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Consistency – be gracious in defeat

When Nadal double faults he does not ask for a third serve. When being caught speeding by police you face the penalty. When defeat comes it is best to bow out graciously.

Consistency and predictability are key ingredients to stable society.  All solutions for Greece’s current economic problems are painful but which solution is consistent? Which solution will show that everybody plays by the same set of predictable rules? 

Greece has borrowed too much money and cannot pay it back. The Eurozone has a no bailout clause and should not be lender of last resort. Greece has to either go the IMF or default. Suppose that the IMF cannot save Greece; all that remains is default. The creditors lose their money and Greece and its people go through hardship accompanied to a lesser extent by many in Europe and a few around the world. Would this be so unjust?  Would this not just set the precedent?  We play by the rules whatever the consequences this creates predictability and stability.

The creditors will lose a lot of money, but that is part of lending money, there is a chance you will not get it back. The fact that the rating agencies did not see this coming and that Greece could initially borrow at similar rates to the rest of the Eurozone is another issue and just another case for not having rating agencies in the first place. This however does not change the situation. Creditors unwisely lent Greece more than it could afford to borrow and they will loose out. 

The Greeks (and potentially their neighbours) will go through a decade, if not more, of hardship and financial isolation. This is not dissimilar to you or me if we go bankrupt. It is simply the effect of having a bad financial reputation. To say the people should not be punished for their politician’s mistakes is further nonsense. Greece is a democracy and its politicians are elected. The people voted in the same people who have let them down decades.

Contagion may resut from the fall of Greece of cause and a few others if not the whole Eurozone may fall, but is this wrong? Should sensible German or Dutch voters, who voted for sensible government budgets be paying Greek welfare? Should our taxes go to bailing out people who made bad decisions? We may all be hit, but those hardest hit should be the ones who placed the highest bets in the wrong place – Consistency and rule of law.  

We should all be free to make our own decisions. At roullete you could bet on red, if black appears you lose. Just because this may have horrible consequences doesn’t mean they tear up the rule book and let you keep your money.  People have placed their bets and a bet can be lost. When a bet goes well you should be rewarded, but in defeat be gracious and do not go crying for help or call foul play. After an epic Autralian Open it may be time for politicians, economists and society to take a leafe out of Rafael Nadal’s book.

Civil Society

What is civil society? Society should be a place that is organized in such a way to allow people to benefit from each other’s ideas. The Welfare State impedes on this, as it constrains mutually beneficial exchange.

There are many that believe that the Welfare State is a sign of a civil society. In this civil society the state looks after the poor, the sick, the unfortunate and elderly. The question I pose to these many: “what made you (society) so uncivil that the state needs to provide these services?”

The purpose of society is to create a more pleasant way of living. Of course “pleasant” is subjective.

 Subjectivity is good and bad. The unique information of every individual makes people dependent on each other. Yet workers and employers are dependent on eachothers unique knowlegde.

It is quite possible that workers who would want to work for certain entrepreneurs (and vice versa) never meet and fail to seize the mutually beneficial agreement creating unemployment.

Involuntary unemployment is not pleasant. Unemployment is therefore an opportunity for somebody in society. Allocating this under-utilized worker properly can create a profit, not only for the broker, employee and formerly unemployed worker, but to the insurance company too.

Currently the insurance company is the state. As the state pays out when a worker is unemployed, and all pay premiums in though general taxation. This insurance should be privatized. Why would the state know how to insure every individual? In the meantime it distorts incentives for the worker, employee and employment broker, who want to find a mutually benificial agreement?

A similar argument can be made for many elements of the welfare state. The creation of the welfare state has not made our country more civilized. It has created an environment in which, alternative solutions to the problems, which the welfare state is supposed to deal with, are excessively constraint. By stopping mutually benificial exchanges from arising the Welfare State is making society less civil.

Thought Provoking Comments: Greece, the BBC, and Oligopoly

Comments are ignored. Some, though,  are more insightful than the blogs themselves. Here are 3 excellent comments that I have read this week.

1. Response to “Turn the BBC into a Cooperative” by Sara Scarlett

Lotus 51 has a great thought experiment on tv-license payer’s forced contributions to the BBCFebruary 7th, 2012 at 9:38 pm

Might I indulge in a little thought experiment.

Imagine a society in which it was illegal for you to purchase a newspaper, magazine or book without a newspaper/magazine/book licence. That it was illegal for you to visit the cinema without a cinema licence, attend a play without a theatre licence, buy music or attend concerts without a music licence. Imagine that all the revenues from these licences were used to fund state journalists, writers, performers, actors to satisfy the cultural needs of the population according to the tastes of a self-selected elite. That you were forced to pay for these events and publications even if you didn’t attend/buy the works of the state producer.

Could we call such a society, free and open?

2. Mark Pennington’s own comment on:  “‘The Left’ and Public Choice Theory” illustrates the confusion surrounding  “market failleur”. Something not being perfectly competative does not mean it is not subject to competition nor that it the government should interfere.

markpenningtonlondon on February 4, 2012 at 11:58 am |

Actually ‘oligopoly’ is compatible with competive markets – not ‘perfect competition’ but ‘real competition’ where firms try do outdo one another on price, quality, organisational form and other dimensions. That is precisely the point that underlies Schumpeter’s emphasis on ‘creative destruction’. Facebook has substantial ‘network’ effects – but it is still a competitive business. The key point here is how much competition there is in the market as compared to how much you would get if politicians/the state ran the relevant industries. Given that to my understanding there are/have been only two parties with any chance of winning elections in the US (similar in UK) you’d be hard pressed to show that ‘democracy’ is more competitive than most markets.

3.In the comments on “The Simple truths about Greece” by From Ricardo Hausmann

There seems to a belief that the Drachma is the solution, because it can be devalued. This comment by mofo illustrates why it is not the silverbullet and unfair to most Greeks.

February 9, 2012 at 3:47 pm

(introducting the Drachma and devaluing it) This seems to me to be a way to take money from everyone who uses the Drachma (by taking away its buying power) and giving it to certain export sectors (by increasing their attractiveness to foreigners due).  Why not just tax everyone and then hand the money to its export sectors?

An Ancient Greek Lesson

2500 years ago the Greeks created a way of life that others admired and copied all over the world. Ancient Greece is often called “the birthplace of Western civilisation”. Now Greece is leading the way in European political failleur. Other politicians should learn the Greek lessons of repeated political and economic  failures. It is time to wake up.

Philip Booth, editorial director at the Institute of Economic Affairs, looks at four aspects to the “Greek problem” in his recent post on Public Service Europe.

1. Deal with the unsustainable debt burden

2. The Euro-zone question

3. Wages must fall in both the private and public sector.

4. Major supply side reforms to allow productivity growth

The current crisis is first and foremost a public debt crisis. The problem is a reoccurring one and would have come about even without the onset of the financial crisis.

Even outside the Eurozone the same problem would exist. Outside the Eurozone in the past debt-holders have lost out due to a currency devaluation. Outside a currency union creditors would therefore demand a currency-risk-premium to fund Greek, Italian, Spanish, French and Portuguese debt, raising the demanded rates on government bonds further.  The fact of the matter is that all these countries are living beyond their current means and placing the burden on future generations.

