Stumbling and Mumbling

Hayek on desert

Elizabeth Anderson does a fine job of demolishing, on Hayekian grounds, the idea that people deserve their incomes. And Tyler Cowen gives an excellent reply. The one thing that’s missing are some direct quotes from Hayek himself. Let me fill the gaps.

There’s this from volume II of Law, Legislation and Liberty (p71-72 in my copy):

[The function of the price system] is not so much to reward people for what they have done as to tell them what in their own as well as in general interest they ought to do. …To hold out a sufficient incentive for those movements which are required to maintain a market order, it will often be necessary that the return to people’s efforts do not correspond to recognizable merit…In a spontaneous order the question of whether or not someone has done the ‘right’ thing cannot always be a matter of merit.

And this from page 74:

It is probably a misfortune that, especially in the USA, popular writers like Samuel Smiles and Horatio Alger, and later the sociologist W.G.Sumner, have defended free enterprise on the ground that it regularly rewards the deserving.

And this from page 64:

It has of course to be admitted that the manner in which the benefits and burdens are apportioned by the market mechanism would in many instances have to be regarded as very unjust if it were the result of a deliberate allocation to particular people. But this is not the case. Those shares are the outcome of a process the effect of which on particular people was neither intended not foreseen by anyone when the institutions first appeared – institutions which were then permitted to continue because it was found that they improve for all or most the prospects of having their needs satisfied. To demand justice from such a process is clearly absurd, and to single out some people in such a society as entitled to a particular share evidently unjust.

Nor was Hayek opposed to redistribution as insurance. This from page 87:

There is no reason why in a free society government should not assure to all protection against severe deprivation in the form of an assured minimum income, or a floor below which nobody need to descend. To enter into such an insurance against extreme misfortune may well be in the interest of all.

Nor even was Hayek opposed to proportional – as opposed to progressive - taxation. He wanted a rule that would stop the former shading into the latter. From page 323 of the Constitution of Liberty comes this:

The most reasonable rule of the kind would seem to be one that fixed the maximum admissible (marginal) rate of direct taxation at that percentage of the total national income which the government takes in taxation.

The UK now obeys this rule.

Professor Anderson is therefore spot on – there’s nothing in Hayek to justify the claim that people deserve their incomes. (There’s nothing in Nozick either, but that’s another story.)

My only concern is that Professor Anderson is attacking a straw man. Surely no-one is stupid enough these days to seriously claim this. We must distinguish between serious political debate and emotional spasm.

Buying cows

Coronation Street’s Jack Duckworth had some good advice last night not only to Tyrone about marriage but also for investors in SBC and Procter and Gamble: “If you only want a pint of milk every now and then, there’s no point buying a cow.”

Jack is reminding us of Oliver Hart’s question: why does ownership of an asset matter?

Hart’s answer, in his crucial book, Firms Contracts and Financial Structure, is that “ownership is a source of power when contracts are incomplete.”

This tells us why we don’t usually need to buy a cow; we can contract easily to get milk when we want it.

But there are circumstances in which it would make sense to buy the cow – if you couldn’t contract to get milk of acceptable quality and price at the times you wanted it, buying the cow might be the best way of getting milk.

So, the question SBC investors should ask is: what can SBC get from buying AT&T that they couldn’t get from a contractual arrangement, such as a joint venture or a stake in AT&T? What exactly are the benefits of control? Why buy the cow?

It’s not good enough to speak of the “heritage and strength of the AT&T brand.” You can get these by buying a small part of AT&T.

Nor is it sufficient to speak of SBC and AT&T being complementary; you have to show how that complementarity can actually raise profits. And again, it’s not good enough to talk of the potential for cost-cutting. History shows that potential often goes unrealized.

What’s more, the superiority of control rights over contractual agreements is easily overstated. The theory is that management fiat gets things done quicker and cheaper than haggling over contracts. But this ignores the prevalence of rent-seeking and bounded rationality within a company. In practice, making the right and effective management decisions can be as difficult as writing or enforcing a contract. That’s one reason why so many mergers fail*.

