Spring 2014 £3.75

From the Institute of Economic Affairs

DOING BUSINESS Singapore style

RUNNING ON EMPTY Why price RECIPE FOR GROWTH controls Jagdish Bhagwati on don’t work INDIA’S DEVELOPMENT THE BIG CHILL THE PLUS STAGGERING Analysis Reviews SCALE OF THE Comment ...and the best of GOVERNMENT OUR BLOG DEBT ICEBERG

SPRING 2014

Inside On the Cover 3 From the Editor 7 Euro zone 4 Fads & Fallacies Philip Booth How France and other on an European governments Why price controls impressive imposed the wrong kind don’t work – and roster of of austerity how they damage contributors living standards

18 Insight 22 City View 10 Cover Story Why the Tim Congdon on QE How the US, the UK living and the rich and EU countries are wage does sailing towards a nothing for fiscal iceberg the really poor

24 Campus 26 Foundations 14 Interview 30 Perspective Your chance to intern at the Examining the work of Nobel Jagdish Steve IEA – and more Prize winner Ronald Coase Bhagwati Hanke on on India’s Singapore recipe for and the growth World Bank’s Doing Business report

34 Rebuttal 37 Briefing 42 Reviewed 44 Soundbite Kristian Niemietz on Labour’s We highlight essential & Revisited misguided plans to deal reading we’ve seen elsewhere Stealth taxes, Fascinating with ever- city states, works on escalating statins and free-market living more 38 Idealog thinking and costs The best of the IEA blog freedom

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FROM THE EDITOR WELCOME … to the Spring 2014 edition of EA, featuring some of the world’s foremost economists – and that’s not a phrase I use lightly. On page 32, STEVE HANKE – once described as one of the 25 most influential people on the planet – scrutinises the World Bank’s Doing Business report – and shows how market- led strategies have created the Singapore success story. On page 14, the renowned JAGDISH BHAGWATI is the subject of an illuminating interview on growth in India – and how trade can help the world’s poorest people. Nobel Prize winner, the late RONALD COASE – perhaps one of the greatest economists in history – is profiled in Foundations, a new series providing insights for budding economists (page 26). And on page 25 we reveal details of this year’s IEA Hayek Lecture by PROFESSOR JOHN TAYLOR – ranked by Bloomberg in 2012 as one of the world’s 10 most influential economists – and a man whose work plays a major part in A-level economics syllabuses. Be sure to book your seats. All this, plus a fascinating – and terrifying – look at the true extent of government debt in the world’s leading economies in our cover story, THE BIG CHILL. And, of course, much more. I trust you’ll find this latest spring edition of EA informative, insightful and inspirational. Do also check out our newest initiative, ieaTV. Featuring hundreds of films on all aspects of free-market economics, it’s a great way of keeping up with all things IEA and provides a terrific vehicle for discussion in economics classes. We’re adding new films all the time – find it now at www.iea.org.uk/tv●

Professor Philip Booth Editorial and Programme Director IEA [email protected] facebook.com/pages/ @iealondon Institute-of-Economic- Affairs 03 RUNNING on EMPTY

In recent months, there have been calls from many quarters to deal with the problems of stagnant standards of living by imposing price floors on wages and price ceilings on rents and energy. But such policies have a long track record of creating shortages – in housing, power and fuel. CHRISTOPHER J. COYNE and RACHEL L. COYNE say it’s a fallacy to suggest that price controls improve living standards...

00 FADS & FALLACIES

n September 25th, and demand is balanced by the level of productivity. 2013, the Financial free-functioning price mechanism. It is important to note that price Times published an If the government imposes a price controls do not make everyone article entitled, “Labour ceiling below the market price, the worse off. Those who are able to leader Ed Miliband quantity of energy supplied will secure goods at the artificially low Odefends UK energy reform pledge”. fall, while the quantity of energy price – in the case of a price ceiling The article discusses Miliband’s demanded will increase. The result – or those who are lucky enough proposed reforms which include will be a shortage of energy in that to obtain a higher price for their the introduction of energy price consumers who desire energy at the services – in the case of a price floor controls in the form of a 20-month artificially lower price are unable to – are made better off. freeze on gas and electricity prices. find an adequate supply. At the same time, those who are Miliband argues that his policy, if The logic of price floors is the unable to secure the desired good, implemented, will address what opposite. Suppose, for example, due to a shortage, or those who he calls the “cost of living crisis” in that the market for labour is are unable to find a buyer for their the UK. coordinated through genuine goods, in the case of a surplus, are This ongoing debate provides market prices. In this case supply made worse off because of the an excellent opportunity to and demand will tend to be price control. review whether price controls are brought into balance. Now an effective means to achieving suppose the government imposes The indirect effects of price controls the end of improving standards a minimum wage, above the In addition to the direct effects of living. To foreshadow our equilibrium wage, with the goal of of price controls, there are also a conclusion, they are not. improving standards of living. series of indirect negative effects Price controls refer to Under the artificially high price, emerging from government government-imposed restrictions the quantity of labour supplied manipulation of prices. on how much can be charged for will exceed the quantity of labour While price controls do legally a good or service in the market. demanded resulting in a surplus change the price, they cannot There are two types of price of labour. In other words, workers overcome the fundamental controls. A price ceiling restricts who want to work at the artificially economic issue of deciding how to prices from exceeding a maximum high price will be unable to find allocate scarce resources among an price determined by government – employment. There is a genuine array of feasible alternatives. In the for example, Miliband’s proposed welfare loss here. Workers who absence of the ability to use prices ceiling on energy prices. A price could be productive and receiving to ration scarce goods, alternative floor, in contrast, prohibits a wage will not be producing mechanisms emerge. the charging of prices below a anything or receiving any wage if For example, shortages lead to pre-determined minimum – for the minimum wage is above their long queues resulting from excess example, the minimum wage. From an economic standpoint, price controls are problematic because they distort the price mechanism’s ability to allocate resources to their highest valued uses. In unhampered markets, prices work to co-ordinate supply and demand and ration existing resources efficiently. By legally manipulating the market price, price controls distort this process. This distortion has both direct and indirect perverse consequences.

The direct effects of price controls The direct effects refer to shortages created by price ceilings and surpluses created by price floors. Consider an unhampered market in energy where supply

“ECONOMISTS HAVE LONG BEEN SAYING THAT THERE IS NO FREE LUNCH BUT POLITICIANS GET ELECTED BY PROMISING FREE LUNCHES. CONTROLLING PRICES CREATES THE ILLUSION OF FREE LUNCHES” – Thomas Sowell

05 FADS & FALLACIES

demand for the good or service in question. This dynamic was evident in the centrally planned economies of Eastern Europe as well as in the US in the 1970s when the government imposed price controls on petrol. Long queues tend to lead to subsequent government interventions with rationing schemes. For example, the US government reacted to long queues for petrol by limiting consumer purchases of petrol to every second day depending on the last number of their registration plate. The emergence of crime and black markets are other indirect negative effects of price controls. Unable to adjust prices legally, producers and buyers may move into the extra-legal market to engage in exchange. Others, desperate to obtain goods for which there is a shortage, may engage in theft. To provide one illustration of black market activities, consider the case of farmers in the UK during World War II. Facing wartime meat price of energy in the future, the problems inherent with price rationing, many farmers would very end that proponents of price controls, why do they continue to under-report animal births to the controls are seeking. remain popular among politicians Ministry of Food and then sell Controls of energy prices have and much of the public? the additional meat in the black been tried before – and failed. The answer to this question lies in market. Returning to the present the important difference between Yet another indirect effect of situation in the UK, what can we the seen and unseen. Price controls price controls is avoidance which say about Ed Miliband’s claim that are readily observable – i.e., seen – in can take on a variety of forms. price controls on energy would that the public can readily observe For example, facing a price lower costs and improve standards the lower price set by government. ceiling, sellers may charge of living? Given the difficulty of understanding additional fees or tie-ins to It is true that the price of energy and tracing the unseen - both the compensate for the fact that prices itself would be lower due to the direct and indirect effects of price are required to be artificially low. legal mandate. But we would controls – it appears to many that Yet another manifestation of price expect this to be offset with energy these controls are pure benefit with control evasion is deterioration in producers compensating on other little to no cost. the quality of the product itself. margins either through additional But the economic way of thinking This may include the substitution fees or deterioration in service. indicates this is wrong-headed. If of low-quality for high-quality In this regard it would be wise the goal is to improve standards ingredients in the production of the to look at California’s experience of living, policy must focus on good itself, poor customer service, with price controls on retail energy incentivising improved quality and or lower investment in maintaining which led to shortages, manifested availability. Price controls do exactly or improving the provision of in rolling power cuts throughout the opposite and, therefore, must services: supply can be made equal the state. be dismissed as a fallacy. to demand by changing either the Most importantly, price controls In reality, price controls lower the price or the quantity and, if the first would discourage energy companies standards of living of many while is illegal, the second will be used from making new, long-term providing political gains to few• more often. investments, which is precisely what In addition to affecting is needed to increase the supply Christopher J. Coyne customers in the short term, quality of energy and improve standards F.A. Harper Professor deterioration will also affect of living. of Economics consumers in the long run. In the What this means is that, at best, George Mason University face of price controls, suppliers Miliband’s strategy can provide [email protected] will have a disincentive to invest benefits in the form of lower in expanding production of the energy bills in the short term, but Rachel L. Coyne controlled good in future periods. with the associated cost of some Senior Research Fellow For example, price controls on form of quality deterioration both F.A. Hayek Program for energy will discourage investments in the immediate term and long Advanced Study in increased energy production term. This is precisely the opposite in Philosophy, Politics in the future. This is problematic of what citizens of the UK need to and Economics precisely because this increased improve their well being. George Mason University supply of energy would lower the One issue remains. Given the [email protected] 06 EURO ZONE

The FRENCH CORRECTION

Showing why EUROPEAN GOVERNMENTS need a NEW APPROACH to AUSTERITY

For several years now, European governments have tried versions of austerity in an attempt to reduce the ratio of government debt to national income and in the hope of reviving the continent’s failing economies. But most of them, says VERONIQUE de RUGY, have failed. Indeed many believe these policies have actually made things far worse. Take France, for example…

