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Economics in Everything: Why were gangsters and police in Britain gunless?

I recently read an interesting article in by Alasdair Palmer in The Spectator about the “The rise and fall of the gunless gangster”. In the UK in the 20th century, there was a  that the lack of guns among criminals. This wasn’t due to the lack of availabillity of guns. In addition the penalties for being caught with an illegal firearm were significantly less severe then, than they are now. So why did so few criminals carry guns?

The reason for criminals not carrying guns reminds me of a game theory economics lesson.

  1. The life expectancy of criminals goes up when neither the police nor their own rivals shoot at them. The absence of guns benefits the criminal fraternity and society as a whole.
  2. Yet for each individual it is obviously advantageous to carry a gun, as this gives the individual an advantage over their counterpart.

This is a standard prisoner’s dilemma with the pay-offs illustrated in the following table.

Police/Criminals No Gun Gun
No Gun 8,8 0, 10
Gun 10, 0 1,1

In the above situation it is “rational” for both the criminal and the police to carry a gun, as in the gunless world both could profit from carrying a gun, knowing that the other will profit from carrying a gun it is logical that the other party also chooses to carry a gun. The situation where both parties are carrying a gun is the “nash equilibrium”.

For society, the optimal solution is where no individuals carry a gun. To get to this situation coordination between the players is needed. In addition a credible threat is required of retalliation against those that carry a gun is required.. Both coordination and a credible threat seem to have been present in 20th century Britain. Alasdair Palmer writes:

“The answer to those questions is something of a mystery. But it seems that, essentially, criminals in London and across Britain took the view that their collective interest in diminishing the level of violence was sufficiently great for them to punish individuals who broke the convention of not using guns. Furthermore, the criminal fraternity was close-knit enough for the credible threat of punishment from criminal colleagues to keep the convention more or less intact.”

In recent years this credible threat has gone. According to Prof. Paul Collier the arrival of criminal gangs from other countries may have led to the change in convention. Many foreign criminals thought it was stupid not to use guns. As soon as the convention could not be upheld, indigenous criminals had no incentive to remain unarmed themselves and reacted by becoming at least as violent.

An interesting policy question would be: Would we want organized crime to be more concentrated to make a “gunless crime convention” more likely?

Not Deflation, but Competition and Regulation are Draghi’s biggest problems

Many financial analysts will focus on the ECB’s announcements today. Last month the FT announced: “ECB unveils radical moves to fight deflation and lift economy” and Bloomberg printed: “Draghi Unveils Historic Measures Against Deflation Threat”. Reading this one would think that deflation is the big European problem.

Deflation is not the problem. The problem is that real market interest rates are too high, due to the toxic combination of more regulation and less competition. Without a reduction in protectionism the ECB is pushing on a string.

I keep on reading that Draghi should tackle deflation. The common logic is that deflation (lower general prices) is the reason that consumers postpone consumption now. Postponing consumption would lead to a vicious cycle with even lower prices and more deflation (you all know the picture). Is this common logic correct?

No it is not. Imaging standing in the supermarket on Monday and you choose not to buy your bread because the price of the same loaf will be lower Tuesday. On Tuesday you know that the same loaf will be cheaper on Wednesday ect. In the end the person that speculates on ever decreasing prices will suffer malnutrition. Postponing consumption is only logical if you know when deflation is going to end and you can time your purchases accordingly.

The stronger conclusion is that if you would expect prices to decrease forever you could actually increase your consumption today. If we assume that we want to have a stable consumption over time and we know that we can buy fuller shopping trolleys in the future for the same amount of money,  we would increase our consumption today knowing that we can afford the same level of consumption with less money tomorrow.  We would know that we would be richer in the future and, thus can spend more today. Predictable longer-term deflation, would increase real lifetime-incomes and create a boom.

What then is the real problem with deflation? A decreasing price-level can lead to a too low real interest rate. The real interest rate is the (nominal) market interest rate minus the expected inflation.  This is the price of money now in comparison to money in the future.  If you save today you can buy more tomorrow if the market interest rate is higher than the inflation rate. If inflation is higher than the market interest rate you can buy less from your savings.


climb2If the ECB wants to stimulate the economy, it reduces the official deposit rate in the hope/expectation that banks too will reduce the market rate for their clients (consumers and businesses) and that their clients will decide to save less and borrow more. The problem is that this market rate is still at approx. 4.5% in many European markets.

The reason for the higher market rates are threefold:

  1. Lack of competition. More competition would force banks to lend at lower rates or loose business. Many banks are protected by national regulators, who insist on rules which they claim are for customer protection, but in fact are barriers for entry and favor large banks with a national coverage who have the scale to deal with the regulatory burden. Euro loans for less than 2% can already be found at Swiss banks, these banks are however not allowed to promote their products across borders.
  2. More stringent capital requirements naturally reduce the amount banks will lend. In a drive to have larger buffers one has to accept that part of the buffers are filled with cash that could otherwise be lent to small businesses and individuals.
  3. Lack of funding alternatives. Compared to the US, companies in the EU are heavily dependent on bank funding. US firms have tried to enter the EU market with direct lending and have had some small successes. The direct lending phenomenon is however still very small in Europe due to the high burden of regulation that these direct lending funds face in the EU.

Draghi can keep on lowering the official deposit rate and increasing the slack, without reforms that will increase the tension with significant advances, all this extra slack is doing is increasing the risk when the disastrous fall occurs.

Be Green! Buy Hydro NOT Wind

The Dutch Energy Company (Nederlandse Energie Maatschappij, NLE) created a publicity stunt to weeks ago in which it called other energy suppliers liars  (Jokkebrokken). They claim green energy from hydro-electric-powerstations bought with green certificates from Scandinavia is less green than windpower generated in The Netherlands.  Although there claim is not new, it is still NOT correct, as I hope to demonstrate in the remainder of my blog.

Most people believe that global warming is a global problem. To tackle the problem, countries have agreed to meet renewable energy targets. Once the target is set it is the duty of policymakers to reach this target as efficiently as possible. Different countries have different endowments of natural resources (including mountains needed for hydro-powerstations). It is inefficient to demand that one can only meet the target with energy produced within national borders. So how do you make the system more efficient?

Well you set up a trading scheme through which countries can buy certificates from other countries where renewable energy is produced more efficiently and sustainably. Green energy bought from Scandinavia reduces the quota of Scandinavian green energy and increases the amount on the Dutch green energy account. Without having a single coal fired powerplant Norway has an 46% coal power mix.  Norway has also committed to comply with the EU climate targets.  As there are not enough certificates to meet future targets, new renewable energy facilities will need to be built for both countries to reach the target. .

So what should happen? The prices of an additional certificate should become the same across sources.

Currently Scandinavian hydro-power green certificates (GoO) are approximately 0.40 euro/MWh, whereas green certificates from Dutch windfarms are about 2.00 euro/MWh (excluding government subsidies). Both certificates account for the same amount of green energy. Dutch business (and much of the rest of Europe) should be buying their green energy from Scandinavia as long as this is the cheapest option.  As the demand for Scandinavian certificates increases and more are sold in the rest of Europe, the price will increase. When Scandinavian countries run out of increasingly expensive certificates,  they will consider expanding their current stock by investing in further renewable resources. Thus the most efficient source of renewable energy will constantly be expanded. More and more Scandinavian certificates will be bought until the price of an extra hydro-certificate is higher than the next best option. As long the European target is not met the price of this second best option will also increase until a third option becomes just as cheap, and then a fourth ect…  Eventually, the marginal cost of an additional unit of green energy will be equal across sources.

In short, if you believe that we are facing a global problem and do not believe that the nationality of your energy production matters, let the market do its job and buy the cheapest option available within the trading scheme. This is not just the cheapest option for the company concerned, but it will lead to a more sustainable energy production by promoting the most efficient source of green energy, leading to a swifter and cheaper reduction of emissions.

(** these thoughts are my own and do not represent those of my employer)

Static Rules in a Dynamic Game

I promised a review of Was the euro a mistake… and does it have a future? I have given myself a couple of weeks to read the monograph,  which came with the discussion. Along with a history and analysis of the problems associated with the Euro zone, essentially 3 solutions were presented:

My personal preference is no doubt  Kevin Dowd’s, which  suggest a complete Free Banking Solution for the Euro zone. The main advantage would be that this would abolish the need for state support within the banking industry. Many say the Free Banking option is unrealistic.

My fear, therefore, is that we are on the inevitable road towards more state support and ever closer dependence.  The main problem of this ever closer dependence is the bad incentives. The ECB, itself, has rightly points out that the current system has many bad incentives built in. Currently the bad economic and fiscal decisions of one country is borne by the whole euro zone leading to a typical “tragedy of the commons”. The optimal strategy, perversely, is for every politician not to bear the individual political burden of economic reform, as they can shift the a large part of the costs of excessive public pampering the all the other members.

The solution according to Bodo Herzog and Katja Hengstermann are enforceable (political) rules. They suggest that countries that do not comply should loose their ability to vote and that this should be put into a constitution like framework to create automatic and credible enforcement mechanism. This could work in the short-run, however, there is no way of knowing what the economy will be like in a year let alone a decade. It is therefore impossible to write rules for every eventuality. The danger is that with every minor crisis more and more rules will be written. This would mean that support for “intergral industries” (read lobby groups) would be all to easy.

The real solution, however implausible it may seem is to depoliticize monetary policy completely and to go back to the future of free banking.  We should remember that Free Banking served society well in the past. These systems did not end due to economic crises. They ended due to government enforcement due to a desire to monopolize money creation and wars.

Discussing the future of the Euro on Europe Day

ImageThere seems to be a day for everything these days even the European Union. Today is also Ascension day which seems fitting after the EU won the Nobel Peace Prize for not waging war among each other for  nearly 70 years.

Of course not all is well in Europe. Following Hayek’s birthday, yesterday, many EU politicians could do with a read of Hayek’s “Road to Serfdom” and “The Use of Knowledge in Society” (both available for free).

I will be educating myself at Hayek’s Think Tank, The Institute of Economic Affairs this evening. The question will be:

Was the euro a mistake… and does it have a future?

What are your thoughts? I will give my thoughts tomorrow.

A Dual Currency Country: the case for Two Pounds

Photo: cowrin (flickr)

Recently the UK Treasury has released a report on the potential currency arrangements for an independent Scotland. This report and  many commentators show a lack of imagination. Yet it is not hard to change the arrangement so that a competativeScottish currency goes from improbable to very possible.   Just four currency options were discussed in the report:

1. A Sterling zone

2. unilaterally keeping the pound,

3. creating a Scottish currency or,

4. joining the euro.

The Two Currency Solution (2+3)

One solution,  currency competition, was not discussed. As discussed in an earlier blog competition between the Euro and Guilder would be a good thing. Similarly competition between the English (rUK) and Scottish Pound would be good too. This could be implemented relatively easily, by choosing to issue a Scottish pound which would initially be pegged to the pound and allowing both the Scottish and rUK Pound as legal tender (effectively adopting the English (rUK) Pound as a shadow currency unilaterally). Initially the English pound may dominate (it is not unusual to adopt an other currency. Panama has used the dollar since 1904 and Montenegro the Euro since 2002). Yet as local economic conditions change the two different central banks may make different monetary choices. Depending on which currency citizens think is more useful they will change between the use of the different currencies allowing the most competitive currency to thrive.

Oligopoly better than Duopoly

In the above solution there would effectively be a duopoly. The BoE and the Scottish central bank would essentially be competing in a two supplier market. Adding the Euro would create competition from the ECB or  simply allowing Scottish businesses and individuals to choose their own currency and have no formal government currency arrangements at all could be even better. As Philip Booth states:

This would decouple the currency from what would be a highly indebted government thus preventing debasement and inflation as a method of dealing with government debt.

As Andrew Lilico has stated the above arrangement  would indeed be a dream-come-true for those who believe in free markets and free banking. Unfortunately Philip Booth also notes that:

there are aspects of EU law which surely torpedo this.. Scottish banks would have no access to lender-of-last-resort facilities and deposit insurance would probably become infeasible. There is a big problem, though. Firstly, EU law requires deposit insurance so we will probably end up with incredibly tightly regulated Scottish banks to avoid a cost to the public purse of a bank going bust.

In the Dual-Currency situation these problems would not arise. The Scottish Central Bank could print Scottish Pounds and act as lender of last resort. As is pointed out the currency choice has become political and  the gloves have come off. The choice for a separate Scottish currency alongside the  rUK Pound would allow the SNP to keep face, whilst allowing voters to go the polling booth knowing that at best they will be gaining a new currency, with potential monetary independence.

My hope is that a successful dual currency arrangement in Scotland will lead to a European rethink of allowing currency competition.

Backloading: The bad idea that thankfully failed

Hopefully the recent vote against the back-loading proposal means that politicians will start enforcing the cap and trade system instead of undermining it. Policymakers should look at the failed policy that lead to lower prices, instead of constantly rigging the system. The flaw is not a market for carbon credits. If implemented and enforced properly mechanism will reduce emissions, the price of carbon at one point in time does not matter. All that needs to be done is cut out the government-failure.



A free market does not price pollution properly. What should we do do? There are two different market mechanisms to limit CO2 emissions.

1. Cap and Trade:

Governments (in there wisdom) decide how much can be emitted, and issue permits to this limit. CO2 is limited to a “safe” level, has been decided apon. The main advantage is that this ensures (if properly implemented) certainty that a certain carbon limit is reached. The price of carbon, at given time, is irrelevant. Prices adjust to reach the level and will not be stable over time.