I’ve no view on whether the SBC/AT&T or P&G/Gillette mergers will succeed or fail. All I’m saying is that, if you want a view, you’ve got to answer the Duckworth-Hart question.

* But just how many do fail? The conventional wisdom that most do so might not be as strong as sometimes thought. Much of the evidence is based upon studies showing that the acquirer’s share price falls after the merger. But these studies are open to criticism, for example from these guys.

Economics, Nobels and ideology

Gareth of At Any Street Corner provides an example of anti-economics.

Orthodox economics, he says, uses fancy mathematics as a “smokescreen” for “regressive social and political ideologies.”

For example, Finn Kydland and Ed Prescott’s work, which won the 2004 Nobel memorial prize, shows “that market-driven reforms are the only policy options; and policy guidance is best left to autistic economists rather than to elected and accountable politicians.”

The Nobel memorial prize, he says, legitimizes this “economics as science.” Most recent winners, have been “narrow minded bigot[s]” who have “nothing to do with Alfred Nobel’s goal of improving the human condition and our survival – indeed…the exact opposite.”

Now, sceptical about the mathematization of economics as I am, I think this is all wrong.

Destroying freedom

I don’t normally like “me too” blogging, but proposals to impose control orders on potential terrorists are so contemptible that I should add my puny voice to those of Tim Worstall, Simon Jenkins, Civitas, Samizdata, Blimpish and Laban Tall.

Here’s my observations.

1. Don’t think these proposals will only apply to a handful of people. Laban Tall draws attention to this chilling claim, in the Scotsman:

Speaking after the Home Secretary, Charles Clarke, announced new laws to control the movements of terrorist suspects, Mr Clarke’s adviser, Stephen McCabe, told The Scotsman he saw this extending to other groups suspected of using violence to further their ends. The Labour MP said: "We can envisage this applying to animal rights extremists and the far-Right, for example.”

For example?

2. Charles Clarke says potential terrorists can’t always be prosecuted because “it isn't always possible to bring charges given the need to protect highly sensitive sources and techniques.” But what exactly is the danger here? MI5 agents can give evidence in court in secret. And surely, in gathering evidence in the first place they are putting themselves in danger. Or am I missing something? Could it be that health and safety culture is infecting the security services?

3. Mr Clarke says: There are serious people and serious organizations trying to destroy our soceity. We are in a state of emergency." What? Against the BNP or animal rights activists? And just how great is the threat from Al Qaeda? Is it really greater than that posed during the cold war or by the IRA during the 1970s, neither of which justified suspending habeas corpus? I'll grant that Al Qaeda want to kill thousands of us. But this does not amount to destroying our society. Al Qaeda cannot do that. Only we can.

4. Could it be that what the government is truly scared of here isn’t just the threat of a terrorist outrage, but the chaos that surrounds it? Part of New Labour’s managerialist ideology is a terror of disorder, of not being in control. Could it be this that makes it so more sensitive to the danger of Islamic terrorists than previous governments were to IRA terrorists or the Soviet Union?

5. Even if we accept that there’s a need to intern people, why should it be the Home Secretary that has these powers? Why not judges?

6. Charles Clarke asks us to trust the government to use these powers sensitively and sparingly. But if we could trust each other, we wouldn’t need government in the first place. And surely, there is no proposition for which there is more historical evidence than that we shouldn’t trust governments. And should we really believe that people who think this is intelligent campaigning are to be trusted to make sensitive and delicate decisions about the balance between "national security" and civil liberties?

Yes. There is a small group of vicious men who are trying to destroy our most valued western traditions – it’s called the government.

Voting the right way

We now know the question we’ll be asked about the EU constitution. We also know the question will be answered in a bone-headed way - by a simple majority.

To see the problem with this, consider three people: Alan, Bill and Charlie. Alan and Bill vote yes to the constitution and Charlie votes no. Under simple majority rule, we sign up.

But what if Charlie feels strongly about the issue whilst Alan and Bill aren’t so fussed?

Say Charlie would spend £100 to stay out of the constitution whilst Alan and Bill would spend only £20 each to join. Then, in principle, Charlie could give Alan and Bill £25 each to stop them voting. The upshot would be that we’d stay out of the constitution and everyone would be better off. Alan and Bill have made a net gain of £5 each, whilst Charlie has bought £100 of benefit for just £50.