07 or months, the French Figure 1: Total government spending in selected euro zone countries economy has been stalled 1,200 or shrinking. 1,119 1,151 FRANCE Its debt to GDP ratio 1,030 is growing and has now 1,000 Freached 90 per cent. The country’s 816 unemployment rate is well above 10 766 787 793 800 ITALY per cent, and a large number of rich and younger 613 French people are leaving, 600 480 494 seeking jobs or a more hospitable 451 SPAIN environment abroad. 400 More ominously, Reuters cited a 284

recent OECD report which warned Billions of nominal euros 200 that France is “falling behind 118 108 106 70 GREECE southern European countries that 44 77 77 69 IRELAND have cut labor costs and become 0 leaner and meaner”. 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 In fact, the whole mess led to Standard & Poor’s decision to Source: Eurostat via European Commission. Accessed on May 1, 2013. downgrade France to an AA+ Note: Expenditure data accounts for all levels of government. bond rating, a move that outraged New York Times columnist Paul been spending cuts and large tax Krugman who seems to think that THE “BEST increases, there was little chance the downgrade has nothing to do that austerity, no matter what form with the country’s economic health BUY” WHEN IT it took, would work given that the and is a plot against France for country should have (or would have) President Francois Hollande’s refusal COMES TO DEBT defaulted if it were not for the to pursue austerity measures and cut numerous bailouts it has received spending (a promise he made during REDUCTION IS over the last few years. his presidential campaign). Among STRUCTURAL other things, Krugman is well- What does the research say? known as an anti-austerity crusader REFORM This distinction between spending- who predicted a few years back cut austerity and tax-based austerity that “Austrians” pushing for fiscal COMBINED matters tremendously for the quality retrenchment would destroy Europe. of this debate. That is because, WITH SPENDING as the large volume of work on What type of austerity? fiscal adjustments by Harvard Unfortunately, the debate over CUTS…INSTEAD University economist Alberto Alesina the merits of austerity (the suggests, when pursuing austerity, implementation of debt-reduction IN EUROPE the important question has less to packages) has been a very frustrating do with the size of the austerity one for two main reasons. Firstly, the WE HAVE package than the type of austerity word itself is confusing because it measures implemented. means different things to different POLICIES THAT In fact, this is one of the rare people. That is because, in theory, areas of consensus in the academic a country can reduce its debt by NEITHER SUPPLY literature: historically fiscal increasing taxes, by cutting spending SIDERS NOR adjustments based more heavily on or by doing a mixture of both. What spending cuts are much more likely makes this more confusing is that KEYNESIANS to achieve successful and lasting not all policies meant to reduce the reductions in the debt-to-GDP ratio deficit and debt qualify as austerity WOULD than tax rises. In their influential 2009 measures. For example, policies that paper, Alesina and Silvia Ardagna cut taxes can be growth inducing and RECOMMEND looked at 107 examples in developed lead to lower deficits because of their countries over 30 years and found supply-side effects and therefore that successful austerity packages might have support from some – defined by a reduction in debt to supply-siders, as well as Keynesians. In a sense, both sides are right, GDP greater than 4.5 per cent after The word austerity therefore but are looking at the problem three years – resulted from making causes a lot of misunderstanding on differently. Supply-siders want spending cuts without tax increases. both sides of the political aisle. On austerity in terms of government This research is consistent with the the free-market side, people will say: spending cuts and not tax increases work of economists at the IMF. “Where is the austerity in Europe?” (public-sector austerity rather In 2010, Andrew Biggs, Kevin when what they mean is “Spending than private-sector austerity) and Hassett and Matthew Jensen of the wasn’t cut very much in Europe, Keynesians want neither. American Enterprise Institute looked and often it wasn’t cut at all”. Their Though austerity has taken place at how successful different kinds of opponents will respond: “It is not in Europe, with some rare exceptions spending cuts are at reducing the true, austerity was implemented in the form of austerity has been to debt ratio. Consistent with other Europe” while pointing to data about increase taxes and has not involved studies, they find that successful the size of fiscal-adjustment packages large spending cuts (see figure1). fiscal consolidations focus spending in Europe as a share of GDP. In Greece, where there have cuts in two areas: social transfers 08 EURO ZONE

(which largely means entitlements austerity debate usually cited to the economy will grow by $1.30. in the American context), and the show that spending cuts do not Unfortunately, austerity critics government wage bill (which means lead to economic growth is by IMF refuse to acknowledge this point or the size and pay of the public-sector economists Jaime Guajardo, Daniel even discuss it. workforce). Leigh and Andrea Pescatori. But even This should make intuitive sense this paper also shows that, whilst Worst buy debt reduction policies to policy makers since austerity spending cuts can hurt the economy In light of these findings we should based on spending cuts signals that in the short run, they do not hurt the not be surprised about the sad state a country is serious about getting its economy as much as tax increases. of the French economy. fiscal house in order in a way that These findings are consistent with In a recent paper for the Heritage increasing taxes and continuing the work that looks at the most Foundation, I looked at the policies spending does not. Sadly, in a time recent attempts at austerity. The implemented by the French of crisis (indeed especially in a time new work of Heritage Foundation government since the crisis started of crisis), lawmakers tend to adopt economist Salim Furth looks at the in 2007. The data show that under policies for the sake of politics rather data from the most recent episodes both Presidents Nicolas Sarkozy and than good policy. Countries in fiscal of fiscal adjustment, mostly in the Francois Hollande “austerity” mostly trouble generally got there through USA and in Europe. He too finds very took the form of spending increases years of catering to interest groups compelling evidence that raising and severe tax hikes. and pro-spending constituencies (on taxes is not the way to go. Specifically the tax increases both sides of the political divide) detailed in the case study (below and their fiscal adjustments tend Supply-side only? left) are notable, taking account also to make too many of these same So, if the strongest research for the of plans up to the end of 2014. mistakes. As a result, failed fiscal Keynesian case were accepted, it The bottom line is that French consolidations are more the rule might lead to short-term concerns austerity is a case study of how than the exception. about growth if austerity were to increase a country’s debt and The second source of frustration pursued through spending cuts. Does trigger a recession. ising taxes, in this debate is that we tend to this mean a country should not try raising spending and not reducing lump together the impact of fiscal to reduce its debt by spending cuts regulation is the “worst buy” policy adjustments on a country’s debt and and shouldn’t engage in structural when it comes to dealing with high its impact on short-term growth. Yet reforms designed to rein in its future levels of government debt. these effects are very different and debt by raising national income? should be looked at separately. I don’t think so. Best-buy debt reduction policies Research shows that, while In fact, there is a strong case to Knowing what to do to get spending cuts will effectively reduce be made that cutting spending and governments out of debt and a country’s debt, they can also lead to reforming a country’s fundamental economies towards higher growth greater economic growth in the short structural problems should be done does not mean that it will be easy. term – though they do not necessarily independently of the impact on European countries have the added do so. Alesina’s work has shown short-term growth, mostly because problem that they cannot set their that, in the past, austerity pursued the alternative of doing nothing and own monetary policy to ease some through spending cuts accompanied letting long-term problems continue of the pain of cutting spending (for by measures such as an appropriate is not acceptable and will bring better or worse). France and many monetary policy, liberalisation of much more harm. other euro zone countries also have goods and labour markets and other Indeed, if we look beyond the a serious banking system problem, structural reforms is more likely short term, spending cuts will tend which is made worse by the fear of to be associated with economic to lead to more growth. In a recent contagion from country to country expansions rather than with paper co-authored with Harvard and this is quite paralysing. recessions. Even Keynesian academics University’s economist Robert Barro Yet, doing nothing is not an such as economist David Romer have we look at the five-year impact option. As such, I would like to see a admitted that possibility. of cuts to defence spending and debate over austerity that unbundles One leading paper in the we find that for each dollar cut the type of austerity that has taken place and that separates the impact of austerity on debt levels and its impact on growth. Hopefully that will encourage countries to FRENCH AUSTERITY: A case study implement austerity packages that actually help their economies rather • Between 2007 and the end of 2012, taxpayers were than hurt them. subjected to 205 separate increases in their tax burden. The “best buy” when it comes to debt reduction is structural reform • The marginal income tax rate rose from 40 to 41 combined with spending cuts and, if at all possible, tax cuts. Instead per cent in 2010 and again to 45 per cent in 2012. in Europe we have policies of tax increases and, often, government • Though Hollande’s proposed 75 per cent tax rate on spending increases that neither personal income above €1 million was struck down by the supply siders nor Keynesians would Constitutional Council, this will be revived in 2014. recommend• Veronique de Rugy • Value Added Tax (VAT), which has been stable at Senior Research Fellow 19.6 per cent since 2007, is scheduled to increase in 2014. Mercatus Centre George Mason University [email protected] 09 THE BIG CHILL The STAGGERING SCALE of the GOVERNMENT DEBT ICEBERG A new IEA study warns that many major governments are on course for fiscal calamity. JAGADEESH GOKHALE and PHILIP BOOTH PRÉCIS

e are all aware of the Figure 1: Indebtedness icebergs in the European Union and the United States. level of government Explicit and implicit debt as a percentage of the present value of GDP* debt. 16.0 However, W governments do 14.0 not produce sufficiently forward- Implicit debt 2010 Explicit debt 2010 looking accounting measures – ones 12.0 that transparently reveal the extent to which a government’s future 10.0 financial commitments cannot be met by future receipts. 8.0 We are therefore generally in the dark about the true extent of 6.0 government indebtedness under current fiscal policies. 4.0 As populations age, the tax base is likely to grow more slowly. At 2.0 the same time, in all developed