2. Carbon Tax

Governments (with similar wisdom) decide how much damage carbon does and tax this amount. In this case the price is stable and predefined yet here is no abatement certainty, but this does not matter as society pays for the costs of carbon with a tax up front. This money can be used for adaption.

The European Union has chosen for option 1. They have set a carbon emissions limit and it is up to industries to find a way to produce within this given constraint. The lower price for carbon credits simply reflects the market’s opinion that these credits are no longer as scarce or that abatement is cheap . A low price does not mean that the cap and trade instrument itself is flawed, nor that the target will not be met.

Not market, but government-failure

So why all this bleating about low ETS credit prices? If the 2030 cap is set correctly we should all be fine right? Yes we will under 2 conditions:

1. The cap is set at the right level

2. The cap is enforced

1. We will never know the “correct level”. Yet for credibility governments should stick to a specified level. It is illogical to choose for a Cap and Trade Scheme instead of a tax and then change the system as soon as the price for carbon is lower than expected.

2. This is where governments fail. The main reason for low prices is not some market-failure. The cap and trading system is still in place. The problem is the obsession of politicians to:

  •  protect “the good old boys” is some favored national industry. This has been pointed out by other bloggers such as: Robert Kyriakides;
  •  kneel to political pressure of lobby groups such as CAN Europe for a green image.

These two obsessions lead to one bad policy. Carbon credits on the cap and trade system market are reduced in the hope to drive up the carbon prices whilst free credits are dished out to national industries. Hopefully the recent vote is a turning point to policy reform. Let us hope that the market mechanism is left to do its job and policymakers will do theirs by enforcing instead of undermining the ETS trading system. If California can learn from the EU’s mistakes their cap and trade system may even work.

The Minimum Wage: A Political Pressuregroup Product

Activists focus on the presumption that a Minimum Wage helps the poor, less skilled, and less fortunate people. Basic logic presented by Precious Meddles show that this is not true. Economists focus on the question:  how much does the Minimum Wage  decrease employment? Instead a more pressing question is who does the minimum wage actually benefit?

When Paul Krugman tells you that “there just isn’t any evidence that raising the minimum wage near current levels would reduce employment”, he is, being dishonest and is relying more on his readers’ ignorance.   In a very insightfull blog Steven Landsburg links to research pointing out that the minimum wage does effect employment.

Among the most careful and thoughtful of those researchers are David Neumark and William Wascher, who in their recent book on the subject, conclude that minimum wages “reduce employment opportunities for less-skilled workers and tend to reduce their earnings; they are not an effective means of reducing poverty; and they appear to have adverse longer-term effects on wages and earnings, in part by reducing the acquisition of human capital.”

I hate using the word fair but Steven Landsburg also points out the unfairness and lack of political wisdom  related to a  minimum wage policy as.

Some people voluntarily pay wages to unskilled workers. If we collectively decide that we need more wages paid to unskilled workers, should we turn to the people who have been paying wages by choice and demand that they pay more?[…..]Letting people vote for expensive programs that “somebody else” will finance is a good recipe for getting people to vote irresponsibly.

The minimum income of the poor is  already defined by welfare income. If the minimum wage for a job is below the income that would be earned on welfare there will not be many people applying for the job. The minimum wage = welfare income + a premium (for getting out of bed early and missing out on “leisure”).

If the government only cared about the disposable income the poor (without taking into account bad incentive) it would simply increase out of work benefits. This would subsequently increase the (efficient) wage that employers would need to pay employees. Seeing as this is not done, who does the minimum wage benefit? This is clearly those employed in low skilled jobs, but that are unlikely to be fired. Namely, senior workers in heavily unionized industries.

As Stephanie Lis points out on the Spectator Blog:

The real poverty in society lies with those who are not in work at all. This increase in the national minimum wage will do nothing to improve their chances of a job – rather the reverse.

Nudge Theory

Small things can make a big difference

On Monday, BBC Radio 4 broadcast a special edition of analysis on “Nudge Theory in practice” with Prof. Cass R. Sunstein co-author of “Nudge: Improving Decisions about Health, Wealth, and Happiness”.  As regular readers will know, we approve of freedom and letting people make their own decisions – Freedom of choice.  A general and correct criticism is that we presume that people are more rational than they actually are. As Daniel Kahneman in his brilliant, must read book “Thinking, Fast and Slow” highlights, people don’t always think correctly. People have many biases which are attributed to decision making “tricks”. Through these biases people make apparent irrational decisions. Nudge theory tries to correct or use these biases to incentives / educate people to make a particular choice.Nudge-cover

Nudge theory is probably best defined as Libertarian Paternalism. People are still given all the freedom to make their own decisions but they are “nudged” to make a particular decision. A good example is opt -in and opt-out on savings for retirement. By automatically opting people in more people will save for retirement. Another example is adding a note on your tax bill giving the true statistic that “9 out of 10 people pay their tax on time”, makes more people pay their tax on time.

The question remains of where does a nudge turn into a shove? In my mind it is where there is no longer a free choice – at the moment where the choice is influenced by an economic or physical penalty. You should not be punished with a fine for opting out of saving for retirement.

Nudging is a great tool in government as well as in business. In the end you want to trust people and let people make their own decisions. Legislating and mandating everything leads to rigid box ticking and a lack of flexibility. Legislating and mandating is still the first instinct for many. However, does the centre really know what is best for the fringes? Is there really a one size fits all policy? By giving people and the lowest decision making level the right incentives by taking non-rational choice into account, through nudging, small things can really make a big difference.

Elderly Care App (free version) Upgrade to PRO? (£xx,xxx.xx)

The only way to supply unlimited demand at the right price is to offer differentiation through two (or more) tiers of products 

This week the British government overhauled the way people will pay for elderly care. The politically symbolic and significant change is that people will no longer need to sell their houses to pay for care. They have, however, not resolved the central issue. Those who with foresightand  save for old age need to pay through their savings, whereas those who burn their income and spend all as it comes in get their care in old age paid for them. The seemingly obvious solution is to give free elderly care to all. This though, similarly to the NHS, would cost the tax payer more and more, year on year. Demand would always outstrip supply. The population’s demand for higher quality of elderly care as with higher quality of health care can’t be satisfied. As soon as a higher standard is available it is assumed that this standard should be available to all.

The only way of supplying healthcare and elderly care to all is through a two tier system similar to mobile phone applications. A free version should be available to all and a paid for version for those who are willing and able to pay for it. The free version should be a basic safety net paid for out of separate defined taxation, whereas the upgrade version should have significant extras. This way those who save for old age can live their old age in more luxury whereas those who chose or were not able to save are still cared for.

More Freedom in an A La Carte EU

Plurality is great for individual freedom in Europe

The first reduction in the EU’s budget and David Cameron’s pledge for re-negotiation of the British relationship with the EU, have been reviewed from many angles. The reality is that nothing much happens at any radical speed in the EU. Various commentators are however right. The EU is at cross-roads. Will it renew confidence and go back to its founding principles or will the Leviathan break its “social contract”?

The EU has many more positives than negatives. It has brought peace and prosperity to a once chaotic continent in a state of nature which was “solitary, poor, nasty, brutish and short” (Hobbes Leviathan). Countries like individuals have given up some of their liberty to come together in a “social contract”. This contract brought about common agreed standard behaviour and set of laws. The EU has, however, forgotten (similarly to monarchs of the 17th & 18th century) that it is not an absolute ruler. The Leviathan’s goal is “to protect life, liberty and property of its people”. People are born free and have the right to remain free. In the EU’s terms this means protecting peace, free-trade, property, and the rule of law. The EU has no reason to reach any further. Reaching further would lead to society giving up more liberty than it needs to. Reducing individual freedom to a potential dictatorship of the majority.

A majority of people would agree with youth unemployment guarantees, a financial transaction tax, a minimum wage or even a living wage, and a 40 hour maximum working week. However, not all would agree (many wouldn’t). It is unfortunate that democracy is not perfect and that we can’t think of a better alternative. So it is up to the minority to create a majority though debate and interaction.

Yet the beauty of the EU could be that it could allow people to vote with their feet. The EU could be John Locke’s United States. If an individual does not agree with a law in their country of residence, they should have the opportunity to move to another country in pursuit of happiness. By promoting the right overall conditions in the EU, through enforcing the social contract but also allowing for plurality, leaving one country for another does not need to be a nasty or haphazard experience. An “a la carte EU” with countries controlling their own policies in a European framework would give the individual most freedom.


How did Dutch politicians Squander Billions on Natural Gas?

In 1959 the drilling started in Slochteren natural gas field. There was some discussion on putting the money into a special fund for future investments. Yet as , Cees Banning described, Dutch politicians have since let 211 billion to go up in smoke.

Instead of investing for the future, 52 billion euros, or almost a quarter of all natural gas revenues, went into financing social security. Only 15 percent was used to improve the national infrastructure of the Netherlands, while 85 percent went to welfare benefits, interest payments on the national debt, and spending on health care, education and public administration.

Natural resources are a one time unexpected income. These windfall gains should have been invested to create a long-term income stream. Instead natural gas has created a Welfare state that the Dutch have got addicted to, but can no longer afford.

Recent Earthquakes due to natural gas extraction have created a political dilemma  Either stop the extraction and lose valuable income which many Dutch take for granted or continue extraction risking further protest from Groningen. If, however, the money was spent more wisely in the first place, there would be no complaints from people at all. They would not  worry about the structural integrity of their houses. Let alone earthquakes. They would already have been reimbursed by the fund and have Japanese houses. Additionally there would be a nice budget to cushion the current crisis.

A Bugdet Victory? The EU again ignores its Treaty

EU leaders may be congratulating each other on decreasing the EU budget for the first time ever, yet they have failed to reform a failing institution. It is time that the EU did what is meant to do instead of meddling in things it knows little about. A new “historical” budget would need to reflect this. The EU budget should focus on European scale projects, NOT regional funding and the Common Agricultural Policy. 

The subsidiarity principle

The EU stick  to its own treaties and stop ignoring article 5 of its own treaty, the subsidiarity principle (skip of quote possible). The subsidiarity principle states that:

1. The limits of Union competences are governed by the principle of conferral. The use of Union competences is governed by the principles of subsidiarity and proportionality.
2. Under the principle of conferral, the Union shall act only within the limits of the competences conferred upon it by the Member States in the Treaties to attain the objectives set out therein. Competences not conferred upon the Union in the Treaties remain with the Member States.
3. Under the principle of subsidiarity, in areas which do not fall within its exclusive competence, the Union shall act only if and in so far as the objectives of the proposed action cannot be sufficiently achieved by the Member States, either at central level or at regional and local level, but can rather, by reason of the scale or effects of the proposed action, be better achieved at Union level.The institutions of the Union shall apply the principle of subsidiarity as laid down in the Protocol on the application of the principles of subsidiarity and proportionality. National Parliaments ensure compliance with the principle of subsidiarity in accordance with the procedure set out in that Protocol.
4. Under the principle of proportionality, the content and form of Union action shall not exceed what is necessary to achieve the objectives of the Treaties. The institutions of the Union shall apply the principle of proportionality as laid down in the Protocol on the application of the principles of subsidiarity and proportionality.

Basically this means that  decisions are taken as closely as possible to the citizen and that constant checks are made to verify that action at Union level is justified in light of the possibilities available at national, regional or local level. Therefore if The Netherlands decides that building roads in the middle of Flevoland is a daft idea, what special knowledge do Brussels bureaucrats have that gives them the right to spend money on it anyway?

The same goes for the CAP. Why should efficient and innovative farmers in Holland support and maintain small inefficient and backward farming in France? Surely the aim would be to have efficient farming everywhere in Europe? Wouldn’t an internal market enable this best instead of subsidies and regulations?

European Projects

Instead of chiseling at the budget the leaders should have defined a leaner and meaner EU that fits within its treaty and designed a budget accordingly. If the subsidiarity principle was upheld the  The EU would focus on European projects. It would strengthen the internal market, not give aid to lobbying special interests. The EU court would settle European disputes that do not fall within national jurisdiction, instead of meddling with national laws. It would set-up a true European patent office to enhance innovation and entrepreneurship, instead of making business increasingly cumbersome.


Instead the leaders have chosen to ignore their own treaty. Spending most of the budget on CAP and regional funds. These funds do not only create inefficiencies at home, but dangers outside Europe. If anything the EU should have learned that the best road to peace is trade. Including Africans  in trade, NOT development aid will decrease the pull of terrorism.

Top Blogs according to Henry

The last six months I have been incredibly busy completing my master thesis. The Master Thesis will appear under essays on this site. I may not have been many writing blog posts, but have not stopped reading other blogs. Below you will find the best five blogs according to Henry:

1. IEA blog
This is simply a must read blog. Especially Kristian Niemietz has been redefining the poverty debate.  A good (free) read is:

“Why a War on Markets is No Substitute for a War on Poverty”

The best post in this period  include:

 The poverty lobby: single-issuers whose single issue is no longer relevant

Why Europhiles and Eurosceptics don’t understand each other

In praise of trickle-up economics and

The Living Wage campaign: shouting at red signals

2. Knowlegde Problem
This is a free-market blog which also looks at energy markets. The blog is run by Michael Giberson and Lynne Kiesling. This is not just a commentary on Economics, Information and Human Action, but has post looking at specific policies in which they have a expert understanding.

3. Marginal Revolution
This blog is probably best know for the ongoing  battle between the main author, Tyler Cowen, and Paul Krugman. It has, however, expanded and now offers the Marginal Revolution University. Let us hope this encourages more people to enter the economic and political debate.