The lesson here is simple and should be well known: majority rule can conflict with utilitarianism. In this sense, the notion of the “national interest” is incoherent; the “national interest” as decided by majority vote isn’t necessarily the “national interest” in the sense of what makes people happier.

There is, though, a simple solution – to use a demand revealing referendum.

It would work as follows. Instead of asking people to say yes or no, we ask them to vote the sum of money they’d pay to sign up or not. In our example, the votes would be:

Alan - £20 to sign up.

Bill - £20 to sign up.

Charlie - £100 to say no.

Then, rather than count votes, we add up the money, and go with the biggest sum. So in this case we stay out.

The next step is crucial. Each voter pays a tax according to whether his vote made a difference. Alan and Bill pay no tax because their vote has not affected the outcome. But Charlie must pay £40 – because had he not voted, our trio would have signed up to the constitution, giving Alan and Bill £40.

Now, there are plenty of arguments against this process. But a lot of them are either silly or arguments against our existing political processes. Here’s what the benefits would be:

1. It reconciles majority rule and utilitarianism by allowing people to reveal the intensity of their preferences.

2. It encourages people to think clearly about the issue. If they vote too large a sum, they risk having to pay a tax. If they vote too small a sum, they risk not getting their way. As Thomas Sowell said, “making people pay is a way of making them think.” (I’ve used this line before – and I’ll keep using it until the message sinks in.)

3. It recognizes that we have obligations to each other. If your preference imposes a cost onto others, it is just as well as efficient that you pay a price for this.

4. It would improve the quality of debate. Picture the scene. A politician is on Newsnight railing against the EU constitution. “Alright”, says Paxo. “How much would you vote to stay out?”

I think these are compelling arguments.

One other thing. Economists have known about these demand-revealing processes for at least 40 years; William Vickrey is credited with their discovery, but some of you might be able to date the idea back to Knut Wicksell. But politicians seem never to question simple majority rule. And they wonder why we hold them in contempt.

On corporate hierarchies

In an earlier post, I asked: “we all know a centrally planned economy is a stinking idea. So why is a centrally planned company a good one?”

Don Boudreaux at Café Hayek thinks the answer is “obvious.” Competition, he says, corrects the errors of hierarchical management:

Because no one is coerced into participating in a private-firm’s activities, for it to survive, the organization must promote the ends of enough of its participating agents. If the organization fails to promote these ends (as judged by each of these agents), it shrinks, disappears, or otherwise changes...The forces of competition and entrepreneurial discovery – fueled in large part by the profit motive and by consumers’ quotidian efforts to get the most value for their money – put constant pressure on these firms to correct their errors.

Much as I admire Don, I’m not happy with this answer.

Equality and immigration

As usual, Blimpish has made a challenging point. Commenting on my earlier post, he says:

High immigration undermines public support for doing anything about inequality (people are happier to redistribute to people like themselves - hence, no meaningful global redistribution is ever mooted). So maybe those who “favour” wage inequality should support immigration and those who are against it should be opposed.

This reminds me of John Roemer’s paper, “Racism and redistribution: a solution to the problem of American exceptionalism.” Here's a bit of the abstract:

We identify two mechanisms through which racism among American voters decreases the degree of redistribution that would otherwise obtain. Many authors have suggested that voter racism decreases the degree of redistribution due to an anti-solidarity effect: that (some) voters oppose government transfer payments to minorities whom they view as undeserving. We point to a second effect as well: that some voters who desire redistribution nevertheless vote for the anti-redistributive party (the Republicans) because that party’s position on the race issue is more consonant with their own, and this, too, decreases the degree of redistribution…We numerically compute that during [1976-92] voter racism reduced the income tax rate by 11-18 percentage points.

That’s a huge effect.

Does this mean egalitarians (like me) should oppose immigration? I don’t think so.

For one thing, equality is not the only ideal. Limiting immigration entails a loss of individual freedom, not only to the immigrant but also to the native population; we are prevented from employing some people or selling our houses to them. Methodological individualists in particular will be unhappy to do this in order to gain some putative non-individualist benefit such as better community spirit.