countries, government social of GDP Percentage of the Present Value 0.0 security and healthcare spending EU-25 United States will rise more rapidly because of promises that have been made * Fiscal imbalance is represented by the peaks and not the areas of the icebergs to today’s older and middle-aged generations. national debt measures. at low interest rates – which less No funds have been set aside to The partial US government competitive nations did in excess. meet these future commitments and, shut-down and the delay in In some euro zone countries, such in any meaningful economic sense, congressional approval of a debt- as Spain and Ireland, governments they represent government liabilities limit increase until the very last bailed out banks, as happened also and a form of indebtedness. minute has cast a bright spotlight in the UK. This article presents the main The recession that followed the findings of the recent IEA Research financial crisis then led to revenue Monograph – The Government Debt TOTAL US implosions and explicit debt levels Iceberg by Dr. Jagadeesh Gokhale, increased rapidly. EU nations have senior fellow at the Cato Institute in GOVERNMENT witnessed sovereign debt levels Washington D.C. surge from 60 per cent of national Like an iceberg, that part of the DEBT IS income during the mid-2000s to government’s indebtedness that is AROUND 100 85 per cent today. visible, the explicit debt, is only a small proportion of the total. PER CENT OF The iceberg beneath the surface To extend the metaphor further, Traditional national debt measures by failing to consider timely NATIONAL are backward looking. They show revisions to current fiscal policies, the extent to which governments many governments are heading for INCOME have not been able to meet the iceberg, seemingly unaware of spending commitments from the calamity they are facing. taxation historically. Additionally, on the processes and constraints traditional debt measures constitute Short-term debt crises in lawmakers must navigate to achieve only the tip of the debt iceberg. the US and EU even temporarily acceptable Any proper approach to The nominal value of outstanding outcomes in an era of rising debt. accounting also measures future explicit government debt is easily The temporary resumption of commitments that would not be measured and reported. It is this US federal operations and small covered by future receipts: that debt that, for example, amounts increase in the US federal debt is how insurance companies, for to around 80 per cent of national limit provides a limited window for example, account. income in the UK. budget policy negotiations between A proper economic measure of However, other government lawmakers with starkly different government indebtedness measures commitments – such as those to policy preferences. the extent to which all future pay future pensions and provide However, the focus has been spending plans cannot be financed healthcare – may be even more very much on short-term crisis by current taxation plans – the sum certain and predictable than the management and the level of of explicit debt (inherited from the government’s explicit debt. debt that has accumulated as a past) and future excess spending Different forms of future result of past policy decisions. That commitments is known as the fiscal spending commitments have debt is, itself, enormous: total US imbalance. It shows the effect of different levels of certainty government debt is around 100 per today’s spending and tax policies attached to them, but government cent of national income. that, if continued, will determine promises to pay future pensions to The short-term situation in the evolution of explicit debt in public sector workers, for example, Europe is not too different the future. are probably even more difficult from that in the US, though the The upward march of explicit to renege on than commitments longer-term outlook is even more debt will continue under today’s to repay explicit government debt. problematic, as we shall see. policies as ageing baby-boomers in The unfunded portions of these In the euro zone, monetary union both the US and the EU are due to commitments are not included in enabled governments to borrow be paid retirement and health care 11 benefits at a time when the growth Included in Included of government receipts is likely to Item explicit debt in implicit remain slow or plateau. figures government debt Policies may be changed in the future. However, policy changes should be judged according to their Accumulated government debt Yes Yes impact on the size of the fiscal imbalance and not simply according Future pensions promised to No Yes to their impact on the current public sector workers government debt. For example, in some EU Future state pensions in social No Yes countries, private pension funds security schemes have been nationalised to reduce the national debt, but the citizens Future healthcare costs for an No Yes who owned those funds have ageing population been given promises of future government pensions instead. Future spending on defence, The current national debt is education etc. that cannot be No Yes reduced but the long-term future financed at current tax rates sustainability of government finances is not improved. The fiscal imbalance shows by The complete indebtedness the explicit debt). just how much policy has to change measure The United States’ federal fiscal in order for the government to The extent of public indebtedness imbalance is 9.0 per cent, of which balance the books in the long and policy choices available to 2.2 per cent of the present value of term. Any policy changes to bring resolve it will largely determine the GDP represents the explicit debt. government finances back to a future economic environments in It is immediately noticeable that, sustainable position are likely the EU and the United States. although the EU and the US have to affect younger and future Key questions concern whether similar ratios of explicit debt, the generations negatively, because those policies and resulting EU has a much larger ratio of they will, in all likelihood, have economic conditions will remain implicit debt. to either pay more taxes or have conducive to advancing living The higher EU implicit debt their benefits curtailed below standards through sustained output arises partly as a result of their expectations. growth, or whether the long- demography and partly as a Changing policy course, dealing term austerity required to resolve result of policy decisions. EU expenditures on social protection programmes are around THE US IS SAILING TOWARDS 30 per cent of GDP compared with 15 per cent in the US. It is THE FISCAL ICEBERG WITHOUT social protection spending which is especially prone to increasing as CHANGING COURSE, ALONG WITH populations age. This problem is then compounded THE UK AND OTHER EU COUNTRIES by more rapid population ageing in the EU. EU countries will with long-term indebtedness and fiscal imbalances will perpetuate have smaller worker-to-retiree getting government finances on a economic stagnation. population ratios in the future. sustainable long-term footing will Moreover, decomposing such That ratio is currently just above not be easy. forward-looking fiscal imbalance 5.0 in the US and about 3.5 in the Sustained and large prospective metrics can help in assessing how EU. By 2040 the ratio is projected fiscal imbalances usually arise from future policy changes would affect to be about 3.1 in the US and 1.8 in rapid projected growth in social different generations – young and the EU. protection expenditures because of middle-aged workers versus retired A relatively lower and declining ongoing demographic shifts. generations. worker-to-population ratio also The beneficiaries of such How large are the indebtedness contributes towards higher implicit programmes usually enjoy icebergs for the EU and the United debt in the EU compared with the considerable security in their States? Figure 1 shows the results United States. benefits. The benefits are usually for EU-25 nations (as a whole) and strongly entrenched – either the United States. Policy options in the short supported by difficult-to-reverse For the EU as a whole, the total and long terms court judgments, constitutional fiscal imbalance equals 13.5 per Recently, weaker EU nations have guarantees or protected by large cent of the present value of future responded to rising explicit debt and influential political interest projected GDP. The explicit debt levels by imposing unpopular but groups. Such benefit obligations is 2.1 percentage points of future unavoidable austerity policies are also frequently protected GDP (this is roughly 85 per cent of while continuing to spend money against erosion through inflation. the current year’s GDP mentioned on crucial government functions That may make prospective above). The implicit debt relating to through bailouts from international obligations on account of such future spending commitments agencies and stronger EU countries. programmes just as inviolable not financed by current tax plans But the long-term fiscal picture as payment obligations on is 11.4 per cent of the present examined in this monograph shows government bonds. value of GDP (over five times that even the economically stronger 12 PRÉCIS

EU nations such as Germany, protection expenditure by around economic constraints they face in Finland and the Netherlands, must one half compared with the level achieving fiscal policies that are deal with the long-term fiscal implied by current policy, to avoid acceptable to a bipartisan majority imbalance problems arising from tax increases if all spending is to of lawmakers – even during the pensions, healthcare and other be met from tax revenue in the short-term – it remains quite social protection commitments. long run. unlikely that US national fiscal The US fiscal imbalance mainly Interestingly, the United States’ policies will soon be placed on a arises from its social security and spending sequestration adopted long-term sustainable course. Medicare programmes which during early 2013 left major social The US is sailing towards the support retiree consumption and safety net expenditures untouched. fiscal iceberg without changing health care expenditures. This is despite the fact that these course, along with the UK and Much of US policy reform will areas have grown hugely in the last other EU countries. have to focus on bringing the few years. It is fair to say that, in some finances of these programmes back Similarly, the fiscal consolidation countries, measures have been into balance – something which package in the UK has tended to planned which will ease the will be a huge challenge given spare pensions, health and other situation. The UK is raising the state that most Americans have not saved to fund their own old age consumption and healthcare but, EU NATIONS HAVE WITNESSED rather, rely on the taxes to be paid by future generations. SOVEREIGN DEBT LEVELS SURGE Closing the fiscal imbalance from the tax side would involve doubling FROM 60 PER CENT OF NATIONAL federal taxes, from today into the indefinite future, or cutting all INCOME DURING THE MID-2000S federal spending by over one third. Resolving the fiscal imbalance TO 85 PER CENT TODAY in EU nations so that all spending could be financed by taxation social protection programmes whilst pension age for example. However, would require, on average, an cutting judicial, community and it is being raised so slowly that life increase of 23.2 percentage points local government expenditures. expectation at retirement will be in the consumption tax rate – This policy is expected to improve longer at the end of that process assuming that such a rise is feasible. private investment and economic than at the beginning. Alternatively, the fiscal imbalance growth prospects as market These measures are inadequate, could be closed by reducing health confidence in national budget and little is being done to ensure and social protection expenditure sustainability improves. However, that individuals save for and fund by about one half. as far as the long-term budget future pension and healthcare costs In the UK, total spending would position is concerned, both the so that these growing costs are not have to be cut by more than US and UK are focusing on the borne by a shrinking tax base. one quarter or health and social wrong areas. For current students, the long- Unfortunately, we are unlikely term fiscal position of governments to grow our way out of these is one of the crucial issues for their problems. Many of the projected generation. If today’s fiscal course expenditures could increase if is continued for much longer, there is economic growth because their expectations are likely to be the commitments are linked disappointed – either in terms of to wage growth, and most are higher future tax rates or in terms protected against inflation of reduced future benefits that will during retirement. be provided by government. Indeed, if countries do not Those larger fiscal burdens will address their fiscal imbalances be likely to increase tax-avoidance now, the size of the necessary efforts on the part of mobile adjustment will increase over time, productive factors – capital and undermining investor confidence skilled workers. As the IEA Research and reducing growth potential. Monograph by Dr. Gokhale clarifies, Instead, appropriate and timely the quicker governments change structural changes to bring public policy, the more painlessly the finances into balance would be situation will be resolved• likely to spur economic growth. Jagadeesh Gokhale Conclusion Senior Fellow The long-term fiscal problems at the Cato Institute faced by most developed countries [email protected] are much greater than is implied by government debt figures. It is Philip Booth possible that, in some countries, IEA Editorial and Download necessary reforms will be Programme Director The Government Debt Iceberg undertaken. However, things look Professor of Insurance and for free at: www.iea.org.uk grim in the US and most of the EU. Risk Management Given the differences in their Cass Business School preferences and the political and [email protected] 13 INDIA: a recipe for GROWTH