4. Coffee House – The Spectator Blog

This is a free part of the Spectator magazine. Unlike the magazine the blog is free. It is a good place to keep in touch with the wider debate in British politics.

5. Guido Fawlkes

Some authors would put this in the “Tabloid Blog” category. It is, however, more informative. It is a must read to stay in touch with the ins and outs of Westminster. We should not forget that the cornerstone of freedom is the freedom of speech. Guido is a protector of this.

How Regulation makes Banks go Bust

by Celesteh

by Celesteh

The recent bail-out of SNS once again shows that competition not regulation is the solution. As Philip Booth explains in “Customers have no incentive to punish mis-selling banks” more regulation (and the implicit consumer protection that comes with it) leads to less critical and knowledgeable customers. With an bail-out  lenders and shareholders too have a certain protection. Customers, shareholders and lenders therefore no longer have the same incentive to check financial (mal)practices.


The solution can only be one with less implicit guarantees derived from regulation. A bail-out by the state must be so unattractive that it should be inconceivable. The terms of the state nationalisation need to include punishments for bad stewardship by the shareholders, lenders, customers and directors that are so severe that nationalisation would be avoided at all costs and other solutions (even bankruptcy) would be appealing. It is time for banks to compete in having the best contingency plan to avoid this unappealing outcome, instead of stating that they are doing what the regulation is telling them to do.
Much like welfare implied guarantees granted from regulation are not a safe safety net for extreme situation, but have become a blanket smothering inventiveness and a competition to the top that society requires.

Digging Holes

Is spending key? Anyone reading chapter John Maynard Keynes or Paul Krugman would believe so. Its argument is appealing, yet to specific as explained in“When is a General Theory really General?”. In chapter 10 of The General Theory, Keynes’, much quoted assessment is that, failing productive investment, even unproductive spending helps. The way to bring an economy out of a depression caused by a liquidity trap could, even be wars and alien invasions according to Krugman or the digging of holes if we believed Keynes.

by Blugeoner86


Unfortunately this unproductive investment has got us in not out of the crisis. Nick Silver in: “Government should focus on delivering higher quality services for less money,”  points to important paper by Tim Morgan. “Wrong Questions give Wrong Answers”, illustrates how between 2000 and 2007, economic growth resulted from two sectors, growth in debt-driven construction and increased government spending. Whilst analysing government spending in “Where’s all the Money” Morgan shows that between 1999 and 2010, the productivity of health and education, declined by 20 per cent. Whereas one would expect efficiency to increase over time given that the public sector was not exactly a model of efficiency in 1998. It is time for the focus on “spending” to stop. We have had our growth in unproductive spending, yet the state is addicted. It is time for the country to enter re-hab. Government activity should be limited and focus on delivering more productivity not less. It is the blind focus on spending, essentially a Keynesian Krugmanite fiscal expansion, that created the bubble.

Companies Should NOT Pay Tax

A corporation tax creates unfair competition and decreases jobs, so instead of enforcing it we should scrap it.  Taxes are unpleasant so the least damaging option should be chosen.

Following the recent row in the UK with Google, Amazon and Starbucks paying very little corporation tax in the UK, I could not help but find it strange that companies pay any tax at all. The tax does not make any sense and  is also avoidable. The UK receives 569.5bn in tax a year of which 43.1bn from corporation tax. This is 7.6% of the total tax take. The OBR (Office of Budget Responsibility) has forecast that this tax take will decrees to 5.8% by 2017-18 (see chart). I think that in a globalised world this tax receipt may fall even further. The UK should at least face the OBR’s forecast and cut this tax to the bare minimum and replace it by a smarter more sustainable tax system – stop taxing jobs and increase taxation on consumption.


Firstly taxing companies does not make any sense as taxing companies is taxing that what is desirable, jobs. Companies create jobs and add value. Without value addition companies would not exist. It does not make any sense to tax these companies you reduce the number of companies (all else equal) . Taxing booze, landfill and Tabaco makes sense as we would like to reduce these activities.

Secondly taking money out of companies in tax reduces the amount these value adding entities can reinvest in adding more value or pay out in remuneration or dividends. If the company does not reinvest and pays out more in remuneration or dividends this money does not escape the economy but will be reinvested or spent

Many forget that companies pay huge sums VAT (value added tax). The total tax take on VAT was 98bn or 17% of the total tax taken. This tax is expected to be stable over the next 5 years. It would make more sense to raise more tax from a stable VAT base and cut taxes to companies.

The question then is raised on how to fill the gap left by corporation tax. As the tax receipts are expected to dwindle the gap that needs to be closed is diminishing. This gap though could be closed by a rise in VAT. Of course a rise in VAT leads to a rise in prices which is partly absorbed by companies by lessening profits and partly passed on the consumers. This will mean that people pay more tax when consuming their income but their income should be higher as companies the job creating vehicles will be taxed less.


In a global world a company is a too larger entity to tax. People live in a country and benefit from the having a government which needs to be funded. Companies though don’t really live anywhere and actually add to the wealth of a country by providing employment, innovation and goods that people want. Taxing this is no longer viable in a global world. As the IBR forecasts the receipts from taxing these entities will diminish.

The argument of course is that companies do use the public resources. My argument though would be that they are a public resource in their own right (being employed generally makes people happier) and that companies regularly pay the higher business rates for public services.

Finally corporation tax in a globalised world is unfair on small businesses who can’t as easily avoid this tax. The tax is an added business cost which its larger competition may not have. To create a level playing field the archaic tax should be cut.

In a global world where corporation tax (a jobs tax) can be avoided it is archaic to keep expecting tax receipts. The OBR has realised this (to a certain extent) and it is time for politicians to take note.

The Third Way is the Wrong Way!

Photograhy: Magnetic Lobster

With a split election result after which both the state economy labour party (PvdA) and the free market liberal party (VVD) are likely to become bedfellows in the next coalition. My worry is the attempt to find a “Third Way” on economic policy. For this third way many look to Sweden. This was not a success.

A popular notion is that Sweden has defied standard economic logic, by managing to grow rich in spite of high taxes and state involvement in the economy. Yet as Swedish writer Nima Sanandaji explains in his recent publication “The surprising ingredients of Swedish success – free markets and social cohesion.” The Swedish experience should be used to argue for the benefits of free-market oriented policies, warn against the economic and social problems that can arise when government involvement in society becomes too large.

Sweden did not become wealthy through social democracy, big government and a large welfare state. It developed economically by adopting free-market policies in the late 19th century and early 20th century. As late as 1950, Swedish tax revenues were still only around 21 per cent of GDP. The policy shift towards a big state and higher taxes occurred mainly during the next thirty years, as taxes increased by almost one per cent of GDP annually economic performance declined. The rapid growth of the state in the late 1960s and 1970s led to a large decline in Sweden’s relative economic performance. In 1975, Sweden was the 4th richest industrialised country in terms of GDP per head. By 1993, it had fallen to 14th. Government intervention had a devastating impact on entrepreneurship. After 1970, the establishment of new firms dropped significantly. Among the 100 firms with the highest revenues in Sweden in 2004, only two were entrepreneurial Swedish firms founded after 1970, compared with 21 founded before 1913.

Since the economic crisis of the early 1990s, Swedish governments have rolled back the state and introduced market reforms in sectors such as education, health and pensions. These are exactly those areas which are particulary stagnant in The Netherlands.  Economic freedom has increased in Sweden while it has declined in the UK, The Netherlands and the USA. Sweden’s relative economic performance has improved according

Both Rutte and Samson, know that they are dependent on a good economic performance. They too should learn Sweden’s lessons and reform the Dutch economy. This should include pro-market reforms which increase economic freedom.

The text was modified and taken from:

 Nima Sanandaji (2012) “The surprising ingredients of Swedish success – free markets and social cohesion.” IEA Discussion Paper No. 41

Draghi is Outright

Photography: European Parliament

Nearly a weak after Draghi announced Outright Monetary Transactions (OMT) to help distressed Eurozone countries, we no little of how this “bazooka” will work in practice. We do not know the conditions to which these countries will need to sign up, but more importantly we do not know how the ECB is going to fund the transactions and through which channels is proposes to purchase government bonds.

To be fair Draghi does not really have a choice. To calm markets bold measures are required. As we know being bold normally means being dangerous too. One of the rules in the ECB’s charter forbids the ECB from financing governments. Thus direct purchases would be in direct conflict of the charter. The ECB can buy bonds from third parties on the secondary market without breaking the rule. Many people, including Jens Wiedmann and myself, believe that this does break the rule in spirit, as this is most definitely still government financing which could tarnish the ECB’s independence.

This looks like a good week for Europe. On the whole, pro-European parties have won the elections in the Netherlands, the German constitutional court allows the ESM to be ratified and Draghi has expanded the ECB’s armoury. Yet, what will this week’s permanent status be in history? The Germans will note that many of the monetary safeguards that were agreed upon when Germany decided to join the single currency have crumbled. These safeguards, were there for a reason. Germany will only be pushed so far. This week might well be the start of the loss of both the ECB’s independence and democratic power, and German faith in Europe and the Eurozone.

Hollande wants to kick Germany out so he can devalue the Euro

Photography: Philippe Moreau Chevrolet

Laissez-nous-faire is a French phrase, which the French themselves seem to have forgotten. In a public debt problem, created by bad public finances and a lack of public and political will to reform the labour market, the French have chosen a Socialist President in Hollande. He has announced plans to raise a 75% tax on the wealthiest and nationalize industrial giants. This sounds similar to economic policies France’s last Socialist President, Mitterand, imposed.

IconicPhotos calls Mitterand’s first years of office were an unmitigated disaster he created 250,000 new government jobs, raised pay for government employees, shortened the work week from 40 to 39 hours, added a fifth week of paid vacation, reduced the retirement age to 60, increased social payments through Allocations Familiales, and nationalized 38 banks and 7 industrial giants. The budget deficit tripled; inflation and unemployment stood in double digits. Mitterrand had to devalue the Franc no less than three times to keep France’s exports competitive.

As we countdown to France’s fiscal crisis, Hollande will not be able to devalue the Euro to regain competitiveness. He will need to reform. Yet there may be another solution, he could devalue the Euro if he persuades the Germans and other Northern European countries leave:

The Buzz quotes George Soros when he says:

“So France’s real choice is, on the one hand, between breaking with Germany to save Europe and restore growth or, on the other, pretending to be in the hard currency boat for a limited time, only to be thrown overboard later,”

If Hollande is one bit like Mitterand, he will definitely take the first option and try to save face by taking the lead in a weak Euro and devalue it immediately.

Tax the Rich! The State Spends their Money Better

The Dutch state spends 50% of GDP

An interesting new project for the BBC Radio 4 programme “More or Less” would be Dutch government expenditure as a percentage of GDP. My dad got on Dutch Business radio (BNR) to advocate for a smaller state but was told by a professor that the Dutch state spend only 30% of GDP. This is obviously not correct. A right-wing magazine (the Elesevier) with interest in overegging government expenditure only quoted 35% 40% as the tax pressure on the average Dutch citizen but, if you look at government expenditure as a percentage of the country’s total income (GDP) it needs to be concluded that it is 50% (this is without taking expenditure on health insurance into account).

Souce: Centaal Plant Bureau voor de statistiek (CBS)

Of course it comes back down to the question what is optimal statistic for measuring the size of the state?  As most other sectors of the economy are measured as a percentage of GDP it is surely only fair that government expenditure is measured in the same terms. The consequence is that we have to conclude that the state is a deemed a good enough allocator of the countries resources to be in charge of half of them. Is that really what the Dutch people think? Are their bureaucrats really that good and the general populous that stupid? The current elections should be one about the future of this expenditure. Should be government really spend this much and if it does who’s income should the government spend? If taxing the rich is the way then government is really concluding that it is a better allocator of resources than those who allocated their resources so effectively to create their wealth.

Please see an article on a the same topic in Dutch “De Staat Gebruik Geld Beter dan het Individu?

Gebruikt de Staat Geld Beter dan het Individu?

Politici kunnen liegen statistieken niet

Het verhaal dat wordt verteld in de Elsevier en door de meeste politici is dat de belastingdruk op de gemiddelde Nederland tussen de 35% en 40% ligt. In realiteit is dit echter niet helemaal waar. Als je naar de belangrijke cijfers kijk dan is het makkelijk uit te rekenen dat de overheid eigenlijk de helft van het Bruto Binnenlands Product (BBP) uitgeeft.  Het lijkt wel of de overheid denkt dat zij beter weet hoe wij ons geld uit moeten geven. Vorig jaar was het bbp 601 miljard en overheid uitgaven waren 301 miljard.


(Overheid Uitgaven/Bruto Binnenlands Product)*100

Cijfers van het Centaal Plan Bureau voor de statistiek (CBS)

In deze statistieken zijn onze uitgaven aan zorg kosten nog niet eens toegevoegd. Als dit erbij opgeteld wordt komen we nog hoger uit.

Waarom is deze 50% zo belangrijk? Wat we met z’n allen nu eigenlijk zegen is dat wij denken dat de overheid minimal even goed is als wij als individueen in het beslissen hoe geld moet worden besteed. Van elke Euro die Nederland verdient wordt 50 cent door de staat uitgegeven. Kan de staat echt het best beslissen?

Waarom is deze 50% zo belangrijk? Wat we met z’n allen nu eigenlijk zegen is dat wij denken dat de overheid minimal even goed is als wij als individuen in het beslissen hoe geld moet worden besteed. Van elke Euro die Nederland verdient wordt 50 cent door de staat uitgegeven. Kan de staat echt het best beslissen?