Far from being the problem, debt-holders stand to loose. To increase the chance of repayment, they are forcing much needed economic intervention. They know that economic growth is the only way out. Some economists such as Paul Krugman, feel that this is in direct conflict with austerity. Yet fiscal expansion and more government debt is the last thing these countries want or can afford. For growth drastic reforms are needed to make these countries competitive. This will be hard with vested interests and a limited political backbone.

It is time for a political awakening. In the Eurozone wages can no longer be decrease  though inflation and currency devaluation. I believe this is a good thing.

Why should competitive industries loose wealth though devaluation, because uncompetitive industries choose not to reform?”

Until now politicians have not accepted that labour flexibility, and less market regulation is needed in a currency union. But they must wake up and realize that the best way to generate economic growth is allowing  market participants to find the most productive way to serve each other.

In Time is a Missed Opportunity

The recent blockbuster, In Time (2011), forgets to tell us the simple lesson that more money and QE, does not make us richer. The relative scarcity  of resources is still the same, yet the economy is distorted, as few benefit at the expense of many when the money enters the system.

Even though it governs our daily lives,”money” is seriously misunderstood by many. Nothing illustrates this more than the recent Hollywood blockbuster In Time (2011), starring Justin Timberlake and Amanda Seyfried. In this film people stop ageing at 25, but are engineered to live only one more year, having the means to earn more time keeps you alive. In Time, time itself, has become the currency.

There is an extensive discussion on Why using time as currency wouldn’t work… . Yet the reasons given are mostly technical or based on one big fallacy surrounding the quantity of money. The purpose of this post is to correct this fallacy, that more money means that everybody is richer (or able to buy more resources). More money simply make all goods more expensive, as the scarcity does not change. Nor will an increase in the money supply have an effect on interest rates in the long-run, as the proportion of borrowers and lenders is unchanged.

In the following clip Ray Cillian Murphy realizes the simple fact that more money (time) will make time less valuable, when he states that many standing by will soon be running again to save time.

Both Will Salas (Justin Timberlake) and Sylvia Weis (Amanda Seyfried) realize that prices increase, yet they then come to believe that simply throwing 1,000,000 more years into the system will have an effect.

In 1730, prior to Adam Smith, in the “Essay on the Nature of Trade in General”, Irish economist Richard Cantillon highlights that an increase in the quantity of money simply leads to more inflation. This insight is used by Hume in “Of Money” and “Of Interest”:

For suppose, that, by miracle, every man in GREAT BRITAIN should have five pounds slipped into his pocket in one night; this would much more than double the whole money that is at present in the kingdom; yet there would not next day, nor for some time, be any more lenders, nor any variation in the interest (Hume 1752).

As the general price level increases relative prices change in the mean time. This is known as the Cantillon effect. The Cantillon effect illustrates how inflation is not constant over time, different goods will change at different rates and to a different scale. We should expect consumer goods to rise fastest this is what the additional money is spent on first and in largest volume. In addition the additional cash is often badly invested, thus creating mal-investment and subsequent slumps.

Instead of being just another Sci-Fi thriller, “In Time” could have taught us a present day economics lesson. Currently central banks all over the world are flooding banks with cash. Bankers will benfit from first use as yet others will loose due to increased prices of consumer goods.

Economic Development: Do not forget Hayek’s Use of Knowlegde.

Hayek’s use of knowledge is not just an attack on socialism, but a useful insight, which all social scientist and especially development economists, should embrace.

We live in a world in which information is: huge in volume, created in a dynamic process, widely dispersed, and subjective. It is impossible to obtain all relevant information “scientifically”. The fundamental question social scientist should, therefore answer, is how to create a society in which the dispersed information, which is unique to every member, is best utilized Hayek (1945).

Hayek got bogged down in his fight against Socialism. After the collapse of Communism, his fundamental message on knowledge was all but lost. His theory of knowledge applies as much now as it did during the Cold War. The current economic system does not utilize the vastly dispersed knowledge in society. As Hernando de Soto points out, the majority of the world’s population is locked out of the system. Yet we must acknowledge that even the humblest people, those with the lowest income or with little formal knowledge, will possess pieces of information which can be decisive in the course of social events (Huerta de Soto 2008). Not utilizing the specific knowledge of the world’s poor is a dangerous waste!

To distort the use of knowledge in society, because of the belief that some central authority knows better, is not only arrogant, but dangerously ignorant of the fundamental problem: no single central authority possesses a complete overview of the dispersed set of information.

We have got to create a society which best utilizes the dispersed set of knowledge. Hayek called this state of society “The Extended Order”. We believe the “Extended Society” is a more fitting term. Social Scientist should debate the use of knowlegde in society. Let us hope we can develop a society in which free (entrepreneurial) exchange through the use of knowlegde is open to all.

I leave you with a thought provoking clip with Hernando de Soto.

Huerta de Soto, J. (2008),“The Austrian School: Market Order and Entrepreneurial Creativity (web version).” Edward Elgar Publishing in Association with the IEA.

Labour is a puppet of the unions – Lib Dems must stand up for non-unionised workers

Image courtesy of the Daily Mail

First Published on Liberal Democrat Voice on 3 November 2011

As a member of the Dutch liberal party the VVD who was studying in the UK during the last election, I was pleased that the Lib Dems formed a coalition with the Conservatives. Yet I feel that a strategy that distinguishes the party from Labour is just as important as one that distinguishes the Lib Dems from the Tories.

Instead of stressing coalition differences, the Lib Dems have the opportunity to show that they are a true alternative to Labour for those that consider themselves working class. The Lib Dems should stress that, unlike Labour, they protect ordinary workers by deregulating the labour market, and do not tend to just burden the unionised workforce with extra regulation. Labour unions do not represent all workers (only 26% of all salaried workers are union members (OECD)), nor do they represent the unemployed. Yet the Labour Party is likely to tend to this minority’s needs.

In total 85% of the Labour party’s donations come from the unions. 62.4% of the union members work in the public sector, where 64.5% of the wages are collectively agreed. In the private sector, where 80% of the workforce works, just 16% of the wages are agreed collectively. These unions, despite being relatively small, have a huge amount of political power, not only because they fund Labour, but also though their election of the party’s leader, Ed Miliband. This power means that Labour is more likely to back the labour union member, rather than the majority of the workforce outside the unions.

This can have a devastating effect on the protection of workers outside the labour unions. Many of the workers outside the labour unions are paying for public sector pensions though general taxation. Additionally, many unemployed are not allowed to take the place of unionised workers who are striking.

Most devastatingly, unions are generally in favour of both immigration controls and red-tape, which hamper entrepreneurship, job-turnover, innovation and growth. Growth and innovation bring new jobs outside the unions’ control at the expense of old unionised jobs.

Collective bargaining, and other employment protections makes it expensive to get rid of workers. This not only slows the innovation process which is critical for growth, but again makes jobs more expensive as the entrepreneur takes the possible future cost of firing a worker into account. The entrepreneur will have an incentive to innovate in such a way to avoid these firing cost. This means that shops may choose self-sevice-check-out systems at supermarkets instead of employing more young workers.

To protect the liberties of the ordinary citizens, to allow ordinary workers to be innovative, entrepreneurial, and free from ridiculous regulation, the Liberal Democrats must make sure that they are the party protecting ordinary workers. The Lib Dems should emphasize the fact that the Labour Party is no more than a Labour Union creating a welfare state for union workers at the expense of ordinary workers and society at large.

A Devaluation

by swperman

Desvalorização do euro...