JAGDISH BHAGWATI is one of the world’s leading economists and an expert on trade, globalisation and the Indian economy. He recently published Why Growth Matters: How Economic Growth in India Reduced Poverty and the Lessons for Other Developing Countries, co-authored with Arvind Panagariya, which was picked as a ‘best book’ of 2013 by the Financial Times. Bhagwati was also the fictional winner of the Nobel Prize in an episode of the Simpsons! In this interview with IEA Editorial Director PHILIP BOOTH, Professor Bhagwati discusses the relationship between trade, economic reform, growth and poverty in India, while also clarifying, at the editor’s request, Amartya Sen’s critiques and arguing why they are misplaced…

14 INTERVIEW

What does the empirical evidence poverty favourably, there is much suggest about the benefits of empirical evidence to support that opening up trade for the world’s element of the argument as well. poorest people? As Panagariya and I explain in The argument about trade helping Why Growth Matters, detailed alleviate poverty is analytically country studies, such as for based on two propositions: firstly, India, show that poverty was trade leads to growth; and, hardly dented during periods of secondly, growth reduces poverty. In little growth resulting from bad turn, the latter proposition can be economic policies and then was broken down into two component reduced dramatically once growth causations which I developed over took off after the 1991 reforms. a quarter century ago in a lecture on poverty and public policy: (1) What were the main reasons for that growth pulls up the poor India’s poor growth performance above the poverty line (making it and high levels of absolute an activist “pull up” rather than a poverty in the 45 years following passive “trickle down” process); and independence? (2) it generates revenue that will The low growth rates – total enable governments to spend on national income grew at roughly areas such as health and education 3.5 per cent a year but population for the poor. Every one of these was growing at 2 per cent - came propositions is empirically testable, after India adopted a series of bad of course. economic policies that crippled DOES TRADE LEAD TO GROWTH? THAT IS CLEARLY OBSERVABLE

So, does trade lead to growth? the economy’s efficiency. These That is clearly observable. But there bad policies were embraced with are two obvious caveats. The trade added vigour when Prime Minister opportunity has to be exploited or it Indira Gandhi came into power does not lead to results. If you open with the support of the left-wing the door but you have no traction in Congressmen: a marriage of your legs, you will not go through convenience turning into a bonding the door. Also, we must ask whether which turned into a kiss of death for such growth is sustainable. I once the country. asked the trade-sceptic Dani Rodrik, who says that there are instances How did the 1991 reforms where autarky has also been contribute to increasing economic associated with growth, whether growth in India? growth associated with autarky The pre-reforms policy framework was sustainable. My answer to this consisted of the following key question is illustrated by the story elements: of how Joan Robinson, my radical Cambridge tutor, and Gus Ranis of 1. A senseless maze of controls: Yale University were once observed one thinks of course of Kafka but I agreeing that Korean growth was once remarked more appropriately a miracle, causing astonishment, that India’s problem was that Adam until the audience realised that she Smith’s invisible hand was nowhere was talking about North Korea and to be seen! he was talking about South Korea! Now, of course, we know which 2. Massive proliferation of public Korean miracle was sustainable. enterprises which were grossly Equally, in The World Economy inefficient and loss-making. Once Arvind Panagariya has analysed a Amartya Sen defended them by lot of cross-country data and found arguing from familiar economic strong correlations between high theory that the losses were (low) economic growth and high compatible with social good, (low) growth rates of exports. revealing that good policy sense Of course, the causation can go means choosing an appropriate from growth to exports; but is model to examine a problem. By this really plausible except in contrast, John Kenneth Galbraith, special cases? who was US Ambassador in Next, as for growth affecting India at the time, showed acute 15 commonsense and policy grasp by describing the approach as “Post “ANTI-GROWTH” POLICIES Office Socialism”. BEGAN TO BE SWEPT 3. Autarky in trade: the Indian share of trade in GNP, and share in AWAY IN 1991. IT WAS, world trade, had both fallen thanks to tariffs, quotas, import licensing HOWEVER, LIKE CLEANING etc. Again, the left-wing economists were supportive of such autarky UP AFTER A TSUNAMI and there is no evidence otherwise apart from unprovable assertions. as women, scheduled tribes frank about their assertions in our For example, Amartya Sen says (ST), scheduled classes (SC) and book. As I sometimes say, their he “told Manmohan”, the prime Untouchables (Dalits). The studies conclusions are more obvious than minister now, that he supported by the noted political scientist Al their arguments. It is noteworthy liberalisation. But, why did he not Stepan also show that these groups that Amartya Sen, who is certainly write publicly and forcefully about are aware of their gains and also a fine economist when he sticks to it? After all, he is not shy otherwise. believe by a majority that their theory, has appropriated the phrase economic situation will continue that Indians are “argumentative” 4. A jaundiced view, and virtual to improve. (which I used in a very different rejection, of inward foreign direct context some time ago to suggest investment (FDI); again there are What more needs to be done to that Indo-US relations were strained quotable assertions by Amartya Sen reduce poverty in India still further? because Indians argued back with and his colleague, the activist Jean We have shown that growth in aid-dispensing Americans who Dreze, that Indians spend too much India has been “inclusive”. But we were then offended) to suggest, time considering whether Coca Cola also argue that we have had less astonishingly, that today’s India is should be allowed to invest and too impact on poverty with our growth a Habermasian democracy. At the little on discussing poverty, blissfully than the Far Eastern economies same time, he has refused to debate ignorant that FDI has often been a have. Among the central differences me on the economic arguments in source of growth that led to has been that India has not used the recent Bhagwati-Panagariya poverty reduction. When the labour-intensive industrialisation book: some argumentative Indian! 1991 reforms started, the equity (which increases demand for investment in India was as little as labour) and has relied more on How would you characterise the US$100 million! skill-intensive and capital-intensive differences between your own industrialisation (which tends to position and that of Amartya These “anti-growth” policies reduce the gains in wages). India Sen, who has also participated in began to be swept away in 1991. needs land and labour-market debates about economic reform It was, however, like cleaning up reform and product-market in India? after a tsunami. And the task is not deregulation in order that markets Sen has made ex cathedra criticisms, yet complete, as Panagariya and I can develop that serve and enrich but, as I stated above, he avoids explain in depth in our book. the poor. This might include, for a debate, telling journalists that “Jagdish wants to debate me but I do not want to debate him”! I have written an article that I have INDIA NEEDS LAND AND titled an epitaph for a debate that LABOUR-MARKET REFORM was not! I have already indicated above AND PRODUCT-MARKET that Sen was opposed, or failed to endorse wholeheartedly, DEREGULATION IN ORDER nearly all the reforms that started dramatically in 1991 and which THAT MARKETS CAN DEVELOP increased the growth rate and reduced poverty. Despite belated THAT SERVE AND ENRICH THE POOR assertions to the contrary, he has produced no evidence whatsoever that he was in favour of the 1991 Is it the case, as some people example, allowing the entry of reforms. So I have argued bluntly suggest, that increased growth Wal-Mart and other big retailers that in this instance his sin with has not translated into improved which would enable small farmers regard to reducing poverty was one living standards for the majority to access foreign markets more of omission. of India’s poor? effectively and bring wider benefits. Now, he wants to make up for this This is one of the many myths by asking for more money to be we destroy in Part I of our book. What are the obstacles to good spent on health and education and We cite empirical studies, some policy in India and other poor and employment guarantee schemes. commissioned by us as part of a middle-income countries? But where is the money to come massive research project on such The obstacle to good policy in India from, if not from growth? As issues, that show that poverty is that any time the government the present government plans to has diminished since the reforms tries to add to the reforms, the same increase such spending while the accelerated growth, and that the set of left-leaning critics go into revenue intake is slowing down improvement in income extends battle against them, all over again. with sluggish growth, Sen is in the to all marginalised groups such This is why we have been brutally position of supporting, wittingly 16 INTERVIEW or unwittingly, excess spending more from the advanced machines. which will lead to more inflation, Without the growth strategy, which will certainly harm, not help, based on outward orientation of the poor and the lower middle the economy to the world, the class. So, Sen is now guilty of a sin high levels of literacy would have of commission as far as poverty amounted to a hill of beans. In reduction is concerned. arguing otherwise, I am afraid that I might also add that one Sen reminds me of Kevin Costner in important difference between us the film, A Field of Dreams. is that I argue that, in countries I might also cite my co-author such as India, Indonesia, Brazil Panagariya, who has written about THE CEASELESS DECLAMATIONS BY PRESIDENT OBAMA AGAINST OUTSOURCING AND AGAINST IMPORTS ARE DEPLORABLE and China, where there are many South Korea. He notes that there poor and few rich, social spending was a massive increase in literacy (“redistribution”) is not a sensible from very low rates to 84.5 per cent programme for aiding the poor. for males and more than 85 per Why? Because, as the famous cent for females by 1966. Yet during Polish economist Kaleci told me in this expansion of literacy, growth 1961/62 when I was working on was modest. For example, from poverty reduction in the Indian 1954-62 it was just 4.2 per cent. Planning Commission, “Bhagwati: Growth accelerated only from 1963 India has too many exploited and and this was due to other changes too few exploiters”. Even if you in policy, including those that led expropriated or taxed away the to a massive increase in labour- incomes at the top, and used the intensive exports. money to help the poor, you could Again, it is absurd to claim that give them maybe one more chapatti India could have supported, despite a day; and that too would not be the huge numbers of our poor, the sustainable if the population grew. level of expenditure on education in So, my solution was that we should the early years that we could afford grow and that growth would much later only after growth had generate the revenues which then occurred and revenues had been could be spent on health, education increased. Panagariya has produced etc. for the poor. the telling calculation that it would Sen has occasionally argued have taken a whopping 22 per cent as if the added chapatti a day of GDP in 1950-51 to reach the would produce growth and hence current, post-reforms, per capita the revenues for further social expenditure on education! spending. Yes, sometimes you can have your cake and eat it. When it comes to trade, how can But Sen has never produced any the West reform policy in a way empirical argument to support this that would benefit both Western euphoric claim! consumers and the world’s Instead he has also claimed that poorest people? education would have a great Developed countries should keep payoff in terms of growth (for their markets open. This is where the example, in his letter to The ceaseless declamations by President Economist where he attacks me Obama against outsourcing and angrily for misrepresenting him). against imports are deplorable: that He invokes Singapore. But the is not leadership. In fact, he sounds high level of literacy inherited exactly like Lou Dobbs, now not in from the Japanese would in itself his CNN job, who used to talk in have led to little in that country. much the same way: but what Lou It was the export-oriented growth Dobbs said mattered less because that led to embodied technology he was not the US President and he being imported and the high did not have the mellifluous voice of literacy made it possible to gain President Obama!• 17 …is a concept that’s gaining traction and support in both the UK and US – and it seems here to stay. But PROFESSOR STAN SIEBERT argues that it doesn’t help the really poor. Instead, it only succeeds in…