Het is over de laatste millennia bewezen dat de staat geld vanuit een centrale locatie slecht benut. Waarom denken we nu echt dat de belastingen zo hoog zijn? Komt dat door de bankiers? Ik meen van niet. Deze verkiezingen zouden over de grote van de overheid moeten gaan. Hoeveel geld mag het individu uitgeven in relatie tot de staat? Maar welke partijen hebben dit in hun programma staan? Net als de overheid slecht is in het verdelen van geld zijn politici vaak slecht in het gebruik van statistieken. Dit zijn statistieken die Rutte van alle daken moet schreeuwen. De overheid gaat in 2012 dan 50% van het BBP uitgeven. Zijn wij als slimme Nederlands echt slechter in staat beslissingen over uitgaven te maken dan onze staat en politici? Zijn wij echt zo dom?!

Link naar een artiekel over het zelfde onderwerp in het Engels “Tax the Rich! The State Spends their Money Better”.

Is Samsom Insane?

Is he Insane?

Milton Friedman:

‘Everywhere capitalism has been tried, it has succeeded. Everywhere socialism has been tried, it has failed. The lesson learned? We need more socialism!’

Albert Einstein:

“Insanity: doing the same thing over and over again and expecting different results.”

Diederick Samsom is not an idiot, he has a Applied Physics degree. Yet as leader of the Dutch Labour Party (PvdA), Samson seems to be questioning previous historical experiences of socialism. Simon Rigelsford and Robert Nozick have an explanation for this intellectual bias, which Einstein might have called insane.

How to Measure Success in Education? – Stop Grading start Ranking!

Michael Gove and David Laws are both thinkers and reformers. One of the problems they now need to think about it in the light of both grade inflation and the current row over GCSE results is  “how to measure success”. As George Osborn and Sir Michael Wilshaw pointed out on the “Andrew Marr Show” last week,  the world is becoming an increasingly competitive and the job of the education system is to give people the education to compete in this environment. As we have pointed out before in “School Rankings” the true measure of success is not an absolute grade on an exam, but a relative grade showing how good you are in comparison to your peers. In this case, how well educated are we in relation to our  peers in the rest of the world?

Due differences in language, culture and education systems it is hard to compare across borders. It is currently pretty much impossible to do without a comprehensive study. A minor tweak away from grading towards ranking would make this exercise easy. As we have previously suggested the first thing to do is to get rid of grade inflation by ranking students with the average grade being the most common and then progressing this with a normal distribution. This allows for a comparison of internal talent through time and across the country without inflation or deflation. Being in the best 5-10% in 1999 would be a similar achievement to being in the best 5-10% in 2005.

To compare internal talent with talent from abroad all that needs to be reviewed is the entrance requirements to institutions abroad. If in 2015 10% of the population reaches the requirement whereas in 2020 20% of the population reaches the requirement education has improved or the requirements to get in have reduced. Grading and achievements should always be relative rather than absolute. This guards against inflation and allows institutions, government and individuals to know how competitive we really are.

End the Unholy Alliance of Anti-market Intellectuals and Political Rents-seeking Business

As Schumpeter stated,

“the capitalist achievement does not typically consist in providing more silk stockings for queens but in bringing them within the reach of factory girls in return for steadily decreasing amounts of effort.”
The expansion of the market has not only spurred economic growth, it has also lifted more people out of poverty, with increasing freedom, than any system in history. Nonetheless Capitalism has failed to gain popular legitimacy and has constantly been under attack.
The  Social Democratic Third Way Folly
The “third-way”, “managed capitalism” or “capitalism with a human face” they have all been tried and comprehensively failed. The fatal conceit of many social democratic intellectuals, wish to  use some managed socialism, is their belief that they can direct social change for the benefit of mankind. These intellectuals develop a social narrative to explain changes in society. Their storyline: changes is disruptive, yet ignore the immense wealth-creating capacity. The economy evolves and creative destruction is a necessary element. Social democratic intellectuals somehow believe that they can act like the schoolmaster handing out benefits to the deserving students, who are under rewarded in the marketplace. They argue that benefits diffuse too slowly, that not all benefit equally and that capitalism should be modified to better address poverty, public health and other social problems. They subsequently increase the size of the state substantially. In many European countries the state spends more than half of GDP (of what the country produces).  The additional regulation needed to “manage capitalism” have resulted in substantial corporate interest. Vested interest protect their positions by undermining competition through wielding political power. The anti-capitalist media academia and arts constantly cry that capitalism creates monopolies, threatens freedom and rewards greed. Yet we must conclude that no monopoly has ever existed without the support of government and that “crony-capitalism” has shown how greedy the social democratic intellectuals themselves really are. This unholy alliance of anti-market intellectuals and rents-seeking business must end!
Lack of Defense
Entrepreneurs are the drivers of economic and technological growth. They are heroes of our society.  Henry Ford, Steve Jobs and Anton Philips, they all thrived to make our life easier, more productive and pleasant. Entrepreneurs, unfortunately, too seem to believe the “politically correct” narrative and doubt their own morality. When current CEO of a petrochemical company is asked if he is doing enough to counter AIDS, poverty or global warming. He is quick to appease his critics.
Schumpeter for saw, the outcome of this cultural biasin the trend towards socialism:
“Rather than educating, business allows itself to be educated. It absorbs the slogans of current radicalism and seems quite willing to undergo a process of conversion to a creed of hostile to its very existence…”
The Age of The Entrepreneur is Coming
The entrepreneur should educate the world and state that by providing more and better petrochemical products he is helping society. The Entrepreneur needs help. This will come in an age in which the dynamic properties of the entrepreneur will be valued to an increasing extent. I am more optimistic that Schumpeter and  and believe that capitalism, which is process increasing personal freedom will gain popularity. A move to freedom cannot be stopped, only slowed with increasing friction. Like the pyramids of Egypt, the Corporative Welfare State too will crumble. The evolution of the digital age will bring a larger demand for personal liberty and political accountability, and much smaller, more local and direct democratic states with it. They will only be able to survive if they have economies which are permitted to adapt to a more open world. The social democratic rising in Europe are hopefully the last flawed attempts at socialism. The winds are changing. The age of the entrepreneur is coming.

An Exit Strategy is needed to Save the Euro

To enter the Eurozone many countries needed to reform their economies. Once entry was guaranteed reforms all but stopped. Instead ludicrous promises funded by cheap credit, kept politicians in power. Politicians in many European countries have been unwilling to reform their economies in good times and seem even less willing to do so in times of crisis. Some believe that more cheap credit is the answer. Yet the real answer is creating circumstances in which politicians will credibly reform.  A credible exit strategy will do this.

Photograph: Pascal Rossignol/Reuters

Certain criteria needed to met to join the Euro. The same criteria must be enforced to stay at the negotiation tables in the Eurozone. If a country does not meet the criteria it can keep the Euro as its currency, but can no longer call itself a Euro-member (Montenegro already uses the Euro without being part of the Eurozone). This leaves countries free to break budgetary rules, yet they must suffer the political consequences, loss of face and power. Only reforms will get them back in, the once so prestigious group. This is more credible than some European finance minister, who will bow to the pressure of his political cronies. I think that even French presidents facing the a loss of power, may be willing to reform their labour-market and public pensions.

Jumping further

The Olympics were impressive and an inspiration for some lateral thinking. Pole vaulters can now reach 6m whiles high jumpers eclipse 2 meters. Both these feats could not be achieved in London in 1918. The main difference is not the increased strength of the athletes, the refinement of technique or the improvement in equipment, but the change in landing surface.

Nobody could jump 6 meters and land flat on their back or 2 meters and land on their neck if they were landing in a sand pit. Nobody would be mad enough to even try.

So what about the triple and long jump? What would change if they were given a different landing surface? I imagine long jumpers running up and diving head first into a pool. What distance could these athletes given a different landing surface achieve? Would there be a revolutionary change?

by Pedro Moura Pinheiro

We want Employment, so Stop Taxing Labour

Environmental and Energy Policy is flawed in many countries. Nothing illustrates this better than Vince Cable’s “Green Investment Bank” or France’s 612.5 million euro attempt to create 10,000 jobs building windmills (that is 61,250 euro a job!).

We want employment, so why do we tax labour? Taxing something means that less of it is used (QED). The surest way to increase employment is by decreasing income tax and other taxes on labour.

The government will still have liabilities and needs to get funds from somewhere. Instead of taxing good inputs such as labour and capital, we should be taxing “bad” externalities such as pollutants.

Harvard Economist N. Gregory Mankiw is in favour of an emissions tax as he suggests a $15 tax per metric ton of CO2 can give an extra tax rebate of $3660 for every worker. Working or creating work will pay more. Prof. Martin Feldstein who emphasizes that taxes on economic inputs, distort incentives and impede economic growth. Yet, he agrees that some taxes on pollution align private incentives with social costs and create better outcomes.

Compared to command and control policies, such as requiring companies to use a certain amount of renewable energy or setting standards for energy efficient light-bulbs, a tax on emissions is far more efficient. A tax on emissions lets entrepreneurs decide how best to reduce emissions. They can do so in a multitude of ways many not yet known to the policy makers. Where an increase in income tax leads to less labour intensive production a tax on emissions would give entrepreneurs an incentive to innovate away from emissions.

Emissions not Energy

As “Sustainability Blogging” rightly points out, a tax on coal or energy is not efficient. A tax on coal assumes that there is a constant proportional relationship between the use of coal (or energy) and emissions. Taxing emissions, not coal, would lead to a better use of coal that minimizes emissions.

Can the tax be implemented unilaterally?

Yes! Some may fear that an emission tax would destroy the competitiveness of the economy. Indeed a emissions tax would be unattractive for polluting industries. However, the lower labour tax would lower the hiring cost of many companies and attract many mobile and highly educated and innovative workers. Therefore, companies with low emissions and relatively high labour cost would have a competitive advantage.  Furthermore there would be an increase in the demand for renewable resources and green innovation, as companies will want to avoid the emissions tax.

The Green Revolution

This real demand will create a green revolution. Green Investment Bank, government subsidy or other non-market environmental policies will fail to achieve this as efficiently. Taxing labour and reducing employment to fund a reduction in emissions is wrong. We should tax emissions to increase: employment, innovation and growth.

I think the picture tells us a lot. Which policy will you choose?

Choose your policy

The Euro Doomed? No it is mismanaged and misunderstood

Ever since the Euro crisis it has been claimed that the Euro was doomed from the start. A BBC documentary presented by Robert Preston has made it almost common knowledge that the political construction of the euro is economically doomed because the European economies are dissimilar. I believe this is not true. The Euro can exist in its current form without Eurobonds, German Wage Inflation or ECB tinkering.

Ever since the creation of the Euro it was common knowledge that the European economies were all different. They all signed up to a stable currency in which price stability was crucial. It was common knowledge that rules were set to be adhered to precisely  to create a stable currency.  It was a political mistake not to enforce the rules and a  failure that countries breaking the rules were not punished with higher borrowing costs. It was not politician’s fault that the market miss-calculated and acted as if all European debt was equally risk free. Southern European debt has always been more risky than German debt and those that miss-calculated should now be making this loss. The Euro was and is not doomed. It was first miss-managed and simultaneously miss-understood.

As argued previously in Graduate Times “Why your hairdresser wants a Central Bank with a single mandate” price stability is one of the main reasons why currency is used a medium of exchange. Lowering a currency through inflation makes everybody poorer and lowering the exchange rate only benefits exporters but makes anybody importing less well off. Basically currency manipulation is a subsidy for exporters. The real means of becoming competitive is not devaluing the currency, but increasing productivity through increasing efficiencies and finding new opportunities.

The argument is that Europe is too economically diverse to have a single currency, is flawed too. Economic diversity not that relevant to the currency. Look at any developed individual country inside (or outside) Europe. These individual countries are as economically diverse as Europe. The north German economy is different to the south, the west again is different to the east. The same can be said for France, UK, The Netherlands, Belgium, Italy etc. Germany may be the motor of the European economies but every single individual economy has its own motor but it does not have its own currency. London does not have a separate currency to Newcastle, nor does Naples have a different currency to Milan.

Within a single currency competition is not fought through subsidies, but productivity. Germany has gone through painful decades making it more productive and in the process more competitive. A politically easier option would have been to artificially make it more competitive through increasing inflation or devaluing its currency, but it chose to do it the sustainable (fair) way through wage moderation, labour reforms and budget tightening. Germany should now be reaping its rewards. It will be a painful path to follow and some countries may not be willing and able, but the only road to growth is increasing economic productivity through real economic competition without tax payer and government meddling.

Those who fail, will try to increase their productivity the artificial way.  This was through devaluation, inflation and ultimately tax payers money. This too is painful, especially if one considers the subsequent break down of financial reputation. This reputation will take years if not decades to rebuild.

The lesson: credibility is needed. As for the US in the 1840’s states will signal their own creditworthiness by including balanced budget amendments and signing other agreements such as the stability pact. To stick to these agreements will mean tough love.  It is not the single currency within a diverse economy that is a problem. All currencies operate within diverse economies it is the way the single currency was miss-managed and miss-understood. All that is required is the rule of law and some tough love to signal creditworthiness.

For all those expecting too much from my predictive ability this  European Championship, this article shows that predicting a winner of something as basic as a football match is an imprecise art and definitely not a science.

Economics Intelligence

Yesterday’s Champions League final has not only been very embarrassing for Bayern Munich. When Bastian Schweinsteiger missed his penalty, I also met my Waterloo.

I had predicted earlier that Bayern would beat Chelsea because they were structurally the stronger team. I based my forecast on the fact that compared to Chelsea, the value of the Bayern squad is 30 percent higher.