First Published 25 July 2011 in The Graduate Times

Greece, it is easy to gain a competitive advantage without devaluing your currency! Just cut all Greek wages by 20%!

A new Greek bailout has been agreed. The question is, will it work? History has told us that four ingredients are needed to solve a credit crisis. The four main ingredients are: devaluation; a short-term loan; fiscal restructuring, and privatisation. The Greek bailout includes three of these, but lacks one essential ingredient: an internal deflation or devaluation.

Devaluation of the Euro is possible. Relative wage levels in the Eurozone will not change, however. Greek wages are way above their relative productivity compared to other European nations. In many industries Greeks simply cannot justify their wages. An internal deflation is possible in a flexible market economy to deal with the competitiveness problem. Hong Kong proved this in their crisis, which lasted from 1998-2004.

Greece does not have a flexible market economy. Instead of allowing for a deflation of wages in those uncompetitive industries (as Hong Kong did), the state could decide to cut all wages in all industries by 20%. This is ofcourse sub-optimal. There may be an outcry, but the alternative – a 20% decrease in everybody’s income due to currency depreciation, is not inconceivable under an individual currency devaluation outside the Eurozone.

Tobin Tax – Keep the Market, Curb Politicians

Tax on foreign exchange transactions will mask political incompetence and make developing nations poorer, argue Henry and Lawrence Gruijters. First published on The Graduate Times.

The European Union’s budget is constantly growing in contrast to the nation states, who have been forced to cut their budgets. To fund the EU many advocate raising funds through a “Tobin Tax” but this has many practical problems. Greg Mankiw points out the most obvious one. Imposing a Tobin Tax is simply not feasible as the trade of currencies will move from London and Frankfurt to the Cayman Islands or Zug. More fundamentally, the Tobin Tax may just be a smokescreen to cover political incompetence.

The Tobin Tax was first proposed by economist James Tobin. The main idea is to levy a very small tax (0.1%) on transactions from one currency to another. The reason for this is that it would make currency speculation driven by small differences in interest rates unprofitable. Such a tax would then “throw sand in the wheels” of global finance, slowing down the movements of the financial sector.

All countries are dependent on foreign investment. The United States, as the biggest economy, is naturally seen as a good opportunity for foreign investors. With a growing debt, a lower economic performance and a lack of political conviction, investors may soon demand higher rates to persuade them not to pull their money out of dollars into say, Swiss francs. Large money flows can lead to a high volatility in exchange rates and interest rates. This is often seen as particularly hazardous for small open developing economies. For instance, large capital flows out of Greek debt mean that it needs high rates to attract investors. Many believe that finance moves too quickly and that a Tobin Tax can slow it down and avoid crashes. Throwing sand in the wheels may, however, have a detrimental effect on the performance of the small open developing economies which the Tobin Tax (according to the advocates) is meant to help.

One of the big puzzles in economics is the “Lucas Paradox”. Why did capital flow from rich to poor countries before 1914, yet after 1945 mainly flow from rich to rich countries? Theoretically capital should flow to the poorer countries as one additional dollar can produce more there than it can produce in the richer countries. Robert Lucas presented two main reasons for the lack of capital flow to poor countries. Firstly, high levels of human capital may mean that rich countries are still a better investment than developing nations. Secondly, after decolonisation political risk increased in many developing nations.

Lucas’s first reason suggests human capital (education) was a less important driver for capital flows or less different before 1914 than today. Some evidence suggests that human capital is indeed more unequal today, yet it is not impossible to copy “human capital”.  Evidence from South-East Asia suggest that after developing the correct educational and intellectual institutions it is possible to raise human capital levels sufficiently in developing nations. Institutions and economic incentives are not only important for human capital growth, but affect the level of political risk too. Looking at the World Economic Forum’s interactive report we see that the effectiveness of the legal system, efficiency of government and the government’s credit rating are also vitally important for reducing risk. In colonial times investors could trust the crown to enforce debt contracts in the colonies. Now foreign investors must trust the foreign countries’ own political institutions.

A currency crisis often stems from a political crisis and the lack of trust and proper economic incentives in institutions.  Financial markets discipline governments as they drive up rates where they feel “political risk” is increasing. James Carville, former adviser to Bill Clinton once said: “I used to think if there was reincarnation, I wanted to come back as the president or the Pope or a .400 baseball hitter. But now I want to come back as the bond market. You can intimidate everybody.” This intimidating power, which can discipline the political world, will be decreased if a “Tobin Tax” is implemented. Many feel this may be good as it gives politicians the power to have an expansionary domestic monetary policy during crises without risking the wrath of the bond market in the short run. Yet the lack of a threat to enforce discipline is bad. It will slow down the reform and development of credible institutions in developing nations. In the Asian crisis, crony capitalism rather that speculation was to blame. In Greece, political ignorance and fraud, not currency speculation, are at the heart of the problems. One lesson hard learnt in the past few years is that politicians are not always the greatest money managers. It would be less damaging if politicians did what is most important and tackled the economy’s institutional weaknesses instead of tackling the monetary flows which highlight their monetary incompetence.

The myth of consumption-led growth

Henry and Lawrence Gruijters explain how public spending may not be such a positive thing, as dynamic effects are often ignored. First published in The Graduate Times

All too frequently we hear that consumption enhances growth. This cannot be further from the truth as the following simple example explains:

A farming society needs to save 10% of its crops in period 1 to reseed its farms and get the same return in period 2. Instead of consuming 90% of its crops the society could accept a period of austerity and consume just 80% of its original crop leaving it 20% to reseed the farm. Assuming that there is an abundance of agricultural land, his 20% will give the farmer 200% of his original period 1 crop. If the society wrongly feels that more consumption drives growth, it may be inclined to live extravagantly and consume 95% of the crops in period 1 leaving the society only 5% of its crops to reseed. Society’s output in period 2 will then be just 50% of its original crop.

Many, including Labour Shadow Chancellor Ed Balls (see his London School of Economics speech), seem to view public spending as a positive thing, so that the more spending there is, the better. They feel that if the UK government and society stop consuming the economy will no longer grow. Economists are obsessed with growth, and there are many growth theories and models. Most emphasise the importance of savings for capital accumulation to fuel investment, none to my knowledge, emphasise increasing consumption. Economists fail to convey the important message that extravagant consumption in one period comes at the cost of lower consumption in the next. There should be more focus on lifetime consumption than current consumption figures.

Shifting Policy from Realpolitik to Free Trade

Lawrence and Henry Gruijters see the move towards Free Trade as the way forward. But can it really supersede the current realpolitik with the troubles and tensions in the Middle East? First Published 15th July 2011 on The Graduate Times.

Shifting Policy from Realpolitik to Free Trade

BBC’s HARDtalk interview with French Foreign Minister Alain Juppé, and William Hague’s foreign policy speech at Mansion House both pointed towards a shift in foreign policy. This shift suggested a departure from realpolitik, and moved towards a policy based on the transformative power of free trade. Free trade is a powerful force. Consider the historical successes of the Marshall plan, the foreign policy following the fall of the Berlin Wall, and the divergence in fates of the two Koreas.