Secondly, it’s a pretty puny sort of egalitarianism that is undermined by ethnic differences. If egalitarians cannot successfully combat racism and near-racism, and present a forceful case for redistribution, they don’t deserve to succeed. I don’t want an equality among boneheads.

And another thing. I should have mentioned Bob Rowthorn’s sceptical take on the economic consequences of immigration. David Green at Civitas has a link.

A Larry Summers moment

From division of labour comes news that scientists have discovered why women can’t read maps.

Could this help explain why there are so few women economists? (A survey by the Royal Economic Society found fewer than 19 per cent of academic economists are women.)

The thing is, maps are a lot like economic models – whether they come in graphs, maths or just words. They are highly abstract things that often bear little resemblance to real-world conditions but they can (sometimes) help us find our way around.

Could it be therefore that difficulties in understanding economic models and in reading maps are related?

A simple test would illuminate this. Is it the case that women economists are better at map-reading than women generally?

Gravity speaks

According to this report, Japan now trades more with China and Hong Kong than it does with the US.

No doubt, this will be the cue for lots of pompous prognostications about the decline of American economic influence.

But isn’t there a more mundane explanation? Isn’t this just what the gravity model of international trade predicts – that countries trade most with their neighbours?

After all, UK trade with the Irish Republic is almost twice that with China (£23.1bn versus £12bn in the last 12 months). This isn’t because Ireland is an economic superpower – it’s because it’s nearby.

Give me a simple model* over high-falutin’ geo-political mumbo-jumbo any day.

* No, I don’t mean Caprice, but since you mentioned it …

Yield mysteries

Remember the laws of supply and demand? If you do, tell the bond markets.

The CBO reported today that “the current baseline outlook [for the budget deficit] is less favourable than the one presented in September*.”

Excluding spending on the wars in Iran, Iraq and Afghanistan, it projects a deficit of $368bn this year and $295bn in 2006. That compares to $310bn and $202bn forecast in September on the same basis.

And what has the bond market done about this rising red ink? Largely, it’s ignored it. Treasury prices fell today. But the fact is that 10 year yields, at 4.2 per cent, are close to historic lows whilst borrowing is close to historic highs. So much for the bond market vigilantes.

How can we explain this? Here’s my effort.

First, bond markets are globalized and what matters for yields is investors’ willingness to hold the stock of bonds, not just the flow of extra supply.

In this context, this year’s borrowing is chickenfeed. A $400bn deficit is only 4 per cent of MSCI’s estimate of the market capitalization of sovereign debt.

Granted, the red ink looks like lasting for more than a year. But there are huge margins of error in long-term deficit forecasts. Figure 1-3 of the Budget and Economic Outlook suggests there’s a 40 per cent chance of a surplus by 2010. That gives bond bulls something to get hold of.

But why should anyone be bullish of bonds? It’s because government borrowing is, in a sense, the counterpart of pessimism about economic growth – and this pessimism naturally favours bonds.

To see why, imagine a closed economy – which is what the world is. Basic national accounts arithmetic tells us that its GDP is the sum of expenditure components: private consumption (C), investment (I) and government spending (G).

On the income side, GDP is equal to profits (P), wages (W) and taxes (T). So we have:

C + I + G = P + W + T

Rearranging gives us:

G – T = (W – C) + (P – I)

That is, public dis-saving is the counterpart of private saving.

In this sense, big budget deficits around the world are the counterpart of economic pessimism, because it’s pessimism about the future that causes companies to invest little even when profits are high.

I’ve left out of this any account of causality. Adherents of Ricardian equivalence would say private savings are low because government borrowing is high. Keynesians would reverse this statement.

Whatever, we shouldn’t be too surprised that global bond yields are low when global government borrowing is high.

Equally, if capital spending – that is, economic optimism – rises, bond yields could rise even as government borrowing falls. I wouldn’t be surprised to see both happen.

* "Less favourable" is one of the best euphemisms since Emperor Hirohito said in 1945 that “the war situation has developed not necessarily to Japan's advantage.”