My reckless claim was inspired by the German economic think tank DIW. Using the same method, they successfully predicted the winner of the Euro 2008 as well as the World Cups in 2006 and 2010.

Well, Saturday’s game showed that the economic approach to football has its limits.

However, the beauty of economics is its versatility. The dismal science not only explains why Bayern should have won yesterday. At the same time, the discipline is also able to point out why the team actually lost.

View original post 397 more words

Schools Contribute and Pay Teachers

Schools to set teachers’ pay – Excellent! Now, pay the school based on their contribution level

Yesterday’s Guardian article tried to set out a balanced view on Michael Gove’s proposal for schools to set their own teachers’ pay. Finally the British government has realised that pay should not set by an ” all-knowing Whitehall”, but should be determined locally, in this case by the schools (It is a shame the Dutch government has not seen it this way “Less Teaching=More Learning”). Even if it doesn’t as an international study showed necessarily improve standards of school, it will at least balance the supply and demand for teaching and create extra incentives for outstanding performance.

Contrary to what Christine Blower, general secretary of the NUT, states national pay scales do not ensure greater fairness and non-discrimination than a system where schools can determine the pay. Would it really be fair to pay an outstanding, dedicated teacher as much as a lazy teacher who doesn’t really care? Isn’t paying the good teachers as much as the bad teachers the real injustice? Isn’t the current system just plain and simple age discrimination where teacher’s pay automatically rises with experience and not with performance?

Christine Blower also argued that schools determining pay would reduce the mobility and create shortages in areas of low pay. This made me wonder whether Christine Blower had ever been taught basic supply and demand economics. Surely the whole point of this exercise is to balance the supply and demand for teaching across the country, in an area with a low supply wages will go up.

Russell Hobby, general secretary of the National Association of Head Teachers, made a more important point. The pay the schools can carve up amongst their teachers is still not linked to the school’s actual performance. As we have argued previously schools should be paid according to their relative performance. This should be measured by the contribution they make to their pupils education. The more schools (and their teachers) add to their pupils education the more they should be rewarded in pay. In turn this increased pay to schools can filter down to increased pay for good teachers. To be clear all pupils passing school with straight A’s does not necessarily constitute a good school (the pupils could have started the school of at such a level that this was expected). A good school is a school that increases the ranking of its students against their peers. For more on this read our previous article in the Graduate Times “School Rankings”.

Failings of Government NOT Capitalism

Food shortage in India is may be government’s fault but more government does not treat the illness.

Monday’s Metro comments sections focused on the ridiculous situation of a bumper crop of grain rotting away in India due to insufficient dry storage to keep in dry whiles millions are dying due to malnutrition. There was a general consensus that this was a situation that should never occur, all solutions though also seemed a bit contradictory. Government should work differently or do more. No – the whole situation has occurred in the first place because government has done too much.

Government and not capitalism decided that it was too expensive to lower the grain prices. The fiscal deficit apparently was to blame for not having subsidies. Surely this case does not require subsidies but merely the removal of bureaucracy and corruption. If government was not involved then the abundance of grain would have filtered through to record low prices for all (especially in the short run in which the wet grain needs to be consumed).

Government and not capitalism decided to allocate money away from building sufficient storage to feed the whole population at the right price to other priorities. If the market was working properly entrepreneurs would have built more storage to keep the grain dry and given that there is more demand (people going hungry) than supply they would have found ways to generate more food.

The solutions of getting government to build more storage / to stop the space program / to stop giving aid to India / subsidise grain are not the solutions. The solution is letting people do with the grain what ever they want. It makes more sense to give the grain at transport costs to any consumer than to pay for the disposal of stinking, rotting waste. Give individuals freedom  and they will find a way of making the most of this opportunity.

Metro, Monday May 14, p.14

Photo by Prabhjot Singh Gill


What will the price of sustainability be? What advantage will it give? Questions people and businesses will need to think about.

Sales, Sustainability, Energy and Politics

Sustainability and Unilever

Unilever has published its Sustainable living progress report. It has made good progress. Most of the progress really impresses me, like the 24% of agricultural raw materials and 64% of palm oil that are now sustainably sourced.

The fact that 100% of energy is from renewable sources is less impressive as at least some of it is from Norwegian and Swedish hydro sources. We all know that this is nothing but “green washing”. Norway has sold so many of its green certificates (proving that the power was generated by hydro) that one could say that it has, in fact, the dirtiest energy mix of Europe.

But most important to me is the rationale behind the plan. It is a rationale that should inspire all CEO’s to follow Unilever’s lead. Unilever states that it is pursuing its sustainability goals because:
1. consumers want it
2. retailers want…

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Are Standards Slipping at The Economist?

I have read The Economist for years and years. More and more frequently I have been asking myself: “What is The Economist playing at?” On its homepage The Economist group states the following:

The Economist Group is the leading source of analysis on international business and world affairs. We deliver our information through a range of formats, from newspapers and magazines to conferences and electronic services.

What ties us together is the objectivity of our opinion, the originality of our insight and our advocacy of economic and political freedom around the world.

It is a worrying state of affairs, when that same newspaper provides the following misleading graphs on military spending and global warming. These graphs not only make me question the economic nous of its journalist, but the objectivity of The Economist Group.

The first graph shows a very unrealistic exponential increase in China’s military spending. If readers look closely  the numbers tell the tale. US is far outspending China.  Even if this insane prediction proves to be right China will only match the US’s annual spend in 2040.  This is warmongering. I feel that the military- industrial complex in the US has begun a public relations offensive. I wish The Economist could try and stay objective instead of being a dumb cheerleader.

What changed in 1990?

!This second chart was actually the Daily Chart on the 2nd of May. The way this data is presented is misleading. The bottom curve seems to be a generally upward sloping line, which would indicate a positive correlation with the CO2 concentration.  Further inspection, however, tells us that it shows the deviation from the 1955-2006 average. From at least 1960-1985, the increase in  CO2 over this period is associated with below average global heat. The article states that temperatures and CO2 levels have risen since 1960.  Increased CO2 levels have not been associated with higher temperatures since 1960, but since 1990! The question should be: what changed in 1990?

I asked Leadership on Sustainability this question the response was the following:

Thank you for your reaction and thank you for pointing out that temperatures of the ocean (and for that matter the atmosphere) did not rise in 1991 compared to 1978. I am not a climate expert and I can only offer a tentative answer: up to recently we have been pushing all sorts of sooth like particles into the air. These particles block sunlight out, reflecting it back into space. An article in Trouw (my daily Dutch newspaper) yesterday highlighted how we are benefiting now from brighter days and better long distance views due to a reduction of pollution. I am assuming that the increase of CO2  causing warming was balanced by an increase of particles causing cooling.

A similar point was made in superfreakonomics by Steven D. Levitt and Stephen J. Dubner.

If The Economist really want to remain (or be) a leading source of objective analysis, it should learn to think independently or at the very least be objective in its presentation. Its readers are not as dumb as they may think.

Random Ballot Voting

Could Random Ballot Voting be a solution to unstable Dutch Politics?

In a post Rigelsford, illustrates the many advantages a Random Ballot would have the British electoral system. Would the introduction of constituencies and Random Ballot Voting make politicians more accountable and increase the trust in politics? I believe so! Just a shame that there is little to no chance that it will ever gain public support.

Stop The Laffer Curve Thinking

Laffer curve thinking is wrong. The political thinking seems to be that tax rates cannot reasonably be reduced unless the reduction will raise more money. This is the wrong way of thinking about the role of the state. If the treasury wants to deal with the deficit, the goal of the treasury should not be to maximize tax revenue, but to minimize distortions.  Frazer Nelson rightly tells us that the decision for a 45p income tax is essentially a political victory for Labour. 

A Labour Party that believes in the benevolent omnipresent knowledge of the mandarins in Whitehall, may debate how to gain maximum revenue for this monolith. The revenue maximizing level of taxation would not worry past conservatives. Edmund Burke, Michael Oakeshott, Karl Popper, and Socrates  would question how much we can ever really know, and they’d prefer the small and the local over the big and the central. Current conservatives, too, should change the structure fo the state to reflect our limited knowlegde.

Empirical Evidence of The Laffer curve

An interesting paper by Karel Herbst, which looks at France, the UK and Ireland specifically and the OECD as a whole has interesting conclusions. The study compares changes in tax rates within countries over time (time-series analysis),  compares the effect of different taxes rates among different countries (cross-section) and tries to take time and country specific effects into account. The final “panel-data studies” is the most interesting. As it tries to eliminate country specific and time effects to isolate the tax effect. We see that the laffer-curve has got steeper over time. Technological advances and increased globalisation mean that tax avoidance is becoming easier, especially for the relatively well off. Thus the maximizing rate is likely to be lower rather than higher.

In its time-series model, (which includes errors which I will not go into here), the revenue maximizing rate is 44% in the UK, yet this is based on results from the 1980’s. The world economy has changed significantly since then. Many of these changes cannot be and are not taken into account. We must remember that all estimations are a “guestimate”. Especially as we see that the model has a maximizing rate of 26% for Ireland. All studies choose to include and omit different variables which may be important in explaining both the tax-rate and the revenue. Accurate estimates have proven to be an illusion and we often see wide range in the significance intervals.

We must  conclude that nobody knows the true present revenue maximizing level of taxation. Is this really a problem? I believe it is not. The laws of economics still apply. Making labour less attractive by taxing part of the income will decrease the amount of labour a worker is willing to produce  and the amount of labour an entrepreneur will want to hire, as he will need to compensate the worker with a higher wage to offset the  extra tax burden.

The rule of thumb should be that decreasing taxes on labour income will increase the amount of labour used in the economy.

Dynamic effects and the deficit

Of course decreasing taxes in a static world does not deal with the deficit. However with the dynamic effects of more work, leading to a higher employment, less unemployment benefits, more output and more profits, the deficit will be reduced.  The conservatives should challenge the conventional wisdom of maximizing government revenues and start changing the structure of the state to match the distribution of knowledge in society.

The ambition should be to decrease the power of Westminster and strengthen communities. It is time the tax-system reflectes this conservative ambition.

Remembering F.A. Hayek with Elinor Ostrom

In a couple of hours I will be attending this year’s Annual Hayek Memorial lecture. This year’s lecture will be delivered by Prof. Elinor Ostrom. She is the only woman to win the Nobel Memorial Prize in Economic Sciences for her “ analysis of economic governance, especially the commons”. Often all commons are lumped together as “Public Goods” and policy makers immediately call for central government regulation and control.

Ostrom’s Solution

An ever larger number of researchers – including Elinor Ostrom, the 2009 Nobel Prize winner in economics – has cautioned against single governmental units at global level to solve these global collective action problems, due in part to their complexity, and in part to the diversity of actors involved. Ostrom proposes a polycentric approach at various levels of society; with active oversight of local, regional and national stakeholders, where  key management decisions should be made as close to the scene of events and the actors involved as possible. Trond Vedeld

This rings true of Hayek’s problem on knowledge, where a central authority simply does not have the information and knowlegde to make the correct decisions. I am curious to know how Elinor Ostrom would improve coordination and the use of complex and dispersed information in the economy, to solve our contemporary economic problems and build a more robust society.

Private Money is a Route Out of Financial Repression

When the Spanish found silver in South America they thought they were rich beyond all imaginations. In reality all the silver of the New World could not bring the rebellious Dutch Republic to its knees, nor could it save the Spanish from an economic and imperial decline. When your hairdresser exchanges her labour for your pounds, she is essentially trusting that the Central Bank does not repeat Spain’s error of creating so much money that her pounds end up being worthless. Competition would give us the opportunity to choose the issuer (and) the money that we believe is most likely to honour out monetary agreement. Glencore, Amazon and Facebook should be allowed to issue their own currencies, which society could use as media of exchange.

As I  have stated before I believe the time has come for a currency debate. I was happy to hear that BBC Radio 4 program Analysis, recently dedicated an episode to the topic. Money is simple. Yet many fail to understand its true purpose. BBC’s analysis for most part completely misses the point on money. It makes money seem some mythical item. In a past posts “Why Your Hairdresser want a Single Mandate” I define the 4 important properties of money to facilitate trade. Money must be:

  1. durable
  2. fungible (liquid)
  3. portable
  4. a store of value

Technological progress has created digital money which is durable and portable, one digital switch and the option of holding multiple currencies is not technologically impossible.

Issuers will be left to compete on liquidity and value. Twe must not only believe that money holds value but also believe that we can use it for trade without excessive transaction costs when converting it to goods (thus liquidity is important).

The Gold Standard

It is not the gold in the vaults of the Central Bank that give money linked to gold its value. It is the constraint of the gold-standard which does. With a gold standard the central bank ties its hands and sends a signal that it can not increase the quantity of money freely to decrease the value of money.

Theoretically there are many assets which could serve this purpose, one could even have money backed by assets of big companies.  In this case the quantity of money could only increase with an increase in the assets of that company.

Competition is Superior to Gold

Admittedly gold sends a powerful signal.  We must however remember that both appreciation and depreciation are not desired. Depreciation will mean that lenders will want a higher interest rate and appreciation may constrain borrowers. Shocks to gold prices could have adverse effects on the economy. There may , therefore, be a far better way for monetary institutions to signal that they will keep the value of a currency stable. I do not pretend to know the signal, yet do believe that competition is the best way to find the correct monetary policy. If we allow private institutions to compete then the money used for exchange will be the money that society feels is most liquid and stable. This will create a race to the top.