In the case of the Arab Spring, a free trade foreign policy does however have some pitfalls. The fall of the wall and the emergence of the Arab Spring may seem very similar. Both were an inevitable uprising occurring in the face of tyranny and neither was anticipated to spread so quickly. There are some major differences between Arab states and Eastern European countries. Arab nations do not have a collective memory of democracy. Without this identity it is difficult to build the necessary institutions for democracy and enable liberal capitalism to function. Moreover, following the fall of the Berlin Wall, liberal democracy combined with free market capitalism was the clear alternative to state communism. In Arabia the choice is less clear. Many Arabs have suffered under “Crony Capitalism”. There may be an opposite drive to a more centralised regime which is not open to trade. This centralised regime will not decrease, but enhance corruption and the power of special interest groups. This would slow the reform of institutions which is necessary for an enterprising economy.

Europe too, can make mistakes. It could be inward looking at a time when it should do the opposite. Southern European countries may not look as fondly to a customs union with other countries that also produce agricultural products. This competitive pressure may, however, have positive results as countries will be forced to farm more efficiently based on their comparative advantage. Product variety may increase as different countries focus on different products which the smaller domestic market previously did not support.

In addition, Europe and the United States may fear Islamic parties. The fear of Islamic states like Iran is often seen as the main reason Western democracies supported dictatorships in the Middle East. Islamic parties should not be feared. Many European democracies have Christian Democratic parties, what is stopping Islamic countries having Muslim Democratic parties? Forcing Islamic parties to act within a democratic framework will over time turn these parties into secular parties. Turkey’s AKP is a prime example of this.

The biggest balancing act will be the different policies towards different Arab nations. Where Egypt is a more homogeneous nation, Libya is more tribal. Where we see Western intervention in Libya, we do not see the same intervention in Syria or Bahrain. We think it is quite clear that liberation must not and cannot be imposed. The EU must avoid being patronizing, whilst still helping Arab Nations to build efficient institutions. But double standards are a problem. Saudi Arabia still heavily discriminates against women and has sent Bahrain tanks which will be used on its own people. Yet Alain Juppé will tell you that relationships are as good as they have ever been with the Saudis. Effectively Europe is still pursuing realpolitik. The right option is free trade (or at least the promise of this with the EU) as a reward for good institutions, yet sticking to the status quo is seen as the pragmatic choice for other nations.

These double standards may be the greatest threat to the success of a customs union. The success of the Marshall Plan was due to enforcing trade between different European nations, which made these nations dependent on each other and the region more stable. The surest way to a stable Middle East is by making vastly different nations dependent on each other. Trade between Arab nations must also be realised in addition to trade with Europe.

Peace with Europe and stability in the region would be a body blow to Al-Quaida. The road to peace is hardly ever smooth. Success will only be achieved if countries trade and become dependent on each other. This will take multiple generations to achieve. Current politicians must realise that their legacy will depend on their successes or failures long after they have left office.

If successful, historians may see 9/11 as a dying spasm of conservative Islam whilst they may see the revolutions on Tahrire Square as a successful Arab Spring. A political failure, however, would mean that the Middle East is remembered for unrest and war. Without political and economic bravery from Europe the Arab Spring may be torn out of the pages of history.

On Pensions

Henry and Lawrence Gruijters comment on the problematic nature of pension reforms. First Publsihed on The Graduate Times.

When did we sign an inter-generational contract? Unions may be demanding strikes from current employees, yet it is us and the future generations who will suffer if this government does not carry out significant pension reforms.

Almost every developed nation has a problem on the issue of pensions. Advances in knowledge have increased life expectancy and quality of life, yet people still expect to retire at the same age. If we were actually allowed to retire this early, despite such knowledge advances and life expectancy increases, we could all end up in retirement for longer than we have actually worked. Imagine that.

Current generations promise themselves pensions, which are paid for by future generations. One generation is therefore giving themselves benefits at the expense of those who cannot vote yet, either because they are not old enough or simply because they are not born. This system has been collapsing due to the debt burdens it places on future generations. The “official debt” for the UK is roughly £650 billion. Pension liabilities to public sector pensions are approximately £1.2 trillion, with other pension liabilities in the order of £2.3 trillion. All in all, the total debt passed on to our generation will be more than £4,000 billion. This is 270 per cent of national income. With a changing demographic adding to longevity and increasingly expensive care, the debt burden due to pensions could become too much to carry.

This problem has been looming for at least 20 years and even without the financial crisis, the inevitable time for change would have come. The shadow pensions minister, Rachel Reeves, believes that reforms should be delayed once again — but why? There is no time to dither: time is money.  The current government has boldly taken the correct step by tackling pensions, even though this will make it unpopular.

There are many vested interests in keeping pensions as they are. Most importantly, the number of older voters is increasing. Secondly, nobody wants to see their beloved parents working longer. Ultimately, we all hope to receive a pension. The government should be applauded for standing up for the younger generations. It is a shame that unions have not done the same, but let’s hope younger members vote with their feet. A lack of reform may be a reason for a student demonstration, not against the government per se, but against the vested interests of the unions.

Bills are still far from being passed and not all the appropriate measures have been taken. Simply raising the retirement age does a lot of good but will not make the problem go away. There should be a fundamental rethink on how pensions are provided and how retirement age is determined in the far future. Should it be a system paid out of general taxation? Is it right that those working in the private sector pay towards public sector pensions? Should it be compulsory or can we trust individuals to decide for themselves? Should there be a retirement age? Is it realistic to force a Glaswegian with a life expectancy below the retirement age to pay into a government scheme?

We are all living longer and thus spending more time in good health on this earth. This is one of the greatest achievements of modern science. Working slightly longer and saving for this extra time should not be controversial, it is a natural necessity.

The Greek Tragedy

It is Greece’s shaky politicians, not the global crisis, that have led it to financial ruin, say Lawrence and Henry Gruijters. First Published on The Graduate Times.

Image courtesy of Zola Chen

So far Greek politicians have not been punished for irresponsibility; only rewarded for spending. A bigger and sharper stick should be yielded to avoid repeat.

Many wrongly blame the financial crisis for any recent financial difficulties. The Greeks are no different. The financial crisis may have accelerated the process, but a Greek crisis had been looming even before their last default in 1998.  Greece has been struggling with fiscal disorder since the early 1980′s. The Greek economy has been notoriously uncompetitive. Its global competitiveness index has constantly been slipping –  even in the “boom” (2000-2007) Greek competitiveness fell. A major reason for being uncompetitive is the dismal public sector performance: 55 per cent of the Greek national product goes into the salaries of public sector workers. There are more than one million government servants in Athens. In addition, there are many mismanaged public sector companies that should be privatised and which are currently subsidised by the government. Combining this mismanagement of funds with the fact that Greece is the least efficient collector of taxes within the European Union leads to a situation where public deficits are a structural problem.

Northern European countries have had many reforms to ensure the competitiveness of their economies. These reforms include: privatisation of utility companies and banks, and the reform of labour laws and entitlements to special interest groups. Due to the vested interest of part of the population these measures are hardly ever popular and it takes brave politicians to commit to these policies. Unfortunately, Greek politicians have traditionally been fearful, ignorant and weak. Greek politicians have more often than not chosen to default — such as in 1983, 1985 and 1998 or to devalue their currency…

Now Greece is part of the Euro, it has benefited from a lower borrowing rate but has not used this economic upswing to make appropriate reforms. Now the inevitable has happened and it does not have the option to default or devalue its currency. It must now do what it should have done three decades ago: reform. The main problem is that given Greece’s history, who really believes politicians will be able to reform the country’s economy?

