us consumers, who gain the vast, vast proportion of it. The entrepreneurs themselves gain some 3% or so of total value created. Only 3% too.

As an example, Jeff Bezos has some $200 billion. A lorra cash, agreed. It’s also true there’s been the “Amazon Effect”. By making the retail system more efficient the simple existence of the company has knocked 0.1 to 0.2% off the inflation rate. Every year for two decades. No, not 2 to 4% off retail sales that is, but 2 to 4% off the whole cost of living for everyone. That’s a sum vastly larger than the Bezos pile - especially when we convert that annual benefit into a capital sum so as to be able to compare it with the Bezos capital sum.

It simply isn’t true, not in the slightest, that the justification for wealth is the tax paid upon it. It’s how much better off are we made by someone having made that wealth?

Tim Worstall

Adam Smith for the win once again

There are those who think that the mere existence of billionaires is, as the cool kids say these days, problematic. There are those who say that it doesn’t matter very much. We’re in that second camp:

The three-day wedding itself — which begins on Friday evening with the traditional Hindu ceremony, followed by the shubh aashirwad or blessings ceremony on Saturday, and a reception on Sunday — would make an extravagant maharajah blush. While the cost of the months-long wedding celebrations has not been confirmed, analysts have estimated that they may have cost up to 50 billion rupees (£462 million). This would still represent a small fraction of Ambani’s net worth of $123 billion (£94 billion), according to Forbes.

An extravagant display indeed. And yet, as Britannica has Adam Smith saying:

….that the self-seeking rich are often “led by an invisible hand…without knowing it, without intending it, [to] advance the interest of the society.”

The point being made is not that someone having $94 billion is either good or bad, this is a comment upon a different part of the action. Those self-seeking rich, through their extravagant display, are moving £462 million from their pockets to the pockets of all those others supplying that wedding.

That initial argument is that billionaires should not have so much. They now have less than they started with and others now have more. That’s that very initial argument - that the Ambanis should have less, others more. So, it’s happening - good, eh?

This mention of “invisible hand” in Theory of Moral Sentiments is not saying that wealth, billionaires, are good. Nor that free markets are the very tops, the Colisseum, the Louvre Museum. Rather, just the obvious note that rich people spend their money which means that other people end up with it.

Which, you know, seems obvious despite all the vitriol directed at the idea.

Tim Worstall