Pressed on private issuers of money, Paul Fisher of the Bank of England, stated that the state monopoly of money is in place to protect us against Charlatans. Who, however, is protecting us  from the Bank of England printing so much money that my wage becomes worthless?

Fiscal Union is Not the Answer: A Historical View of US and EU State Debt

Fiscal unity is not the answer to the Eurozone’s problems: credible future surpluses are. In his Nobel Lecture (only starts after 17:00), Thomas Sargent looks at two historical attitudes towards individual state debt in the US. His main message is that investors buying debt today have expectations on tomorrow’s future government surpluses.

USA: To bail-out or not to bail-out

After the War of Independence state bonds were trading at a significant discount. Many doubted whether the debt would be repaid in full. Hamilton and Washington decided to bail-out the state bonds in return for more centralized taxation. The main argument for the bail-out was that the debts were accrued for a federal cause (independence) and thus all states should share the cost. This was a clever political move as creditors would want a stronger central government to guarantee the repayment of the debts. This initially had strong positive economic effects as interest rates decreased with creditors expecting future federal surpluses.

The downside came in the early 1840’s.  Cheap credit  allowed many states to expand infrastructure and public services in their states. Eventually as recession hit investors noticed that the many projects did not have the anticipated returns and creditors doubted if they that they would be repaid as interest rates increased. Now the federal government decided not to bail the  indebted states out as it was deemed unfair for a state that had spent  its taxes on public works in its own state to be bailed out by other states taxes. The individuals in the more thrifty states had not had the benefit of the same expenditure on public works. 

This came as a shock. Many investors had expected the federal government to bail-out the individual states. In addition many, especially foreign creditors, could not easily distinguish between different state debts, this led to some contagion and the federal bonds rate also increased.

The positive outcome was that states started to signal their own creditworthiness by including balanced budget amendments and signing other agreements. These agreements increased investors expectations of future surpluses and a decreased the rate of interest demanded on government debt.

Eurozone: Fiscal Union is a race to the bottom

The EU should not fall in the trap of a Fiscal Union. Fiscal Union increases moral hazard. The best strategy in a Fiscal Union is for every European country is to increase its debt and hope another country’s surpluses will cover it. This is a race to the bottom. We need a race to the top. Eurozone countries should compete in creditworthiness by signally future surpluses to investors.

Local Wages need Local Decisions

The national pay rates should be scrapped. Localized wages are a good idea lets hope the government allows the decisions to be local too. We do not want central mandarins setting local wages. Unions have reacted angrily to plans to scrap national pay rates for some public sector workers in the UK. Yet this is a one of the better plans put forward by the Chancellor.

Private Companies do not pay IT analysts in Bangalore doing the same job, the same wage as their equivalent employee in Zurich. They would be mad if they did. In Bangalore the same talent is willing to work for a lot less and the cost of living is considerably less expensive.

Due to the low wages and ample IT talent India is able to attract lots of work. Why deny different regions in the UK that same opportunity? Brendan Barber of the TUC believes that this will drive workers to better paid regions. If this is so, those regions will be able to decrease their wages as there will be an ample supply of employees whereas lower paid regions will need to increase their wage to attract talent. People seem to forget the more important effect. Localized wages will also allow companies to make the opposite move. More companies will move North where wages are lower and no longer inflated by a national wage. This will increase employment and wages in the north. Wages should converge.

Eric Ollerenshaw MP is wary of the North South devide on the Conservative Home Page. He is right to point out that a focus on private investment and not public services is the way forward. A more regional approach would solve the problem private companies face when hiring people in areas with a high dependence on the public sector. Currently private companies are being out priced by a public sector which pays more than the private sector, with greater benefits. This leads to private companies using less labour than they would otherwise to be competitive, or not moving North at all.

There is one big caveat that may emerge in Osborne’s plan. It is conceivable that instead of setting a central national wage, the same central bureaucrats in London will determine the regional wages. This is still wrong. How does the central authority know what the going rate is? Central mandarins setting wages should be avoided. Public sector institutions should compete on the local labour market and allow their local branches to hire local employees at local rates.

A European Constitution should Limit Brussels’ Power

The Eurozone has set a dangerous precedent. At the same time as, some policy makers are patting themselves on the back after avoiding a messy Greek default, others realize the consequences, and are considering constitutional reforms, to shut Pandora’s Box.

Greek politicians have more often than not chosen to default — such as in 1983, 1985 and 1998 or to devalue their currency. Yet again they have been relieved from their debt and given an extra tranche of IMF and Eurozone aid for their troubles. If the spineless Greek politicians can get this kind of charity, I do not expect Ireland or Portugal to feel inclined to stick too their current arrangement with their creditors.

Only foolish politicians could ignore the gaping hole in the current arrangements, in which rogue governments are able to free-ride on the credibility of the rest. The proposed solutions seems to focus on more fiscal unity and more power in Brussels. Yet the true solution is a constitution limiting the power in Brussels and allowing individual states to create more flexible economies that are able to compete in a global economy instead of adhering to petty central regulation.

As I have illustrated in an earlier article European central planning can not work, because the right information is not present at the European level. The EU should have just three roles:

  1. Promote free-trade:The main role of EU should be to promote free-trade among its members. Free-trade increases the size of the cake, yet also has losers. Where Germany may be comparatively better at making cars than Italy. Italians may be comparatively better at producing espresso machines. Workers at Fiat and Krups may well loose out, workers at Volkswagen and Bialetti win. It is important for the EU allow workers to move between countries to where their labour is valued highest. To ensure mobility and true free-trade European citizens should, not only be able to settle and work in any other EU country, but also be able set up bank accounts and join any social insurance scheme. This would create competition between social insurers and regulators.
  2. Enforce equality before the law: This means that law in each individual state are the same for all EU citizens within that state. Within every state, state laws and regulations apply. This applicability must be equal for every EU citizen. In this case an overarching authority is appropriate.
  3. Foreign Policy: Personally I am not in favour of trade sanctions. I believe trade is the best way to create peace. Yet if we want to impose sanctions or promote a certain foreign policy objective, this cannot be done by some states within the free-trade area whilst the others do not. This would not only make foreign policy ineffective, but distort the real terms of trade within the Union.

What about fiscal rules? I think this is a completely separate issue from the European Union. In the past a Greek government would print money and devalue the Drachma to pay-off its debts. In the Eurozone members will need to obey the rules of the club. Policy makers should find the best way to enforce these rules. In the EU countries should compete to find their most productive methods.

A Century of Financial Repression

Since 1910 we have been living in a world of financial repression. Initially the reason was to fund a World War, yet since 1936 there has been an inflation bias, and fiscal expansion has become widespread. As Steven Kates wrote on the 9th of March:.


“In 1844, and indeed all the way up until 1936, the idea of using government spending as a stimulus was maintained only by economic cranks. Now, of course, it is the mainstream”

Analysing historical consumer price data in The Netherlands issued by CBS Statline, we can see that inflation is very much a modern phenomenon before the first World War prices were relatively stable for more than a century. Technological advances and the increase in global trade, made products, that were previously expensive, (bread, tea, sugar, coffee and rice) cheaper. Since then, however, policy makers have consistently had an inflationary bias leading too a increase in prices and a decrease in the value of money. 

On Friday Paul Mason wrote an excellent article on “financial repression”. In which he illustrates the incentives of governments to get rid of the debt through inflationary policies. As Carmen Reinhart and Bellen Sbranica show capital controls are needed to do this in an open economy, so that people can not easily move their money away to another country. Governments have solved this by forcing pension funds and other institution to hold a certain amount of home government bonds.

In the Economic Consequences of Peace, Keynes realized the incentive for policy-makers to drive-up inflation and warned of the consequences, as he stated:

“By a continuing process of inflation, government can confiscate, secretly and unobserved an important part of the wealth of their citizens.”

 It is a shame that his followers did not listen. 

(please click on the graph to see it in full size)

Energy Companies could Pay Customers for using Smart Grids

This post features an other entrepreneurial opportunity in the Energy Sector. There is an incentive for energy companies to pay us for using energy saving technologies during peak hours.

 In the energy market there is a difference between peak and baseload prices.  Peak prices are higher  than baseload prices. In peak hours energy companies need to use extra more expensive sources of energy to meet customers’ needs. As we can see from the graph more than a €20 difference per megawatt hour is not unlikely. Considering that energy companies go trade several TWh (1 000 000 Mwh) a month this is serious money.

Energy companies want customers to shift consumption from peak to base so they do not need to switch spare capacity on and off.  Electricity companies try to give customers incentives with different peak and baseload prices. From the elasticities we can see that customers are likely to react. Companies could however do more.

Energy companies could give away energy saving appliances for products used during peak hours and/or give away smart-energy systems which automatically decrease energy usage of for example laptops (which can store energy) when prices are higher, and increase energy usage (to charge batteries) when prices are lower.

Filippini M. (2010). Short and long-run time-of-use price elasticities in Swiss residential electricity demand, CEPE Working Paper 76, Centre for Energy Policy and Economics (CEPE), ETH Zurich, July 2010. [pdf, 263 kB]

The Guilder and the Euro

After reading the Lombard Street Research (LSR) and some commentaries, I believe that a currency debate is necessary. Both the Guilder and the Euro have their own advantages and disadvantages. So why not both the Euro and the Guilder?  Using both currencies maybe the solution.

Counter-factual research or research using “comparables” is difficult and always open to debate. We must, therefore, focus on the main arguments and not the exact figures.

Lombard Street Research argues that:

  1. There were fundamental problems with the European Monetary Union (EMU). Instead of enforcing discipline and low inflation on the historically more spendthrift thrifty economies in the South. The narrowing of the rates between the Eurozone economies allowed politicians in Italy, Portugal and Greece and the private sector in Ireland and Spain to go on a spending binge. This has lead to a divergence in labour costs. Historically financial market would have adjusted sooner pushing rates up and depreciating the currencies. Rates have only recently moved, with dramatic consequences. Without the possibility of devaluing the currencies, internal adjustments are needed, yet the politicians seem powerless and the economies (in particular the labour markets) are simply do not seem flexible enough to achieve Hong Kong’s feat during the Asian Crisis.

  2. Dutch financial prudence and modest wage gains, would, historically, allow the Dutch  Guilder to appreciate against most European currencies. A currency appreciation increases the purchasing power of consumers. It may hurt competitiveness of exports, yet it can also spur innovation and productivity gains to keep up with competition.
  3. Sweden and Switzerland have done as well outside the Eurozone as before the advent of the Euro. In comparison the Netherlands has fared less well. We must remember that Sweden went through a housing crisis in the late 90’s and that Switzerland is a unique “safeheaven” economy, which does skew results. Yet living in Switzerland, I can confirm that  modest currency appreciation is not the curse, but drives high added value economic development and innovative activity.

Arguments against and exit Eurozone are that :

  1. The creation of the Eurozone deepened capital markets. The Euro is seen as more liquid ensuring that it is easier to settle trades in this currency.
  2. A single currency also facilitates trade as it reduces the currency risk. It may also enhance travel and labour mobillity with and small transactions across borders.
  3. Transaction costs have been reduces as Eurozone banks need to hold less money balances to effect foreign exchange transactions.
  4. An argument against the return to the Guilder, is that the Guilder will inevitably be pegged (at least initially) to the Euro. This does not necessarily make it more flexible. Yet I feel it is unrealistic that it would not have appreciated against the Euro due to the current imbalances. This would not only have decreased the cost of a Greek bail-out, but also increase purchasing power in The Netherlands.

LSR looks at a policy decision within the current convention of one sovereign currency. Yet currency competition, with both the Guilder and the Euro serving as legal tender could be the solution.  Money is a medium of exchange that facilitates trade, with the advantage of eliminating inefficiencies of barter. Money must serve 5 purposes. It must be affordable (low transaction costs), durable, liquid, portable and store value. Modern electronic banking means that durability and portability are not a real issue. The Euro and Guilder would then compete on liquidity, transaction costs and price stability.

Many might claim, like Ben Bernanke did, that currencies already compete on the Foreign Exchange (FX) market. This is the case, yet the FX market is not complete. What I propose is that wages, taxes and any electronic transaction can be made with both Guilders and Euro against the most recent exchange rate (a  typical account will have X Euros and Y Guilders). This will allow not only those trading on the FX market to choose the most convenient currency, but everybody in the economy to make a decision on what their expectations are and in what currency they wish to be paid and pay with.

It is Time for a Currency Debate

Both Ron Paul and Geert Wilders  are presenting arguments for changes to our currency policy. Instead of dismissing the source it is time for real arguments in much needed currency policy debate.

Tomorrow Lombard Street Research (LSR) will present a report on the costs and benefits of Euro and Gilder (gulden) for the Netherlands. The NOS has already brandished Lombard Street Research as Eurosceptic. I do not think this is useful. The PvdA (Labour Party) and  D66 (Liberal Democrats) are now questioning the report before having read it. It would be more helpful if  they waited for the final results, like the CDA and VVD have done.

I was lucky enough to meet the founder of Lombard Street Research Prof. Tim Congdon at the Shadow Monetary Policy Committee (SMPC) in August. The SMPC discussed issues in the Eurozone (see minutes). I do have disagreements with Prof. Tim Congdon and Jamie Dannhauser (also LSR), but they presented reasonable arguments for their proposals and they were happy to discuss differences in opinion, with myself and other interns.

I presented Hayek’s (1974) argument for competitive currencies. Otmar Issing has a good publication on currency competition on the EU. The benefits of currency competition in the context of the EEC, were set out in Vaubel (1979), Wood (1989) and were subsequently urged suggested  to European Finance minister by Chancellor Nigel Lawson as an official policy under the John Major’s Government (HM Treasury 1989). Just last week Ron Paul (video) urged American policy makers to talk about competing currencies in the U.S. Yet Ben Bernanke seemed to dismiss the whole concept and he would not consider it as a serious option.       