The only solution is taking fiscal power away from Greek politicians and giving it to the European Union entirely. Furthermore, this should become a standard procedure whenever a country breaches the Stability and Growth Pact for a period longer than two terms of government. The loss of sovereignty is the ultimate threat to politicians, and a sure way for them to loose the following elections. Markets will see this threat, find it credible, and believe that appropriate reforms will be taken by politicians to ensure fiscal stability within the monetary union.

Many may feel, like the demonstrating Greeks, that this is a new type of colonialism, which infringes on national sovereignty. Yet sovereignty has not done the Greeks much good. A default and leaving the Euro will mean a return to the old ways and a continuation on the series of Greek defaults and economic underachievement. With the advantages of joining the Euro comes the responsibility of stability. If certain politicians cannot credibly promise responsible policies, they should be coerced into action. Like all behaviour, political behaviour needs to be governed by both a carrot and a stick. If the stick is hard and sharp enough, the hope is that it will not need to be used often.

School Rankings


First Published 29 May 2011 in The Graduate Times

The Gruijters brothers explain their controversial ideas for a new way of assessing schools based on the performance of their pupils.

As our previous articles have made clear, we are supporters of this coalition. It is a shame however, that this reformist government has got into a habit of U-turns and moderation. To be remembered in history this government has to do the opposite. It has to go further and faster in its reforms, especially with education.

The government has done a lot of good for education in a short space of time. It has created ‘free-schools’ funded by the tax-payer. Schools can choose who teaches, what they teach and how those who run the school are rewarded. Yet the incentives do not go far enough. The school should be rewarded for performance and should, like any viable business, be allowed to make a profit.
Secondary schools should be paid on performance and contrary to common belief performance is actually rather easy to measure. At the age of 11, prior to leaving primary school, all children should take a national exam – as many already do – but they should then be ranked according to their results. This process should be the same before children are to leave secondary school. Schools should then be paid a taxpayers fee according to their children’s change in performance ranking.

Say for example we have two children: Beth and George. At age 11, George is in the best 10% of the country and Beth in the best 80%. Then at leaving secondary school Beth is in the best 60% and George the best 15%. In this case Beth’s school has added more value to her and is paid more for her education than George’s school, which has been unable to sustain his achievements. Through this incentive those schools which increase their students’ performance in comparison to their peers will be rewarded for doing so.

An added advantage to this ranking, instead of stating an absolute grade, is that we have accurate statistics across generations of performance levels of schools and pupils. Like all Dutch children, British children will be able to compare their results with their parents’. This will also be a help to universities when they try and attract the best students. No longer will they need to weed out where there may be grade inflation, because all scores will be relative to each other. Moreover, when pupils are ranked, it will be easier to see which school is best for an individual child. The school that adds most value to a child with a similar pre-secondary school ranking to your child’s is the one to choose. Therefore the system can be used prescriptively by parents also.
All this, easily achieved through ranking instead of an absolute score for children’s exam performance.

Why public sector workers are like bankers

Public sector workers should not be surprised when they look in the mirror and see a banker, says The Extended Society

On the 10th of March 2011, Michael Johnson of The Centre for Policy Studies asked the following question on the BBC’s Wake Up To Money programme: “Is it reasonable that 80 per cent of the labour force essentially finances the certainty of income in retirement of the remaining 20 per cent in the public sector, when they themselves will not be able to enjoy the same certainty?”

It indeed seems unreasonable that those in the private sector should be funding the pensions of workers in the public sector. When viewing a cut in pensions, however, it is hard not to feel sorry for those who made the rational choice to join the public sector because they believed they would get a higher pension when they retired. For this reason it is not surprising to hear that Lord Hutton believes these promises should be kept.

It is right for the Government to keep its past promises on pensions in the same way as it was right for banks to pay the bonuses. Apart from the legal implications of not keeping these past promises on pensions and bonuses, such a decision would severely undermine the credibility of both employers.

Perverse incentives, such as government guarantees, low interest rates, and a government desire to expand home ownership, have fuelled seemingly immoral banker bonuses. The subsequent meltdown of the banking systems means that the taxpayers own many of the banks,  and are thus effectively paying the bonuses themselves.

Where public sector workers may not be demanding footballers’ wages, evidence suggests that wages in the public sector are not lower than in the private sector. It is therefore questionable that the extra cost that public pensions bring should, akin to the banker bonuses, fall on the taxpayer. Of those taxpayers benefited by the 20 per cent in the public sector, it is the 80 per cent in the private sector that pay the bill.

Many public sector workers demand that bankers pay back their bonuses with higher taxes. In this light, some private sector workers may ask for a special tax on public sector workers. We will not suggest such petty actions; in a past article, it was pointed out that the “Extended Society” has not blamed the bankers for their mercenary actions. Here, again, we will not blame public sector workers for theirs. We would simply like to illustrate that bankers and public sector workers are not as dissimilar as they may like to think. And that it is right for the government to seriously re-think its pension policies.

A Strange Turn

The Extended Society explains why the government’s repealed forest scheme is less commercial and more community focused. First Published on The Graduate Times.

The recent decision not to sell off forests baffles the Extended Society somewhat. People appeared to be worried that forests would become commercial entities. Yet the Forestry Commission, the current regulator, is also the seller of 70% of the timber entering the British market.

To state that the current regulator is not a commercial entity is naive. As Miss Spelman told the Economist: “The Forestry Commission is selling Christmas trees, for goodness sake. What is the state doing selling Christmas trees?”

It is true that the portfolio of the forestry commission includes heritage forests. As a regulator, however, the Forestry Commission could do its true job and regulate these forests appropriately, insuring they go to appropriate owners. Forest areas that have already been used for commercial purposes by the Forestry Commission could be sold to commercial owners; others would need to be sold to charities. Both would still need to be regulated.

The whole purpose of the scheme was to give heritage forests and woodland back to the community. This would mean that the community would be able to decide how their forests would be run. They could, if they wished, charge anybody an entrance fee from anyone who does not have a pass, and issue a free pass to neighbouring residents. This way Sutton Park could be free for Sutton Coldfield residents.

The error of the government is that they wrongly presented it as a cost-cutting scheme, which it is not. It is a Big Society scheme. They should have communicated it as a policy that would take away duties from the government and give power to the people.

If presented in this way any amendment to the scheme would be taking power away from the people, and who would want that…?

Big banking bonuses

Henry Gruijters says the government needs to listen more to Hayek and less to Keynes to avoid extravagant bonuses. First Publshed on The Graduate Times.


If asked what a government should do, the answer we do not expect to hear is “nothing”. There is a feeling – certainly on the Left – that the state should control and manage the economy and that leaving economic decisions to the market is simply too risky. In this light, it is hardly surprising that Britain has been operating under a Keynesian policy of active government ever since the 1930s. However, choosing to limit the state, as the great Austrian rival Hayek would have liked, might just save the government on the issue of bank bonuses.

The Keynesian philosophy states that if the market is no longer willing to invest, the government should take up the slack by investing itself. This would have a “multiplier” effect through the economy. The investments themselves should theoretically reap returns as well. Evidence of a multiplier is weak, as often public expansion replaces private retraction. In addition, there is a good reason why private investors are not willing to invest,  because they feel the potential risks are too great and that the returns do not warrant the investment. Why should the government know any better, and be willing to wage war against the market with tax-payers’ money?