18 INSIGHT

he living wage paper is well written, and has strengthened thereby). campaign is designed good ideas on how to advance The living wage campaign to relieve poverty, the living wage, including seems here to stay, and we but it is misdirected amending the corporate need informed discussion about because being jobless governance code to require this policy. Five arguments Tis the most important cause of listed companies to publish the against the living wage are poverty. Also, low pay is the proportion of their staff paid given below.w. result of low skills. We all wish below the living wage. to see a continuing reduction in There is now a “living wage Jobs are vital to improving poverty, but we need to address accreditation process” to which living standards the underlying issues of poverty. several local authorities have The best research here is by By tackling the structural signed up, as well as high profile Steve Nickell who says simply issues, we can get to the root private sector employers such as (2004, p C2):“worklessness is causes of poverty, such as KPMG, Deloitte, Linklaters and a key factor” in determining poor education and family Lloyd’s of London. whether people are poor. breakdown, rather than The living wage is also Using a relative definition masking them through the receiving heavyweight academic of poverty (see below for an living wage which benefits support with Professor Alan examination of the concept those working in prospering Manning of the LSE (2012, p of absolute poverty) based on firms whilst doing nothing for 23) envisaging the Low Pay receiving less than 60 per cent of the really poor. Commission making “non- median household income after The concept of the living binding judgements” on housing costs, Nickell points out wage is attractive, and it is affordable wages by sector. that about 20 per cent of people receiving well-funded support He sees such judgements in the UK are poor, and this both in the UK and the US. The as strengthening the arm happens mostly when no-one in Resolution Foundation’s latest of employees in securing the household works. From his report (Lawton and Pennycook, better pay deals (and perhaps data, we can construct Table 1 2013) shows this support. The trade unionism would be for individual poverty in 2000. We see that 27 per cent of people are either workless, or % of each % contribution only in part-time work. These % individuals type in to overall groups are highly likely to be poverty poverty relatively poor. For example, 64 per cent of the workless are in Workless 17 64 51 poverty. Only 8 per cent of those in full-time work are in poverty. Because the living wage Part-time work 10 29 14 cannot reach those without work, and many of those in Single/couple one work who would benefit from or both full-time 73 8 35 the living wage are from well- working off families, it cannot help the really poor. Lawton and Pennycook (2013, Total 100 21 100 p36) even admit that only 10 per cent of low earners live in Table 1: Poverty and work status Source: Nickell (2004) Table 2. poor households, so that (p37) “the biggest beneficiaries from Lowest level, broader LW coverage would be Lowest level literacy quantitative literacy middle income households”. This is, indeed, a very interesting UK 22 (17) 23 (25) concession from the proponents of a living wage. Germany 14 (19) 7 (21)

Netherlands 11 (12) 10 (14) The UK’s school and welfare systems fail the poor Sweden 8 (13) 7 (13) Of course, getting people into work, and raising their skills so US 21 (22) 21 (33) that they earn more in work are the problems that need to Table 2: Adult illiteracy, mid-1990s be solved. Source: Nickell 2004. Scores are from the International Adult Literacy Survey (IALS) in mid-1990s (bracketed scores OECD 2013 Adult Skills Survey – 16-65 ages). The UK has a high percentage Note: Quantitative literacy measures knowledge of basic mathematics. of adults who are poorly

19 skilled. Table 2 shows how the UK is as bad as the US, which is a much bigger and more heterogeneous country. Countries such as the Netherlands and Sweden do much better than we do with those at the bottom end of the ability range in the education system. We should try to address this problem through the education system. However, it is worth not- ing that family breakdown leads to poor schooling and poor employment prospects. Iain Duncan Smith, Secretary of State for Work and Pensions (CSJ, 2007, p5) puts it well: £ “In the UK we now have one of the highest divorce rates, and the fabric of family life has been stripped away...with destructive effects upon millions of children...and links with addictions, educational failure and serious debt”. Table 3 shows the progressive breakdown of the family. This breakdown links to the way in which the welfare state penalises BECAUSE THE LIVING WAGE intact couples with children, the “partnership penalty”. CANNOT REACH THOSE WITHOUT For example, in a typical household where the man WORK… IT CANNOT HELP THE earns £15,000 and the woman REALLY POOR (caring for children) £5000, the school system, including, for improvement for the bottom living together brings £2,300 in example, reducing local authority 10 per cent – increases in real benefits; but, by living apart, the and union control. But the living wages represent a considerable female carer gains £7,800 (CSJ, wage has nothing to contribute reduction in absolute poverty. 2007, p89), a partnership penalty to these important issues. Moreover, it is interesting to of £5,500. note that the improvement has This penalty is felt only by The market works come as much in the 1986-98 low earners who become It is important to emphasise period, before the national progressively more entrapped that the free market has minimum wage, as after. by the welfare system, a process delivered real improvements in This absolute reduction in well explained in Charles living standards for unskilled poverty has come about at the Murray’s famous 1984 book workers. These improvements same time as relative poverty “Losing Ground”. have come about without social (measured by the ratio of the These problems need to be engineering or union action – or top to the bottom 10 per cent) addressed via changing the indeed a minimum wage. has worsened, which shows welfare system, and improving Table 4 shows this real-terms that relative poverty can be misleading when it comes to consideration of the living Percentage of families 1972 1992 2001 2011 standards of the poor. with dependent children The living wage is not Lone parent 6 16 20 24 especially “moral” The living wage comes from Couple 94 84 80 76 the same school of thought as the national minimum Table 3: The rise in lone parenthood wage. However, the living Sources: CSJ (2007, p26) and Labour Force Survey (LFS), Office for National Statistics wage is intended only to apply 204 INSIGHT selectively, raising wages only Real earnings, in where they are already relatively 1986 1998 2011 Increase high (amongst employees of 2011 prices government and big firms and, as we have seen, predominantly Bottom 10% of earnings 4.80 5.88 7.00 46% amongst people who are not in distribution £/hour the least-well-off households). Donald Hirsch (2012), for the Top 10% 14.78 22.13 26.75 81% Rowntree Foundation, believes “the moral pressures are winning out over the economic Ratio top/bottom 3.1 3.8 3.8 pressures for a number of employers wanting to be seen Table 4: Increases in real earnings for the bottom 10 per cent Source: ONS (2012) to be doing the right thing”. But the living wage would Parliamentary constituencies with Parliamentary constituencies only help “the haves”, which highest incapacity benefit rates with lowest incapacity does not seem particularly (population 16-64) benefit rates praiseworthy or moral, especially if it came at the expense of high youth and long- Glasgow East 16.8 South Cambridgeshire 2.9 term unemployment. To give an idea of the groups that the living wage would pass Glasgow North East 15.3 Maidenhead 2.7 over, Table 5 shows long-term unemployment in terms of Aberavon 15.0 Buckingham 2.4 working-age incapacity benefit claimant rates. Liverpool Walton 14.8 Wimbledon 2.3 We see, for example, that Cambridge has a rate of only 2.9 Table 5: Incapacity benefit claimant rates, November 2011 per cent, but Glasgow East has Source: McInnes 2012 Table 3. a rate of 16.8 per cent. In other words, people have given up There are better policies John van Reenen from the LSE looking for work and are seeking than the living wage and Richard Lambert (formerly alternative pathways through A functioning market – which from the CBI) in an article in the the benefits system in places would require both lower FT on January 30th 2013 make such as Glasgow and Liverpool benefits and lower wages in three suggestions to improve because jobs are so scarce. Liverpool than in Cambridge productivity and wages based These are also areas of – would attract business, and on people, infrastructure and multiple deprivation, because relieve poor unemployed people. innovation. nearly half of the families in Additionally, this would – if Under the people heading Liverpool (CSJ 2007, p86) the planning system functioned they call for better schooling are also headed by a lone properly – also attract people and training, including more parent. Yet the living wage to move to seek higher-paid autonomy for schools to campaign would aim to raise employment in more prosperous bring us to the levels of the wages in Wimbledon and areas. To facilitate this, tax breaks Netherlands as mentioned Buckingham. for businesses in development above. They also call for more areas could be considered. investment in transport, telecoms, energy and housing. References Finally, they call for more CSJ (2007), Breakdown Britain: Fractured Murray, C. (1984), Losing Ground, New competition in banking. Families, London: Centre for Social Justice. York: Basic Books. These ideas, if implemented Hirsch, D. (2012), The Living Wage: Where OECD (2013), Skills Outlook: First Results properly, leave the living wage Morality and Economics Meet, blog post for from the Survey of Adult Skills, Paris: in the shade. They could be win- Joseph Rowntree Foundation, 12 Nov 2012. Organisation of Economic Cooperation and win policies rather than policies Lawton, K. and Pennycook, M. (2013), Development. that lead some poor people to Beyond the Bottom Line – the Challenges ONS (2012), Real Wages up 62% on gain at the expense of others and Opportunities of a Living Wage, Average over past 25 Years, London: Office and people in relatively well- London: Resolution Foundation and IPPR. for National Statistics off households to gain at the Manning, A. (2012), Minimum Wage: Van Reenen, J. and Lambert R. (2013), expense of those who cannot Maximum Impact. London: Resolution Britain needs a long-term prosperity plan, Foundation. Financial Times 30 Jan. get jobs• McInnes, R. (2012), ESA and Incapacity Nickel, S. (2004), Poverty and Worklessness Professor Stan Siebert Benefit Statistics, House of Commons in Britain, London: Centre for Economic Briefing Note SN1420, July 2012. Performance. University of Birmingham [email protected] 21 QE and the RICH Poor old ‘quantitative easing’ (QE). Has there ever been an important economic policy that has been more thoroughly misunderstood and misjudged? TIM CONGDON