I think it is time for a proper debate on the optimal way to decide on the currency we use and I hope the inevitable critics (which may include me), have good arguments and reasonable proposals going forward.

The Extended Society wants more effective Use of Knowledge

My main argument is that society should find better ways to use dispersed knowledge. Victor Steenbergen was worried that I might be distracting some readers from my central message and asked me yesterday to refrain from making the argument that “Markets are Good” and “States are Bad”. I have indeed criticized the state for “picking losers” in “Government picking Losers in Public Transport”. Not many economist actually believe that picking winners is the role of the state. Even Prof. Krugman seems to agree with me in “What do Undergrads Need To Know About Trade? “. Victor has also accused me of talking too much about “left” versus “right” in relation to development aid. When in actual fact I believe that the blind application of the Washington Consensus by the “right” is as dangerous as the omniscient belief associated with the “left” in the central allocation of development aid. I think it is good for the public debate to point out moments when I we should make different decisions.

Am I an anarchist who believes there should be no state? No! The state has the important ability to enforce agreements and mitigate informational problems often related to public goods.

The article “The Other Hand: High Bandwidth Development Policy” by Ricardo Hausmann, that Victor linked, emphasises that I may be misunderstood and I should make my argument clearer. The point that many seem to be missing is that I believe states are not using the dispersed knowledge available in society. Public policy competition will create a race to the top and better institutions for developed and developing nations. Indeed Ricardo Hausmann emphasises the complexity of societies and how societies differ in their public policy design. There is probably not one best solution for all societies. We must allow an evolutionary approach in which society optimizes along some internal solution.

In the same way that central planning can not work, because the right information is not present at the central level, information about how one policy idea, often designed for one purpose, may have unintended consequences in other sectors, is ignored because the correct information is not available to policy makers at the high level. Therefore a decentralized (competitive) approach where decisions are made at the level where the relevant information is available may work better for the provision of public policies. A competition in which policy designs compete in a similar fashion as I envisaged for financial regulators” Competition creates a Race to the TOP: The EU should seek Liberalisation not Harmonisation” could work. Competing policy makers will enhance the important connection between private and public sector as they keep the internalized public benefits. Competition in regulation and policy making is not an alien idea. As Hernando de Soto points out in this video, the majority of the world’s population live in the extralegal system and many use local rules and traditions to enforce contracts and deal with information problems. The reason they use this system is not because they are Libertarian, but because they feel this extralegal system serves their needs in a better way.

It is not up to me to decide what an optimal policy design should look like. Every society is different and subject to innovation and change. The policy designs will develop and adapt to deal with change as long as different designs are given the opportunity to compete in the use of knowledge, to increase the productivity of the economy. As Rodrik stated: (in “Institutions for highquality growth: what they are and how to acquire them”) “participatory and decentralized political systems are the most effective ones we have for processing and aggregating local knowledge.

Do Public Transport Subsidies really increase Mobillity??





Why is it that Americans travel more than the Dutch?

And why is it that they travel so much more by car?

Travel is a good (not a bad). We must question why Dutch (and other Europeans) are less willing to travel. There could be a multitude of separate answers to these two questions. We have too few data points, to make any statistical judgement. I would, however like to entertain one hypothesis.

Could low mobility be induced by a flawed transport policy which makes mobility more expensive in The Netherlands? The Netherlands subsidizes its trains 1.5bn a year (that is 2/3 of the ticket price). The train is only used for 8% of the journey. The use of the most popular form of transport (the car) is taxed at more than 40%. The United States chooses to subsidize its oil companies, which provide gasoline for the car which is used for nearly 90% the distance travelled.

It is a simple law in economics that increasing  price decreases the quantity consumed. In The Netherlands it could well be the case that the cost of travel, be it by public transport or car, is more costly and thus consumed less. Policy makers should be wary of bringing the people let alone the countries’ economy to a halt.

Governments should Reform to change the Dynamic of Society

Governments in the UK and The Netherlands should be looking for at reforms for a dynamic solution to their budgetary problems instead of focussing just on cuts. Reforms that allow society to make more decisions using the unique knowledge of every individual  are going to benefit growth and reduce dependence on the governments coffers. 

In the Netherlands there is currently a debate on  future budgetary cuts. One of the most outspoken commentators is Coen Teulings in the FT.  In the UK, George Osborne  too, is in a “Tug of War” on the Budget. Both countries seem reluctant to cut further. In reality both governments have merely decreased an increase in government debt in the past years. In 2006-2008 The Netherlands did have a small budgetary surplus.  The UK must go back  to 2001 to find a surplus (Eurostat).

Budgetary cuts are often as presented as a binary option. It is more useful to talk about reforms that will change the way the economy is run. Some initially budget neutral examples would be:

  • increasing the income tax free amount and offset with reduced housing subsidies
  • reducing subsidies on public transport, and decreasing fuel duties.
  • Reducing employment regulation and abolishing development aid.

The net static effect is zero (or slightly less). This way both governments will be able to concede some ground to the opposition, yet the dynamic effect could be far reaching.

Work will have a higher reward ,as workers will keep more of their money and the reduced employment regulation reduces the cost of hiring, giving employers and employees the opportunity to share the difference.

As stated earlier the transport budget has been a political disaster.  This policy will allow people to find a better way to transport each other. This not only decreases the government expenditure on public transport, but could generate economic growth though innovation of new methods.

Charities are important. Funding, however, is limited. Charities should compete for funds. Individuals must decide, which charities do the best job for society and get the most funding. This will create better charities as they race to the top. It is not up to the government to decide who is the most charitable. Some charities will focus on domestic efforts other will look abroad. In time, charities may be able to take over roles of the state. The focus of charitable giving should be determined by society, not the vanity of of government officials demanding international bragging rights at political gatherings.

A Dynamic Solution to Government Debt is ignored

I was surprised when I heard Mark Littlewood of the Institute of Economic Affairs (IEA) debate for the increase in fuel duties expected in August, even though earlier research by Paul Withrington for the IEA illustrates that the government transportation policy has been a disaster.

Mark Littlewood was right to state that the government is running out of money and a credible plan is needed to reduce the national debt. Mark is, in most circumstances, against higher taxes and I feel this was his moment to make a more sophisticated, dynamic efficiency, argument. The government could reduce subsidies to rail and not increase the fuel duty leaving the net effect on the budget unchanged.

This policy only has an upside. Statically the aggregate budget is the same. Yet the dynamic effect means that the transport market is less distorted giving the economy a better chance to grow and reducing the deficit. this is just one of many dynamic options open to governments. There will be more on economic reforms tomorrow.

Great Arbitrageurs are our Great Inventors

There might be an brilliant inventor who could find a way to get oil out of the ground for half the price Yet finding a trader that can use his knowledge on the commodity market to get the same oil for half the previous price is equally as useful.

There is an obsession among policy makers and the general public with manufacturing. Manufacturing is deemed socially superior to financial services. This is a fallacy.  Often the financial services are lumped together as “bankers”, who presumably just move money around. Some misled economist even believe that a Tobin tax would move talented people with strong work habits – into other activities, which will benefit the economy more.

If this were truly the case, some great entrepreneur could use his unique knowledge to reap the rewards of the benefits these great minds (which are presumably currently underproducing), may have elsewhere in the economy. Distributing workers where they are most productive is a valid occupation for our labour market arbitrageurs.

Government picking Losers in Public Transport

Parliamentary questions where asked about the quality of the rail services and the bonuses paid to officials at the NS (Dutch Rail-services). Public dismay about the quality of public transport is not just a Dutch problem, but a problem witnessed in most European countries and the US. The problem is not regulation or lack of competition on the rail, but over regulation and the barriers to competition off the rail. The government should get out of the business of picking losers and allow each individual in society to pick their winner. This will not only allow the government to lower the taxes on fuel, but also allow individuals to find the most convinient way to transport each other.

Distance travelled in 2007 per method

Road users need to pay a lump-sum road tax and and indirect taxes though duties placed on petrol. The record price of 1.80 Euro a litre in the Netherlands has been blamed on high oil prices, yet  72 cents (40%) of every litre goes straight to the government in The Hague. By contrast public transport is subsidized.  In addition Dutch students are given a public transport pass paid for by the state, which allows them to use it for free.

The CBS (Dutch Central Agency for Statistics) 2007 statistics on personal transport show that 75% of the total  kilometres travelled in The Netherlands is by car. Compared to just 8% by train equalling the amount travel by bike and scooter. The train therefore seems unpopular even though it is heavily subsidized and train passengers do not bear the full burden of their transport choice. The government is backing a looser by subsidizing an unpopular form of transport and taxing the use of cars.

Allow people to find the best way to transport each other

The arguments for subsidizing public transport is that it enhances the mobility of students and elderly. Yet why not give students the money (or an voucher) and allow them to find the best way to transport themselves? This may mean that students set-up their own transport system based on car-pooling. Likewise entrepreneurs may see that setting up a transport company to cater for the elderly could be a good business. 

7.7 million taxis

Other members of the public may also choose to give rides to those without a car in return for compensation. Currently regulation means that only taxis can do this. The argument for the privileged position of taxi drivers is that customers should be protected from dangerous people offering them rides. Anecdotal evidence suggests that this regulation has not banished scum from the taxi-industry. Instead of creating regulation, this problem could be solved by entrepreneurs. Entrepreneurs could use brands to distinguish themselves from competition and signal quality.

With cuts looming in The Netherlands, industrial action by the public transport unions is likely to affect the country. This may be the time for entrepreneurial Dutch citizens to show how innovative they truly are. Lets hope the government will let them.

Energy Policy: an Entrepreneurial Opportunity

Limited rationality or imperfect knowledge is not an excuse for state intervention. Information problems are an entrepreneurial opportunity. You are all entrepreneurs  and in the word of Charlie Sheen, taking the opportunities give to you, is “WINNING”.

Many economists believe that asymmetric information or “irrational” behaviour is a reason for government intervention. In most cases this is a fallacy.  This weekend I will be doing an “investment cost analysis” for a lecture on Energy Economics and Policy. My professor complains that many households do not take advantage of profitable energy saving, because they do not know about the possible savings (hence it is important for use to do investment cost analyses).  He said that a buyer takes certain costly steps before investing. He must take the sellers’ word that a technology is more efficient. A buyer could hire someone to analyse the product’s efficiency or the benefits of a renewable technology.

If this is mutually beneficial trade there is an alternative, the seller could signal the product’s advantages by opting for part of the efficiency gains. Sellers could offer to do an energy saving innovation in return for an option. The option could be the lowest of a fixed fee or a x% of the difference in energy usage in the following x years.

This is a typical example of Hayek’s use of knowledge. An entrepreneur who can use knowledge to his own advantage can make a profit. Economists should focus more on the process (the use of knowledge) and less false assumption of perfect information. In more cases than not finding an information problem, is finding a problem for entrepreneurs not the government to solve.

Workfare Slave Labour? No, it’s Education

Youth Fight for Jobs really does live in a cuckooland. The recent row concerning young people working in a back to work program for Tesco and other private companies,  without pay free really does beg belief.   Surely, as The Express and Guido Fawles make clear, doing some work (voluntary or not) for job seekers allowance is not slave labour. It is work in return for money, experience and education. Firstly I will refute that this is slave labour.  After which I will argue that this scheme is one of the best ideas the government has had and discuss the expansion which all taxpayers should be demanding.

Slave Labour?

Firstly this labour is voluntary and therefore cannot be slave labour. There is a choice between working for the allowance or not getting it. Furthermore, the argument that this allowance is below the minimum wage does not stand up to scrutiny either. The minimum wage is an artificial amount which bears no relation to the productivity of the individual working. Training people to do a job has a cost. If this cost outweighs the productivity, they should in effect be paying for training rather than receiving a wage. In this case a middle ground has been reached. Private firms get free labour in return for training and the taxpayer pays an allowance to those being trained (not dissimilar to education).

The Taxpayer a slave?…. more so

To a certain extent though, the hard working taxpayer is a slave to those who refuse to work. 20% of my wage goes straight to taxation through income tax and another 11% to national insurance add onto this council tax of £121,- per month and VAT at 20% of my disposable total income after all this then one will find that 43% of my income has gone to government. In effect I have been a slave for 43% of my time working purely to fill the government coffers. Considering I am contracted to work 40 hours this would be almost 17.2 hours a week (In reality I do a lot more than 40 hours a week, but that is my choice).  This is the true slavery. Those who contribute to society work more than half their life to pay for government, whilst those who do not pay tax are not willing to work 30 hours for their jobseekers allowance as well as some experience in the work place.

Great scheme should be expanded

As we have previously argued in “A Case for giving Something for Nothing”, we are against a minimum wage in the first place. This scheme enhances the productive capability of the population. If there was the combination of 1. people willing to take the job at minimum wage without 2. benefits being taken away and 3. an employer to take workers at this minimum wage, volentary unemployment would not exist.

1.       People will take a job at less than minimum wage, if they retain their job-seekers allowance and training / experience when holding down a job.

2.       People are threatened with losing their benefit, if they do not work. Sitting on the sofa doing nothing is easier than going to work and having a purpose to get out of bed. Sometimes you need to be tough to be kind.

3.       The productivity of the unemployed (especially with little experience at holding down a job) may not be as high as the costs of minimum wage. In this case cheaper labour (this includes a lighter burden of regulation) may entice companies to give people a job and the experience.