A perfect, healthy market can suffer from a lack of “effective demand” and the government may want to pick up the slack. Government intervention in this country has, however, not typically been temporary, but constantly present; even when there was no lack of effective demand in the build-up to the crisis.

Governments on both sides of the Atlantic have for decades encouraged home ownership.  The home-owning democracy is only possible with cheap mortgages. The NINJA mortgage (“No-Income-No-Job-or-Assets”) was itself partly responsible for fuelling the bubble. The issuance of loans to people with a low or no income was actively encouraged by the government as we have discussed.

This cheap credit and bank protection caused severe moral hazard. Those who knew the extent of the risk were not taking it, and due to financial alchemy the loans became part of triple-A bonds. This meant that there could be thousands of miles between the issuer of the mortgage and the owner of the loan. Further moral hazard occurred when it became clear that the government would bail out the banker if the investment went wrong. This meant that bankers were able to roll the dice and, if the bet paid off, they would get a massive return and an enormous bonus. On the other hand,  if the bet did not pay off, then the government would bail them out anyway. It was a zero-sum game.

The example above has striking similarities to the Austrian explanation of cyclical swings in business resulting from uncontrolled credit expansion at the hands of the government. If there was no government safety-net, bankers would be a lot more wary when taking risky investment decisions. Bondholders would still demand insurance on their deposits. To avoid bank-runs, banks would, therefore, need to insure each other’s credit. To make this insurance hold they would scrutinize each other’s investments, since everybody would bear the cost of only one bank’s imprudence.

The public can get angry with the bankers; one could state that it is “immoral” to acquire such enumerations under such severe social circumstances. However, the public should remember that it is their representatives in government that have made the bonuses possible by providing a safety-net and cheap money for all.

The French Building Windmills

Thanks to environmental concerns, 2015 may see the advent of wind power but it will not kill off nuclear power stations and cheap energy in France First Published on The Graduate Times.

With the advent of the Fifth Republic, France soon found itself in a decade of Gaullist reform. In a country that is often opposed to reform, French Nuclear Power should be hailed as a major success story. This reform led to France having low electricity costs, which makes it a favorable location for business, especially when power is a major input for production. An extra benefit is that its power is also low on CO2. Furthermore many other European countries benefit from this as 18% of its energy is exported.

This, however, is about to change as politicians are about to make a major policy blunder. In 2015 France will enter into the offshore wind arena. The government hopes that France’s expansion in offshore wind will boost employment; the ever-optimistic Nicholas Sarkozy stated that this will eventually represent 10,000 jobs in sectors such as construction and maritime services. There is a catch! According to documents released on Wednesday 26th January by the Environment and Energy Ministry, this will bring about a 4% rise in consumer power prices at 25 euros per household per year. France will have 24.8 million households in 2015, the total social cost of subsidies for these wind farms alone will be 612.5 million or 61,250 euros per job per year.

I am not saying that the people involved in the wind turbine will have salaries equal to 61,000 euros a year. I am just illustrating the fact that it is a rather expensive way to create that many jobs. One could pay 10,000 people 61,250 euro to do nothing all day and everybody would be as well off (minus the hassle of actually building the windmills).

I can hear people saying that this is worth it for the windmills. The fact is that windmills will not get rid of the nuclear power plants. Windmills will simply make everybody’s electricity more expensive in a country that is already exporting a large amount of its extremely cheap energy. Energy produced by windmills is notoriously unpredictable; I can tell you with 98% certainly what the demand for electricity will be tomorrow. You will, however, not even be able to tell me with 90% certainty how fast the wind will be tomorrow let alone how much energy the windmills will actually produce.

To make matters worse high prices will not only affect the poor French, but Brits too. This is in part because the current government is going down the same doomed path, but also because much of the French exported nuclear power goes to England. The French having their heads in the sky will make life more expensive for all of us.

For 2011, a big debt needs a big society

Lawrence and Henry Gruijters take a comprehensive look at where the UK’s economy will be heading in 2011. First Published on The Graduate Times.

For 2011, a big debt needs a big society

2011 in economic terms will be be remembered for a VAT rise and the reality of the squeeze. Britain’s public debt is an eye-watering £952.8 billion (ONS) and 64% of the GDP, with interest payments rising to approximately £43 billion. Currently, 3% of Britain’s GDP goes to servicing this debt. This seems a scandalous amount, considering that this interest payment is equal to approximately 66% of total 2010 VAT tax receipts.

But figures do not tell the whole story. The reasons for running a deficit can be split-up into two groups: government investment and demand management. It could be argued that a budget deficit can be an investment. For example, higher spending on the transport infrastructure improves the supply-side capacity of the economy, promoting long-run growth.

To illustrate the second reason to run a deficit we, like Paul Krugman in his book The Return of Depression Economics, will summarise the following story by Joan and Richard Sweeney. The Sweeneys are members of a babysitting co-operative. In this co-op everybody gets coupons which entitle the bearers to one hour of babysitting. The babysitter would receive the appropriate number of coupons from the baby-sittees. In this way every couple would get as many hours of babysitting as they provided. There came times when there where simply not enough coupons in circulation, as couples accumulated coupons for the future. This ran down other couples’ reserves.

A demand crisis was born. Couples who felt that their reserves of coupons were insufficient wanted to babysit and did not want to go out. But one couple’s decision to go out was another’s opportunity to babysit. Opportunities to babysit became hard to find as everybody was supplying the service, making couples even less likely to use their coupons except for very important occasions.

The solution was simple – increase the demand for coupons by making going out cheaper, by supplying more coupons or increase demand for babysitting yourself and issue new coupons. These were sensible solution as there was no problem with babysitter production, but a lack of effective demand. The lesson for the real world – bad things can happen to good economies, making occasional government intervention not so costly. This is a case of imperfect coordination. Instead of government intervention a clever entrepreneur who could find a better way to coordinate could solve the same problem.

Do the these reasons justify the UK’s current deficit? To some extent, people are right to say we should continue spending to get us out of this mess and boost demand. It is difficult to claim that this deficit reflects investment opportunities as the large amount spent on the NHS may be deemed as an investment in the labour market, but is hardly an investment which will not also need to be made as new generations enter working life.

Give or take a financial crisis, whether you believe in Keynes or not, we have spent too much over the last decade. Nothing more expresses this problem than the answer to the following question: Do you think your children will be better off than you are? Invariably in the last 60 years the answer to this question has been an overwhelming yes! Recently the answer changed to no. Polls and the news like to attribute this to a lack of optimism. This is wrong – the situation is because we have spent the inheritance, and then some.

There has been a problem of ‘deficit bias’. Spending more and getting into debt, and then spending further more and getting in to even further debt. This may be good for the baby boomers, whose pensions we all still need to pay, and who are proportionately the most important catchment group of voters. Overspending now is giving future generations the burden of a higher debt that at some stage will need to be paid off with higher taxes. Firstly these taxes will reduce output. Secondly higher government debt will also divert savings from investment as interest rates are too high to exploit investment opportunities, which will once again reduce future growth.

The Extended Society therefore concludes that there is a dual problem. The current crisis may be due to a lack of effective demand, which calls for extra expenditure. This expenditure will slow growth, because the public acknowledge that current expenditure equates to future taxes and higher future interest rates ‘crowding out’ investment. The problem is a commitment one. We would love to commit to reducing the deficit when times are better, but judging on recent evidence this is not credible.