he rationale of QE would surely endorse the view Others say that banks were is simple and can be that stability in money growth is solvent throughout the crisis, and explained in a few preferable to instability. that they were obliged to shrink paragraphs. But much Unfortunately, in late 2008 and their loan portfolios and securities confused nonsense has early 2009 many leading economies, holdings only because of a sudden Tbeen written about it, and that including the UK, were close to a and misguided tightening of bank nonsense has led to foolish and monetary disaster. If nothing had regulation which began in October unjustified criticism. been done, the quantity of money 2008. But, whatever the precise was about to collapse by hundreds cause of the trouble, a big fall in the Did QE stop the Great Recession of billions of pounds. quantity of money was imminent. turning into the Great Depression? Indeed, the prospective rate of Fortunately, the creation of Standard theory and a great deal of evidence argue that the demand to hold money balances is stable. QE IS PART OF MONETARY POLICY This stability of the money demand function means that changes in the AND MONETARY POLICY CANNOT quantity of money and nominal national income are roughly equi- IN THE LONG TERM CHANGE SO- proportionate in the medium and long runs. CALLED “REAL VARIABLES” SUCH In other words, a change of a certain percentage in the quantity of AS THE DISTRIBUTION OF INCOME money is accompanied by a change of more or less the same percentage BETWEEN LABOUR AND CAPITAL in nominal national income. Data from many countries over decline, of about 1 per cent a month money by the state is easy. All that long periods of time show that this (or 10 per cent a year), was similar is required is for the government or assumption is not silly, even if the to that seen in the USA’s Great the central bank to borrow from the short-run relationship between Depression of 1929 to 1933, when commercial banks, and to use the money and income is problematic. the quantity of money went down proceeds of the loans to purchase Given these facts, most sensible by over a third in under four years. anything (government securities, people would accept that steady The reasons for this parlous tanks and planes, old boots) from expansion of the quantity of money state of affairs are debated. Some the non-bank private sector. ought to be one aspect of macro- ‘experts’ blame the banks for having The effect of the purchases is to economic policy. They might have too much risk in their balance increase the bank deposits held by doubts and reservations about sheets, and so being in danger of the private sector agents. People and the emphasis to be placed on this ‘going bust’ and failing to repay companies can write cheques against principle, but almost everyone depositors in full. the deposits, which are therefore 22 CITY VIEW money, and the new money balances Share prices and national income (1991=100) can then circulate an indefinitely large number of times. 350 In essence, QE was and remains nothing more than the large-scale 300 creation of money by the state. In the particular case of the UK, since early 2009 the amount involved has 250 been about £400 billion. Sure enough, in detail the 200 mechanics of QE and the analysis of its effects can be hugely complicated. But the heart of it 150 is that it caused the quantity of money to be about £400 billion – 100 Share prices – FTSE 100 index or roughly between 15 per cent and 20 per cent – higher in mid-2013 Gross domestic product than it would otherwise have been. 50 in nominal terms Even allowing for some technical caveats, an unambitious conclusion 0 is that nominal national income 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 today is over 10 per cent above the level at which it would have been without QE. Furthermore, QE did stop the short-run changes in asset prices are Great Recession becoming the Great partly attributable to movements in Depression that was threatening in the quantity of money. early 2009. But, in the long run, the real value of corporate and property QE and asset prices assets depends on savers’ It would be nice to think that QE preferences, not on monetary would be given three cheers by the variables. Since the beginning of commentariat. However, that is not UK equity investment on modern at all the case. professional lines in the early 20th Many pundits give it one cheer century, the quantity of money and for stopping a worse economic the level of national income have downturn, but say that it rescued increased a very large number of the bankers, and bankers are wicked times, but the valuation of equities and undeserving by definition. has changed relatively little. Well-known columnists such as Liam Because of the cyclical volatility Halligan in The Sunday Telegraph of the stock market, share prices Tim Congdon’s claim that QE is the last refuge of were depressed in early 2009, with Money and Asset Prices in banana republics and bankrupt the FTSE 100 index down at its Boom and Bust empires, and that it foreshadows worst point, in March, to a low of is available for hyperinflation. Another boo has 3512. That was little better than free download at: come from critics who assert that half the all-time peak FTSE 100 www.iea.org.uk/publications/ QE gave an artificial boost to asset figure of 6930 at the end of 1999. research/money-and-asset- prices and was therefore biased in Since early 2009 the stock market prices-in-boom-and-bust favour of the rich. has moved back towards the all- According to Merryn Somerset time peak, but never quite made it. Webb in an article (“A policy that The figure shows that share prices Moreover, despite all this alleged stigmatises the well-off”) in the and nominal national income have favouritism of public policy towards Financial Times on 12th October, in risen by more or less the same over the rich, the level of UK share prices the aftermath of QE: “those with the last 20 years taken as whole, but today is lower than it was over a money have simply bid up prices the year-by-year fluctuations have decade ago. of existing assets”. The further been much greater for share prices. More generally, although asset consequences have been that QE The recovery in the stock market prices are affected by monetary “has pushed down the purchasing between early 2009 and today was policy in the course of one business power of the general population partly due to the increase in the cycle, monetary policy cannot affect and devastated their savings”. quantity of money due to QE. This the real level of share prices, or But QE is part of monetary can be agreed. income and wealth distribution, policy and monetary policy cannot Without QE the quantity of across a number of business cycles. in the end change so-called “real money and the UK equity market Further, it needs to be variables” such as the distribution would have been much lower, and emphasised that QE has been good of income between labour and the recession would have been for demand, output and jobs, and capital, or the valuation of some more intense than it was. This can the extra employment has been of capital assets relative to others. also be agreed. greatest benefit to the poor• It must be admitted to Merryn But QE cannot be blamed for the Tim Congdon Somerset Webb that asset price surge in share prices back towards International Monetary fluctuations are far more volatile the 1999 peak, since QE had not at Research than national income and that that stage been invented. [email protected] 23 Our student programme is kindly supported by campus METRO BANK Ellie-lujah!

Conference Call Congratulations to Ellie Heatherill, from Runshaw College in Leyland, Lancashire, who Our programme of one-day conferences was chosen as winner of our Annual Essay hosted at schools around the country continues Competition. to expand. She won the Dorian Fisher Memorial Prize Recent events have taken place at Bromley for her essay on “What do economists see as the Girls School; Bootham School, York; Nottingham sources of economic growth and which of these High School; Loretto College, Middlesbrough; do you think is most important?” Royal Grammar School, Guildford; King Edward Congratulations also to runners up Alexander School, Stratford upon Avon and Radley College, Jackson, Daniel Dowe, and Tom Rutter. Abingdon. An awards event took place at our Westminster We’re already planning our schedule for headquarters for prize winners and those placed Autumn and Spring of the 2014-15 academic year. in the top 10. If your school would like to attend a conference Details of our 2014 competition will be or you’re interested in hosting an event, then published soon at contact Christiana Hambro: [email protected] www.iea.org.uk/essaycompetition The INTERN-ET! Want to undertake supervised research and participate in a programme of educational events including lectures, debates, seminars, and discussions – as well as social events – for six weeks during the Summer? Then you should apply to be part of our Summer Intern Programme, which runs from July to September. This year we are inviting applications from people interested in taking part in specific research topics as part of a team, including Christian social teaching, and the private provision of ‘public goods’, as well as those from people who have a project of their own in mind• Apply at www.iea.org.uk/ Students-and-teachers/internships

24 CAMPUS ROADS to FREEDOM The first regional event of the UK Liberty League took place in Manchester last October with over 60 attendees and speakers including the IEA’s Dr Steve Davies.

This year’s Freedom Forum – the largest youth political event in the UK – will be held in London on 11-13 April. Details can be Taylor-made found at the UK Liberty League website: www.uklibertyleague.org opportunity

Applications are now open for this year’s Freedom Week, to be PROFESSOR JOHN TAYLOR, of held in Cambridge on 14-19 July. If you’re interested in applying to Stanford University and the Hoover attend and would like to learn more about liberty and free markets Institution, will give our showpiece from top level academics, go to the Freedom Week website: Hayek Memorial Lecture at Church www.freedom-week.org House, Westminster, on June 25. Bloomberg have listed Professor Taylor as one of the world’s 10 most influential economists and his work plays a major part in today’s A-level economic syllabuses. His research made a key contribution to the changes in monetary policy that led to the long period of stability and growth from the early years until the financial crash. He’s been an incisive critic of economic policy since 2008 and he will talk about the policies that have inhibited economic recovery since the financial crash and related economic concerns. Attendance is free. If you’d like sign up, e-mail: [email protected]

TALKING the TALK The IEA continues to give talks at schools, universities, and other venues around the country. Recent visits include Gumley House School, Dulwich College, Stretford Grammar, UCL Debating Society, Durham Economic Society, and Bristol and Exeter Universities. If you’d like an IEA speaker to talk at your institution or organisation then contact us at [email protected]

25 COASE WORK

In the first of a series of introductory articles, IEA Education Director STEPHEN DAVIES profiles a man who made a giant contribution to the world of economics

onald Coase died last will be in the 21st century. His work made up of many self-employed year at the age of 102. is highly relevant to the core topics people all contracting with each Arguably he is one of the on current A-level economics and other. But this is not what we see. greatest economists in the undergraduate economic and social Instead, much economic activity is history of the discipline. policy syllabi. organised through firms of various RHe was only in his early twenties The area where Coase first sizes with the majority of people as when he presented the lecture that made an important contribution employees. What makes a company, ultimately led to him winning the to economics was that of industrial for example, have an accounts Nobel Prize in economics. organisation. department rather than contracting Though Coase’s most important In his article, “The Nature of the with self-employed accountants? ideas were developed decades ago Firm”, he looked at a simple but Coase’s great insight was to and have influenced economic profound question: why do firms realise that economic transactions policy enormously, perhaps their exist? Classical economic theory such as trading or making contracts most profound influence on policy would lead us to expect an economy are not costless. 26 FOUNDATIONS