If these 3. problems with the unemployed were  tackled the labour market would become more competitive through lower real labour costs and would become more productive as former unemployed gain experience. One must not forget that training, education and experience all come at a cost. To a large extent the private sector covers this cost through on the job training. The public sector contributes with education.  This  scheme is no different, rather than tax payers paying for people to look for work, tax payers are just paying for people to work and gain experience. To a certain extent it is another way of paying for education.


Bank Regulation, Private Central banks would way the costs of regulation and the costs of default

Thank you Colin for writing an interesting and though provoking post: “Real banking innovation requires a separation of basic banking from the rest of the financial services”. Whilst  agree with most of the post I do not see why a separation is a requirement. I agree that this will give consumers a choice, but do not see why the system should be limited to just the one option. In this post I have outlined a way in which I believe regulation could develop, so that consumers have a more flexible choice and more effective regulation. We all agree that a 100%  cash reserve ratio would not have much risk, yet this would make banking services extremely expensive.  Competition in regulation has been the norm throughout history and my belief is that this makes regulation more effective and less intrusive.

Bank regulation

In the current fractional reserve banking arrangement, it makes sense to have a private central bank (or central banks), who is (are) responsible for a group of banks that are directly connected to the payment system. They are in effect banker of the banking system. Private central banks could act as regulators, deposit insurers and lenders-of-last resort. In this system regulation would not need to be imposed by a government. Regulation would be determined by the central banks trading-off the costs of regulation to its banks (and the subsequent costs to banking services)  and the benefits of regulation that decreases the probability of  insurance and lender-of-last resort costs. In such a system regulation will no longer be bureaucratic and misdirected, but design to protect what we need protecting: the payment system.

Complex companies

I can already hear people saying that I have only focussed on bank regulation. What about the “complex financial companies”? The case has been made that the collapse of AIG may have take investment banks and the whole financial system down with it. This seems at the heart of EU and US regulation on hedge funds. Yet creating wider and wider regulation only makes regulation more complicated and increases the incentive to make the financial companies themselves complex and inefficient. It would make more sense to increase the insurance premium paid to central banks higher for those banks lending to these riskier counter-parties (or are part of the same company). Thus if a bank has exposure to an investment bank, which in turn has exposure to a hedge-fund, one would expect the a higher insurance premium and more regulation from its central bank. The higher premiums will mean that commercial banks will demand higher fees from hedge-funds and investment banks, who themselves may want to be more transparent to get a better deal.

The Volker Rule/ Glass-Steagall

In this system described, I believe that the Volcker Rule may well apply in many cases without it needing to be prescribed. Different banks will have different insurance schemes (some may protect all the depositors money, others a proportion, yet other a fixed amount). They will all have to pay premiums for their cover.  Depositors are free to choose the bank that offers the scheme that best fits them.  This may be a bank which is essentially a utility bank, which probably pays a low premium for 100% coverage of deposits, but need not (It could well be the case that a $30.000 cover at more complex institution is sufficient for most depositors as long as the banking fees are low).

Here again competition amongst central banks who both want a cheap lending system and safe deposits will lead to a “Race to the Top”. I do not see the logic in deciding the “best” option for everybody ex-ante at our desk. It would be more efficient to let the individual depositors and banks decide the best option when they put their own money on the line and need to pay for the costs of the banking system.

An excellent reference on this topic is “Central Banking in a Free Society” by Prof. Tim Congdon. In this covers  Prof. Congdon the Northern Rock affair among other things. An somewhat dry presentation followed by an highly interesting discussion can be seen in the youtube clip.

Less Teaching=More Learning

Teaching is not just about what goes on in the classroom. Popular belief states that smaller classes create better results. As The Economist has however pointed out, scientific research does not support this popular belief (Classroom Crush). Larger classrooms with better prepared teachers gets better results than small classrooms with teachers having less time to prepare. Spending more money or forcing more hours on pupils and their teachers does not significantly help. Better teachers more than anything determines the outcome. Better teaching = Better results.

This is why the Dutch government in particular, and plenty of other goverments in developed countries, should stop pushing for more and more teaching hours by teachers in front of smaller and smaller classes. The teachers in the Netherlands were right to strike on 26 January 2012. If only teachers spent less time in the classroom and more time preparing for teaching, the results would get better, according to the latest research.  As we have already argued before in, “School Rankings” in the Graduate Times, schools should be completely free to do as they please as long as they get the right outcomes. There is no way a national body knows the best way to teach every pupil at every school. A government paying by  the pupil and by results through a ranking system would be  one (of many) ways to give schools an incentive to find the best teaching method.

Just to be clear. We are not arguing for the state to get more teachers in, or to legislate for particular formulas. No – we want schools to make their own mind up. If they think teaching less = more, or that money otherwise spent on a fancy smartboard could better be spent on higher wages (for better teachers), they should get the freedom to progress in this way. We need an incentive for those that do well. As long as the outcome is an well educated population, nobody should or will complain.

Competition creates a Race to the TOP: The EU should seek Liberalisation not Harmonisation

The EU financial directives should be ditched. The Telegraph gives 6 reasons why. Yet we feel that there is a more important 7th reason: competition will create better regulation. Policy makers should remember that economic actors meet at stock marketes for mutual benificial gain (a stock market without investors is as useless as one without companies). Competition between stock markets will allow the stock markets which can deliver appropriate investor safegaurds to flourish.

In The Telegraph, Mark Hoban, Financial Secretary to the Treasury focusses on the problems the EU faces in agreeing on financial regulation. The Economist points to the flawed Dodd-Frank act as an example of bad regulation, yet feels that the harmonized Americans are doing a better job than the more dispersed Europeans. Both Mark Hoban and the Economist should read “Does Britain Need a Financial Regulator?” and realize that professional investors and exchanges have an incentive to develop the appropriate regulation and that this does not need to be a function of a transnational body or even national body.

In the same way that the process of producing and distributing bread changes, the financial system too is subject to innovation.  The best way too find the appropriate regulatory system  and to keep up with innovation is by allowing different stock-exchanges to compete.

Competition in regulation between exchanges creates a race to the top not to the bottom. Yes, an exchange may wish to stop short of suspending a listed company for misbehaving because of revenue loss, but an exchange needs investors as well as companies, as investors can walk away too. The companies want cash and the investors are looking for investments. All that is lacking is trust. To gain trust parties must find ways to communicate. Due to centralized regulation the most efficient way to communicate may not be found. 

Competition is a requirement to discover the best regulation and the best way for potential investors and companies to communicate. Different types of regulation impose different costs on different market users and constrain financial innovation in different ways. Throughout history we see that competition brings about important innovation in all industries including finance.

The early development of the Amsterdam stock exchange is remarkable example of spontaneous development of rules and enforcement systems in the most difficult of circumstances. The Amsterdam stock exchange began in 1602 and swiftly included facilities for future settlements and transactions, opening up the possibility of default. The exchange managed the risk of settlements, which was important for liquidity.  Many contracts were not recognized or even forbidden by Dutch law. The exchange developed its own rules and regulations, based on reputation, so that parties met their obligations even though they could not be enforced through the Dutch legal system. The punishments in this system were many based on industrial boycotts and loss of reputation.

The precursors of the London Stock Exchange (LSE) were the informal exchanges in coffee shops in the 18th century. These also developed systems of rules and enforcement. Those that did not settle their accounts where “named and shamed”.

We must remember that too lacks regulation might allow companies to dictate terms, yet in a competitive environment they would struggle to find any investors on the exchange. Investors and companies need each other.

If this thinking applies to stock exchanges surely it also applies to  other regulation where economic actors have communication problems such as with, accounting standards, disclosure, corporate governance and deposit insurance. More on those topic will appear on this blog shortly.

In the constitution of Liberty F.A. Hayek noted that the ”power of the professional administrator … is now the main threat to individual liberty” (Hayek P. 305). The developed world should learn the lessons Hernando de Soto is trying to teach the developing world. Centralized rules exclude innovative ideas and unique knowledge. Societies will create their own rules in an extra-legal system. The best way to find the appropriate set of rules and regulations is by allowing different institutions to compete and evolve creating a race to the top.

Some Thought Provoking Comments: 1. On Capitalism in Crisis, 2. OnThe Welfare State and Civil Society

Comments are often ignored. Some, though,  are more insightful than the blogs themselves. Here are 2 excellent comments that I have read this week.

1. On The Becker Posner Blog, both Becker and Posner have been debating the FT topic “Capitalism in Crisis” The following comment made me think of many European governments spending more than 50% of its citizens GPD.

Unfortunately, what we can see in western Europe and US has nothing to do with capitalism. Among other deformations, huge amount of activities which are in capitalism performed by entrepreneurs are carried out by governments. If we ask “is capitalism in crisis” in this situation, this question is meaningless. (Posted by: Ed)

2. Via an Post Imagine There’s No Welfare, Its Easy if You Try by Marc Eisner on the Pilius blog I came across the following comment which puts across a point I wished to make, this week’s earlier post, Civil Society. At Ace of Spades, one commentator linked to the post (with the tag: “Americans seem to have difficulty imagining a time when there was no pervasive government-run welfare state”) commented the following:

There was a time when the arm of the federal government did not reach far at all, and citizens had to rely on themselves, their friends, their families, and their communities for help and support. And you know what? It worked, mostly. … Misery and hardship is the lot of humanity on this earth. Yet our forbears managed to not only get by, but to build the greatest nation in the history of the world…and they did it without an overbearing, interfering, smothering nanny state monitoring their every breath. There was a time before the welfare state, folks. Honest”

I truly believe that society left to its own devises is human enough to find a better substitute.

France and Germany are reaping what they sowed nearly a decade ago

Where the political ideological push towards a home-owning democracy, pushed the US to the brink back in 2008. An obsession with fiscal disobedience by the Euro’s leading economies, has played no small part in the current crisis.

In yesterday’s address in Strasbourg, Monti rightly stated that France and Germany were at the genesis of the crisis.  Back in 2003, The New York Times and The Economist, amongst others, commented on Mr Chirac and Mr Schöder’s decision to break the Stability and Growth Pact. Both claimed that deficits were important to maintain growth.

To balance this binge of spending cuts have to be made at some point. Politicians have put it off to the extent that they no longer control the matter. The market has forced their hand.

Small countries too are facing a new recession. It is hard not to feel sorry for The Netherlands and Austria. The Dutch finance minister at the time, Gerrit Zalm, called storming the Bastille a better idea than Mr Chirac’s storming of The Stability Pact.  Karl-Heinz Grasser then finance minister of Austria claimed that any compromise would eventually damage the credibility of the Euro.

Unfortunately both Zalm and Grasser have been proven right. The Germans and French may be pointing at the Greek politicians, who have been the lowest form of political scum in the past decade (Corruption, cronyism, fraud and embezzlement seem to have been rife). It is wrong for Greeks to display Angela Merkel in a Nazi uniform. It is however appropriate if the French and Germans, instead of just blaming the South, did some soul searching of their own.

The Market View: France more like Indonesia (BBB) than the UK (AAA)

We often listen to central authority. The rating agency, are the authority on credit worthiness. They are currently slapping governments on the wrist. Much attention has been devoted to challenging the rating agencies. Sarkozy has even commented that France  is in a better state than the British economy . Furthermore he and seems obsessed with a flawed Tobin Tax. In reallity France may be more like Indonesia (BBB) than the UK.

Do you trust the ratings agencies? If the answer is no! It is insightful to look at the opinion of the dispersed knowledge of the CDS market. In the market investors put money where the rating agencies just have their reputation; those investors who know best will make money. These graphs illustrate that the current market believes that the UK  is in a better state than France, Germany and The Netherlands.

UK outperforms EU Peers

This blog will not go into the calculations of the implied probability of default, this and far morecan be found on the Deutsche Bank Research website. The prices of CDS (bond insurance) is determined by the market. It is therefore interesting to see if the opinion of many market participants varies greatly from the rating agencies.

Yesterday Moody’s warned that both the UK and France might be downgraded. The market, however, believes that the probability of default differs greatly between the UK and France (as can be seen in the first graph). Amongst fellow AAA rated countries the UK performs rather well with lower implied probability of default than Germany and The Netherlands. France on the other hand performs badly and has a similar implied probability of default as Thailand (A-), Indonesia (BBB-) and The Philippines (BB). It would not be surprising to see these countries who have managed there public debt well recently, upgraded and to see France downgraded in the near future.

France is more similar to Indonesia (BBB) than the UK (AAA)

Of course market sentiment is fickle and could change. It is important for the UK government to remain credible.


Bankwatch is Wrong on the Volcker Rule!

 The best way to increase transparency and make banks care about the safety of deposits is by exposing depositors to the risks of bad banking by no longer bailing them out.

According to Bankwatch the Volcker Rule will give consumers more choice on where their money should be invested, thus decreasing the risky operations of banks with deposit money. There are many reasons why this will not work, most of these reasons are highlighted in Finical Finance’s post “The Volker Rule:Fixing Problems We Don’t Have.  In my opinion the main reason why this regulation will fail is linked to bad incentives. Incentives do matter! There is little incentive for depositors to choose the safest bank.

Currently all bank deposits are efffectively state backed, as failling banks gets bailed out. Depositors a free to deposit their hard earned savings at the bank offerring the highest return, knowing that they have an implicit garantee. Without a bail-out (this implicit garantee), depositors would loose a proportion of their deposits and will therefore choose their bank more carefully (ballancing both risk and return).

To attract depositors banks, in turn, will need to be a lot more transparent on what they do with their depositors’ cash. It is important for regulators to get incentives right and they should therefore allow depositors to loose money.

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