The way out is unclear but the European bond markets may be key. They could scare governments into a credible path towards fiscal consolidation. This is avoidable – credibility in this case is mainly a political problem, political credibility must be enforced. If markets knew that running a structural deficit when demand is sufficient spelt out political suicide, markets would trust that debt would not get too high.

The Big Society is the second solution. We do not suggest tax increases, but spending cuts and social reform giving responsibility to the people. This will include increasing labour mobility and wage flexibility to avoid unemployment. The sole motivation should not be to make the state smaller, but to make the state work better. The amount spent is a poor guide for performance. Over the past 50 years almost every sector has been transformed by innovation and technology increasing productivity. No sector has changed as little as the state. With ageing populations needing ever more state help, the left should have as much interest as the right in state matters. The great part of the big society is how it is focussed on productivity and medium to long-term savings, not short-term cuts which may stifle growth.

The Extended Society hopes that 2011 is not just known as the year in which austerity started with a tax levy, but is remembered as the year that the premature idea of the Big Society truly came of age.

“We have solved boom and bust”

From the Notebook – Henry and Lawrence Gruijters question some recent claims by Ed Miliband. First Published on The Graduate Times. 

“We have solved boom and bust”

On the Andrew Marr show, Ed Milliband was questioned about Labour’s spending during their time in office. Whenever it was put to him that Labour spent too much he denied this was the case. His argument was that it was not Labour which created the huge budget deficit, but the financial crisis.

Similarly, it was not overspending that caused the budget deficit, but the bad regulation on the financial system. When questioned about Keynesian economics and saving in good times, for the bad times, his answer was similar. Overspending was not a problem, overspending was an investment in our future. The problem was the financial crisis which then put us into more debt. It is true that the financial crisis drastically increased government debt from 6% to 10%, but how can a government credibly claim that there will never be an end to boom and bust?

As Tony Blair and Alistair Darling’s memoirs show, the reality is that Labour were worried about overspending, but did not want to cut back. In times of crisis, politicians may want to defer the saving to better times (not a bad economic thing to do).

However, the government has not saved during the good times either. Politicians inflate the good times and then blame this subsequent overspending on a bust. The market, however, can not be fooled by a session of Prime Minister’s Questions or an Andrew Marr interview.

What Shakespeare could tell the G20 summit

All that glisters is not gold – the Gruijters’ find a modern day link between Shakespeare’s The Merchant of Venice and the G20 summit. First published on The Graduate Times.

What Shakespeare could tell the G20 summit

You may not think William Shakespeare could be useful for imparting nuggets of economic wisdom, but the bard’s tragi-comedy ‘The Merchant of Venice’ could certainly teach the aspiring economist something.

In ‘The Merchant of Venice’, a young suitor, Bassanio, asks a rich merchant Antonio for a loan, as he has fallen in love with the rich Portia, but doesn’t dare to woo her empty handed. Although Antonio has his wealth invested at sea, Antonio is willing to extend a loan to Bassanio by signing a bond with Shylock. Instead of  charging interest, Shylock says that he will take a pound of flesh if the loan is not repaid in time. Antonio thinks this is kindness, but Bassanio suspects Shylock of ulterior motives.

Currently, China, like Shylock, has effectively been lending a vast amount of money to the US consumer, not just for mutually beneficial trade, but for more economically sinister purposes as well; to manipulate the terms of trade. Like Antonio, the US has not cared that much when the weather was fair (the ability to buy cheap goods only makes the Americans richer), but as soon as the storms of crisis have appeared on the horizon much rhetoric has been used to force an appreciation of the Yuan (or Renminbi). Like the pound of flesh, the under valuation of the Renminbi is the real purpose of the build up of Chinese foreign reserves, not the return of the bonds.

As in ‘The Merchant of Venice’ it seems that Shylock or China has total control. Yet like in the contract between Antonio and Shylock (the bond only allows Shylock to remove a pound of flesh, not the “blood”, of Antonio; thus, if Shylock were to shed any drop of Antonio’s blood, his “lands and goods” would be forfeited under Venetian laws) this contract too, has a major flaw; the US could simply turn the printing press on and print so much money as to effectively inflate its way out of the current debt by making the Chinese reserves worth less.

Does this mean that the US will inflate its way out of trouble? Probably not, the mere threat of doing this will inevitably lead to the Chinese selling dollars and allowing the dollar to depreciate against the yuan as the supply on the money market increases.

All monetary authorities should see this same nexus between the creditor and debtor and understand that holding reserves to keep one’s currency “undervalued” may seems a sensible tactic, yet is definitely unsustainable. As in ‘The Merchant of Venice’, the debtor is eventually the winner. A future with limited foreign reserves could then be the eventual outcome of the G20 summit without an official result. This is an outcome the Extended Society and the beautiful Portia would prefer as it encourages mutually beneficial trade, and not the hoarding cash in gold and silver caskets.

Why your hairdresser wants a Central Bank with a single mandate

The task of a Central Bank to ensure that money holds its value is frequently misunderstood – this is why.

Why your hairdresser wants a Central Bank with a single mandate

What is money? Money is a medium of exchange that facilitates trade, with the advantage of eliminating inefficiencies of barter. It is a unit of account, which facilitates valuation and calculation, and it is a store of value which allows economic transactions to be conducted over periods of time as well as geographical distances. Money must therefore, be affordable, durable,fungible, portable and store value.

Gold and other precious metals fulfil most of these criteria and were therefore regarded as ideal monetary material. Now, however, we no longer carry gold Aureus or silver Denari (Roman coins, which outlived the Roman Empire), but pieces of paper, copper and a magnetic strip on a plastic card, which by themselves are quite useless. Yet this money does have value, even though it is no longer linked to a precious metal, because society accepts it as a convenient form of payment for trade. To keep the trust in any currency intact, the Central Bank has the responsibility to make sure the currency holds its essential properties. As digital and paper money in this age is generally affordable, fungible, durable and portable the central bank has just one main responsibility – to ensure that money holds its value, through stable prices.

Often in history this task has been misunderstood. 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. What the Spaniards, like many before and after them, failed to understand is that the value of something is not absolute. Money is worth only what someone else is willing to give you for it.  An increase in the supply of money will not make society richer – monetary expansion over time will merely make prices higher.

Economies are subject to trends. After the great depression and the Keynesian revolution, governments felt they could manage the economy, exchanging inflation for unemployment. In practice, however, this experiment also ended with the familiar story of increasing prices.

Now again though, policymakers are making a similar mistake. Theoretically price stability is the prime task of central banks and the single target for the European Central Bank. Yet central banks with both price stability and a growth mandate, like the Federal Reserve and the Bank of England, are using Quantative Easing to push prices up and devalue currencies; a worldwide currency war is what many economists now fear. The rationale for devaluing one’s currency is clear: it makes your country’s products cheaper, because wage costs become relatively lower, and this subsequently can lead to a higher output and employment.

This policy of currency depreciation and inflation is a bad solution to a deeper problem of labour market inflexibility. Inflation and currency devaluation decrease the value of my and everybody else’s money so imports become more expensive, whereas in the best case scenario domestic prices only rise slightly. In effect the policy of subsidizing the export-orientated industries makes everybody else worse off.