There are what we now call become on average. standard contemporary economic transactions costs, things such as the And crucial issues in the policy thought, externalities occur when cost of making and agreeing the debates about the energy and economic activity leads to costs contract and of supervising their railways industries can only be or benefits for third parties not work, which might be more or less understood if we think about involved in the original activity or difficult if people are not employed transactions costs. transaction. by a firm. In a world without these Was railway privatisation a Because these costs and benefits costs we would not have firms. mistake, or was it just foolish for are not internalised (i.e. borne by However, because transactions the government to split the train the party responsible for creating costs do exist there is an incentive companies from the company that them) the price system does not to reduce them by having a single operates the track? do its work properly and resources transaction (the employment Should energy companies be are not allocated efficiently. Some relationship) rather than a whole vertically integrated or should they goods will be over-produced and lot of separate costly ones. split up? One course of action might others under-produced. The solution Much standard economics and lead to more competition but it may in standard A-level thinking is business studies teaching assumes also lead to much higher costs. government action, usually through the existence of firms but does not explore why they exist. It is only when you realise that the critical explanation is the nature THOUGH HIS MOST IMPORTANT and level of transaction costs that you will understand better not only IDEAS WERE DEVELOPED DECADES why firms exist but also why at any time there is a predominant form AGO…PERHAPS THEIR MOST of industrial organisation, with variations between sectors. PROFOUND INFLUENCE ON POLICY It is transactions costs that will determine how much outsourcing WILL BE IN THE 21ST CENTURY – including to developing countries – takes place. If transactions costs Coase made perhaps his greatest taxes, subsidies or regulation. decline then there will be a rise contribution in his 1960 paper, Coase showed that it is not clear in outsourcing whereas a rise in “The Problem of Social Cost”. where the blame for creating the transaction costs will lead to larger This dealt with one of the central externality lies and that in many and more integrated firms. It is ideas of modern economics, one cases the way to maximise efficiency also the level of transaction costs that pervades the A-level syllabus: is not through government action that will determine how large firms the problem of externalities. In but through private bargaining. Coase used a real life case of a dispute between a farmer and a rancher over the damage done by the rancher’s cattle to the farmer’s crops. Provided the property RONALD COASE: KEY INSIGHTS rights to land, crops and cattle are clear and the transactions costs of • When transactions costs change – negotiation are low enough then the fence will be built, as long as for example because of changes in the cost of building the fence is less than the value of the damaged communications technology – industrial crops. If the crop farmer has a structure could change radically property right not to have his crop trampled, the rancher will build the fence rather than pay compensation • If the wrong structure is imposed on an to the farmer. If the farmer has no industry (for example, in railways in the such right, he will build the fence to keep the cattle out. Crucially, the UK) this can be very costly. initial allocation of the property rights does not matter for efficiency, • Bargaining between affected parties can though it may for fairness. What this means is that when often overcome the problems caused by there are externalities there may not be a need for government externalities. Governments should not regulation or taxes as the problem get in the way of such bargaining. can be resolved through what has now come to be called Coasean bargaining. • Public goods can often be provided However, if the transactions cost privately by tying their use to private of bargaining are very high then a bargain may not be possible. For goods. example, the transactions costs involved with compensating people living below sea level who may be affected by the externalities of 27 FOUNDATIONS

carbon emissions or compensating increase welfare on balance. those affected by green-field The third example of Coase’s property development in the south- originality was in the area of ‘public east of England might be too great goods’. These are another example to get an efficient outcome using of what is seen as a ‘market failure’ markets alone. in economics courses. In these cases we may have to The consumption of a public resort to legal rules, but very much good is non-excludable so, once as a second best option. Crucially, they are provided, they bring equal

HIS GREAT INSIGHT WAS TO REALISE THAT ECONOMIC TRANSACTIONS SUCH AS TRADING OR MAKING CONTRACTS ARE You can read NOT COSTLESS more about HOW CHINA BECAME CAPITALIST at: www.iea.org.uk/publications/ the legal rule should aim not at benefit to both those who pay for co-published-books/ achieving an outcome designed them and those who do not. how-china-became-capitalist by planners but at achieving The result, in standard theory, is the outcome that people that there will be a strong incentive themselves would have wanted for people to not pay and to “free to a change in broadcasting policy if they had been able to bargain ride” on those who do. The good with the creation of tradable efficiently. will then be supplied sub-optimally. property rights in the electronic In practice, we can try to One classic example of a public spectrum rather than licences solve these problems by making good of this kind suggested in the granted through a political process. property rights more extensive literature is a lighthouse (others Later in his life he did important or by trying to mimic market include national defence). In his work on entrepreneurialism and mechanisms (for example, by carbon 1974 article “The Lighthouse in the way industrial production was trading or agreements between Economics”, Coase used empirical organised. developers and parish councils economic history to show that His last major book (with Ning that can help compensate people private action had successfully Wang, and published by the IEA affected by housing development). produced public goods including when Coase was 101) looked at Technological innovation may lighthouses. In this case privately how China had become a broadly well play a large part in reducing owned ports paid for lighthouses in capitalist economy and argued that transactions costs in these areas in order to increase their own income. this was due mainly to action by the future. The crucial thing was the ability ordinary people in China, rather Coase was very much a realist. of people to find ways to co-operate than by government policy. He realised that in many cases for mutual benefit and find ways Coase’s work was creative, government action may lead to to connect non-excludable goods original and full of insights that higher levels of social cost (due to to excludable ones (in this case the should lead us to question many a misallocation of resources) than use of the port). Subsequent work of the complacent assumptions of if the original externality had been has shown that almost all the classic much contemporary economic and left unaddressed. The burden of public goods can be and often are political thinking• proof for the need for regulation provided privately. has to be put on the government Coase’s work had important Stephen Davies or agency making the regulation to practical applications in many areas IEA Education Director show that their action will indeed of public policy. It led, for example, [email protected] 28 NOW SHOWING...

DAN HANNAN on Europe

COMING SOON:

MATT RIDLEY on fracking

CHARLES MOORE on Margaret Thatcher

www.iea.org.uk/tv DOING BUSINESS: Singapore style

In A-level and undergraduate economics courses, there’s some discussion of the institutional conditions necessary for economic growth and development. In this context, the World Bank’s Doing Business report has provided useful information…but it’s under attack from various campaign groups. In this article, STEVE HANKE stresses the importance of good policy and institutions and the role of the World Bank’s report in achieving these things…as well as examining Singapore’s role as its star pupil.

30 PERSPECTIVE

ince 2004, the World Bank has produced the annual Doing Business statistics in Africa, for example, are report, which ranks countries on 10 factors reflecting the ease with often generated using incomplete which entrepreneurs and businesses may conduct economic activity in data and faulty methodology – a given country. resulting in systematically flawed At first glance, such a survey would hardly seem controversial. After statistics in many countries. Sall, with so much unreliable data coming out of official government statistics Similarly, as Oskar Morgenstern offices these days, one would think that an unbiased system for ranking the documented (Morgenstern, 1950), ease of doing business would be a useful tool – not only for businesses, but for the incompetence and wilful governments as well. trickery of many governments Indeed, since 2005, a total of 1,940 reforms have been implemented by often render data less than reliable. countries to improve their rankings. And, several prominent heads of state, More recently, this “lying statistics” such as Russia’s Vladimir Putin, have made public pledges to improve their problem has been witnessed with countries’ Doing Business rankings. official exchange-rate and inflation As it turns out, however, a few countries (specifically those with low data in countries such as Iran, rankings) are none too happy about the Doing Business report. Most notably Venezuela, and Argentina. China (which ranks 91 out of 183) has been pressuring the World Bank to scrap the Doing Business rankings and weaken the report’s analysis to the point of irrelevance. It hasn’t helped that certain less-market-friendly NGOs, such as ECONOMIC OXFAM, have also joined the Chinese government’s crusade. Indeed, under pressure from China, World Bank President Jim Yong Kim GROWTH IS, commissioned a panel to “study” the Doing Business rankings and present recommendations for “improvement.” Not surprisingly, the commission QUITE LITERALLY, recommended doing away with the actual ordinal rankings, and switching to a less embarrassing evaluation of each country. A MATTER OF Yes, the panel’s recommendations are nothing more than a thinly-veiled attempt to gut the Doing Business report. Stripping the ordinal rankings and LIFE AND DEATH “reforming” the report’s methodology would have the effect of completely destroying the report’s credibility and usefulness as a policy tool. Worse still, some governments will Fortunately, the Doing Business report has one very important ally, Jim simply stop reporting official data Yong Kim himself. A campaign to save the report has also been mounted by when they don’t like the results – see Doing Business report co-founder, former World Bank Group Vice President North Korea and Syria, as well as Michael Klein. Zimbabwe circa 2008. These World Bank insiders recognise a simple fact. The Doing Business report The solution to this problem represents one of the few uniform, objective metrics available for measuring the is to develop unbiased statistics, ease of doing business across 183 countries. Indeed, in 2005, when asked what I using objective data. As Peter Blair thought then-newly-appointed World Bank President Paul Wolfowitz should do Henry (Henry, 2013) shows, stock on his first day, I said his first stop should be at the office of the Doing Business market data can provide a useful report staff. tool for measuring the effectiveness of economic reform efforts. Henry Good data, bad data also highlights the importance of For an organisation whose stated goal is the alleviation of poverty, it is relying on objective data, rather important to have objective metrics by which to measure economic prosperity than ideology, to develop tailored over time (and thus the alleviation of poverty). One common metric for economic reform packages for measuring economic prosperity is per capita income. The evidence is very clear different countries. that prosperity affects health – especially life expectancy – in a positive way. That said, objective data on Yes, economic growth is, quite literally, a matter of life and death. That said, macro-economic growth must also relying solely on per capita income as a measure of economic progress can be complemented with micro-level be problematic. For starters, this metric can be skewed for certain countries data on specific reforms. This is by “outside” factors such as famine, civil war, discovery of natural resource where the Doing Business report deposits, etc. There is also a more basic question of the quality of the data comes into play. Rather than rely being used to produce these economic statistics. on often dubious official statistics, As Morten Jerven illustrates in his recent book, Poor Numbers, economic the Doing Business report uses data collected from over 9,000 accountants, lawyers, engineers and other business professionals around the world. And, the Doing Business report provides vital data on the structural strengths and weakness of a given economy. By “structural” I simply mean the “rules of the game” for small and medium-sized businesses – in short, the government-imposed regulatory costs of starting, running, and closing a business in a given economy. This also addresses the problem of data being skewed by outside factors such as famine and civil war, since the Doing Business report looks at factors over which governments 31 PERSPECTIVE have a greater degree of control: a few examples are in Table 1. As it turns out, a country’s Doing Business ranking can actually tell us a lot about a country’s health as well. Countries with better Doing Business rankings also tend to have higher life expectancy rates. A sceptic might claim that this simply results from richer countries being able to afford better healthcare. But, the Doing Business report does not measure how rich a country is; it measures the costs imposed by government on businesses. So, what is going on here? In short, when governments embrace market-augmenting, business-friendly policies, the cost of doing business goes down and economic prosperity tends to THE DOING BUSINESS REPORT increase. Prosperity, in turn, leads to improvement in medical and public REPRESENTS ONE OF THE FEW health factors that result in higher life expectancy rates. UNIFORM, OBJECTIVE METRICS For a real-life example of this transformation, simply take a look AVAILABLE FOR MEASURING at the country that has held the number one spot in the Doing THE EASE OF DOING BUSINESS Business rankings for the past two years running: Singapore. ACROSS 183 COUNTRIES