A better solution would be to increase productivity and to cut wages in those industries that can not compete at current wages. For export-orientated industries this means that they must compete at a global level, without reliance on the government. As Keynes wisely remarked: “If nations can learn to provide themselves with full employment by their domestic policy…there would no longer be a pressing motive why one country need force its wares on another or repulse the offerings of its neighbour.” It would become, instead, “a willing and unimpeded exchange of goods and services in conditions of mutual advantage”. In other words, today’s turmoil over currencies and trade is a direct result of our failure to solve our employment problem.

And so we come to the hairdresser. A hairdresser does not compete at a global but a local scale, and his/her wage depends on her relative local productivity. Yet with QE she will be subsidizing the export industries, due to a reduction in the value of her real wage, which is subject to prices (if prices are higher she can consume less).

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. There would be a lot more trust if the Bank of England had a single mandate: price stability.

We see unemployment and the related issues in the labour market as a principal problem, which will be touched on in future articles. What is your opinion on monetary policy, the economy or the labour market? We’d love to know!

See Ferguson, Niall. “The Ascent of Money a Financial History of the World” and Skidelsky, Robert. “Wars of Austerity”, Project Syndicate for further reading.

This was first published on The Graduate Times

A case for giving something for nothing

Instead of cutting benefits, should everyone be receiving them? A radical policy originally by Philippe Van Parijs, here championed by Lawrence and Henry Gruijters, suggests we should do exactly that. First published on The Graduate Times.

A case for giving something for nothing

As part of cutting the budget, George Osborne is trying to solve dependency on government, specifically the ‘poverty trap’. People are stuck in the ‘poverty trap’ for two reasons: employers are unwilling to employ them because their productivity does not exceed the minimum wage plus non-wage costs; and the rewards of employment do not significantly exceed the benefits they receive for being unemployed.

Orthodox thinking (which has translated into policy) since Thatcher has been to get people out of benefits and back to work.  The means of doing so has been via disincentives in the benefits system and training to increase the potential productivity.  The initiative of being even tougher on people on benefits will most probably be this government’s proposal. The idea is that everybody should work and contribute to society and nobody should be receiving something for nothing. In actual fact, however, another convincing route out of the poverty trap is doing the opposite, giving all people exactly something for nothing through a Basic Income (BI).

Philippe Van Parijs argued most comprehensively for a BI in Real Freedom for All – What, if anything, can justify capitalism? A BI would be given to everybody, no matter where they are from, where they live, how much income they have, or the type of household. Giving people something for nothing comes at a cost. Instead of government doing (and funding) almost everything people need to do (and fund), people will have to do almost everything through their own income, which is subsidised by government through the BI.

Van Parijs argues that this would pull anybody out of the poverty trap, as no matter how much somebody is paid they will earn enough to take on a job that matches their productivity. He also argues that a BI would have the economic advantage of giving entrepreneurs the opportunity to take risks as they will have a BI to fall back on.

On the liberal front, he argues that everybody is capable of productivity and just because their productivity is under the minimum wage, this should not mean they cannot get a job.  At the same time it gives people the opportunity to do with their lives what they want to do. If I want to follow a particular career, I should not be pressured by lack of resources into following a different career. A BI would give each individual real power in the economic market through having basic demand. It would, through this, give everybody the freedom to live the life they want to live.

As with communism, a BI guarantees everybody an income and a job (if they want one) as they would only need to be paid as much as their productivity. According to Van Parijs this is the only way in which capitalism can be justified. People need an income in capitalism for ‘real’ liberty. Only through BI can this coalition’s aim be realised. As Nick Clegg put it, the coalition’s aim is to give “everybody no matter where they are from or who they want to be the opportunity to live their life the way they want to live it”.

Many objections have been raised to the idea of BI and for most of them Van Parijs has a convincing answer in his 600-page long book. More important, however, is what you think of this idea? What objections would you raise? Could a BI work? How much would a BI need to be? What would you do if you got a BI?

Oil Spills and Social Cost

We have all benefited from advantages of cheap oil, so should BP have been allowed unlimited liability? A look at the social impact of the Deepwater horizon oil disaster. First Published on The Graduate Times.

Image courtesy of Garry Tanner

In an excellent chapter in More Sex is Safer Sex, Steven E. Landsburg tells us how Ronald Coase solved a centuries-old problem in his paper The Problem of Social Cost (1960). In 1597 there was a legal battle between two farmers that became known as Boulston’s case. One farmer grew corn, while his neighbour raised corn-eating rabbits, which more than occasionally ate from the other farmer’s corn. The court ruled that because the rabbit farmer didn’t actually own the rabbits (he merely dug burrows to lure them for trapping) he could not be held accountable for their behaviour. Even though the judge’s logic here seems a little messy to say the least, this ruling was affirmed by subsequent courts well into the 20th century.

An alternative (opposite) view was held by the great economist A.C. Pigou, who looked at the rabbit issue and correctly declared that ownership is not the issue. Subsequently, however, he made a grave mistake by declaring that “fault” is the issue and that the rabbit farmer should be held responsible.

Pigou’s reasoning is wrong too, and it took a lawyer and economist by the name of Ronald Coase to get it right.  His solution follows: first of all we should not lose sight of the problem: 1) rabbits eat corn. Secondly we should remember the cause: 2) The rabbits eats corn because they are near corn. Thirdly we should not lose sight of the symmetry: 3) The corn is close to the rabbits in the same way the rabbits are close to the corn. Therefore we may conclude that both parties are at “fault”. Remove the rabbits and you solve the problem, or remove the corn and you also solve the problem.

This problem can be configured to fit many other cases, even the common and contemporary problem of neighbours making noise. When my neighbour plays loud music, he imposes a cost on me. But when I call the police instead of wearing ear plugs I impose a cost on him.

Often simply removing one of the agents is neither possible nor optimal. A property right solution is proposed following the Coase Theorem. Here one of the Agents (the polluter or sufferer) has the right to silence or the right to play music. If the sufferer has the right to silence, the polluter will be willing to pay a certain amount to play loud music for a certain period. But if the polluter has the property right the sufferer will be willing to pay a certain amount for the polluter to reduce the noise level, or be silent for a period of time. The efficient amount of noise will then be produced as soon as parties are able to bargain and property rights are efficiently enforced so that all (external) costs are internalized.

BP’s case
Now in 2010 more than 400 years after Boulston’s case, we have a case which fits the same three-way logic of Ronald Coase.

1) The problem: Drilling for oil may cause pollution to the Environment.
2) Cause: Oil is found in the environment
3) Symmetry: The oil is close to the environment in the same way as the environment is close to the oil.

BP drilling oil therefore imposes a cost on society as it may damage the environment. Yet stopping or making it prohibitively expensive to drill in the environment also imposes a cost on society: more expensive oil. The solution is to make sure that both parties take these costs into account. BP takes possible environmental costs into account, and society takes the benefits of having cheap oil into account.

In this case the property rights were effectively given to the (sufferer) US government as owner, who auctioned the oil field for a particular price, with a limited liability in the event of an oil spill. If the US government valued the environment more it would have raised the price of drilling and thereby made it less attractive to drill in the Gulf of Mexico; with less drilling there would be less chance of an oil spill. However the apparent preference for oil is reflected in a lower price for the oil fields, more oil drilling, and a higher probability of an oil spill.  Therefore, the right balance between the desire for cheap oil and a clean environment was struck when the fields were auctioned off.

We have all benefited from cheap oil and it would be wrong to not stick to the other side of the deal and submit BP to unlimited liability. It would be like receiving money from your neighbour to be silent, and having received the money, play loud music after all!

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