Lee Kuan Yew’s “Singapore about how to modernise the country – a strategy which I have dubbed the Strategy” “Singapore Strategy.” This strategy contained the following elements: Singapore gained its independence • Stable money: Singapore started with a currency board system – a simple, in 1965, when it was, in effect, transparent, rule-driven monetary regime. Currency boards operate thrown out of Malaysia. At that on autopilot, with automatic adjustments keeping the system in balance. time, Singapore was poor. Indeed, Accordingly, currency boards deliver discipline to the spheres of money, Singapore’s real per-capita income banking and fiscal affairs. For Singapore, a currency board provided stable in 1965 would be roughly equivalent prices and free convertibility at a fixed exchange rate, which attracted to that of a country like Kosovo or foreign investment. Angola today. However, Singapore’s leader, • Singapore refused to accept foreign aid: This is a far cry from many Lee Kuan Yew, had clear ideas developing countries, where, when you pick up the paper, all you see are politicians and bureaucrats trying to secure foreign aid from someone, be it an NGO, a foreign government, or an international financial institution such as the World Bank. By contrast, “no foreign aid” signs hung, and still hang, figuratively, outside every government office in Singapore. ABOUT • Singapore strived for competitive private enterprises: This was accomplished via light taxation and light regulation, coupled with completely open and THE free trade – in short, policies that enabled Singapore’s private businesses to AUTHOR become Asian tigers. • The rule of law: The Singapore strategy emphasised personal security, public STEVE HANKE – seen here order and the protection of private property. addressing the IEA’s State of the Economy conference – served as To accomplish these goals, the key was a “small”, transparent government a Senior Economist on President – a minimalist government that avoided complexity and “red tape” – hence its Reagan’s Council of Economic top ranking in the Doing Business report. Advisers and as a Senior Advisor To implement this principle, Singapore appoints only first-class civil servants to the Joint Economic Committee and pays them only first-class wages. In exchange for these high salaries, the of the US. Singapore Strategy demands that the government run a tight ship, with no In his long and distinguished waste or corruption. career, he has advised By embracing Lee Kuan Yew’s Singapore Strategy of stable money, no governments around the world foreign aid, first-world competition, and law and order; and by demanding and was once named by World a government that is absolutely free of waste and corruption, Singapore Trade Magazine as one of the has transformed itself from a poor, barren speck to a global financial centre. 25 most influential people in Indeed, a recent survey ranking the world’s top five financial centres put the world. Singapore as number one – ahead of Switzerland, Hong Kong, London and New York. 32 In Singapore, the market is the guiding principle of the economy, just as Lee Kuan Yew’s 1965 manifesto provides the guiding principles for Singapore’s THE SINGAPORE government. Indeed, the key to understanding the Singapore Strategy is to realise that it is a strategy in which the Singaporean government is STRATEGY mandated to produce market-augmenting policies that encourage economic growth. DEMANDS It should thus come as no surprise that Singapore today is one of the freest, most flexible and prosperous economies in the world, as reflected by its THAT THE number one Doing Business ranking. And, lo and behold, Singapore ranks in GOVERNMENT the top ten with regard to health outcomes. As William A. Haseltine noted in his recent book (Haseltine, 2013), Singapore RUN A TIGHT achieved dramatic, cost-effective healthcare results by embracing efficiency and fostering competition between private healthcare providers and the SHIP, WITH NO government. WASTE OR CORRUPTION Doing business topic Methodology (summarised) Indeed, when it came to health care, Lee Kuan Yew once again Procedures to start up and formally ruled out passing the begging bowl Starting a business operate a business and instead insisted on personal responsibility, via fee-based services and personal health savings Dealing with Procedures required for a business in the accounts, among other innovative construction permits construction industry to build a warehouse solutions. While the Singaporean Procedures required for a business to government does play a central role Getting electricity in the country’s healthcare market, obtain a permanent electricity connection the key fact is that Singapore’s health system is one characterised Procedures necessary for a business to by simplicity and transparency – Registering property purchase a property and to transfer title resembling neither the massive public monopolies of Europe, nor Legal rights of borrowers and lenders with the complex regulatory nightmare of the US system. Getting credit respect to secured transactions and the If developing countries were to sharing of credit information embrace the Singapore Strategy, they The strength of minority shareholder too would climb the Doing Business rankings very rapidly. Corruption Protecting investors protections against directors’ misuse of and poverty would decrease, income corporate assets for personal gain and growth would increase, and, I Taxes and mandatory contributions suspect, health outcomes might just improve, as well. Paying taxes and the administrative burden of At the end of the day, the key to paying taxes and contributions implementing meaningful economic The time and cost (excluding tariffs) reform is objective data by which associated with exporting and countries can measure their progress. Trading across borders So long as Jim Yong Kim holds fast importing a standardised cargo of and preserves the Doing Business goods by sea transport report, as is, countries will continue to be able to make strides and The efficiency of the judicial system in Enforcing contracts measure their progress. resolving a commercial dispute The Doing Business report provides a framework for economic The time, cost and outcome of reform and serves as a challenge Resolving insolvency to implement it around the world. insolvency proceedings If countries such as China are embarrassed by a poor Doing Table1: Doing Business report methodology Business ranking, they should leave Source: World Bank (www.doingbusiness.org/methodology, accessed 12 August 2013) Jim Yong Kim alone, and give Lee Kuan Yew a call• Steve H. Hanke References Professor of Applied Economics Haseltine, W.A. (2013), Affordable Jerven, M. (2013), Poor Numbers, Johns Hopkins Excellence: The Singapore Healthcare Cornell University Press, USA. University, Baltimore System, Brookings Institution, USA. Morgenstern, O. (1950), On the Senior Fellow and Director, Henry, P.B. (2013), Turnaround: Third Accuracy of Economic Observations, The Troubled Currencies Project, World Lessons for First World Growth, Princeton University Press, USA. Cato Institute, Washington D.C. Basic Books, USA. [email protected]

33 O MISSING the POINT!

Labour’s plans to deal with the UK’s escalating cost of living recognise the symptoms – but not the cause. Using regulation, price caps and subsidies just won’t work, says KRISTIAN NIEMIETZ…

34 REBUTTAL

he Labour Party’s 2013 trap. Conservative politicians have supply capital for free, energy prices annual conference in proposed rent controls and higher would not tumble. Brighton was dominated by minimum wages and the Liberal A much larger share of energy the issue of living costs. In Democrats have proposed more retail prices – 16 per cent in the T principle this is good news. childcare subsidies. case of electricity, 10 per cent in It shows that the Labour Party now Housing, energy and childcare the case of gas – is explained by recognises that the surge in living have been among the areas with legal obligations to buy energy costs is a determinant of living the most rapid cost increases (see from renewable sources (Niemietz, standards in its own right, which is Figure 1). Senior speakers at the 2012, p124-132). If there were a independent of the general state of Labour Party conference have special ‘renewable energy tax’ the economy. announced that they will cut levied on each energy bill, with This recognition places the housing costs by expropriating the revenue being handed over to party miles ahead of economics developers who are sitting on renewable energy producers, public commentators such as the undeveloped land, cut (real-terms) anger would be directed at the Independent’s John Rentoul, who energy costs through a price freeze government responsible for this levy. still denies the existence of a cost and cut childcare costs by raising In effect, the current of living crisis, and insists that the the entitlement to free childcare to decline in living standards was 25 hours. Each of these proposals is simply another consequence of the a symptom treatment that ignores THE MOST general economic flatlining. the causes of the prior cost increase He is wrong. The Labour Party is in the respective sector, and each of STRAIGHT- absolutely right to address the issue these proposals would be counter- of living costs separately, because productive even when taken as a FORWARD WAY on its own, an economic recovery mere symptom treatment. will do nothing to solve this TO REDUCE problem. The cost of living crisis is a An energy market oligopoly? matter of supply-side constraints. Energy is probably the most ENERGY BILLS Unfortunately, while the Labour obvious example. Labour leader IS TO ABOLISH Party conference speakers aptly Ed Miliband’s argument is simple: describe the problem and its energy corporations are ripping RENEWABLE consequences, the solutions they off consumers, which is why the propose are not solutions at all. The state, the natural ally of the ENERGY basic problem is that the party is underprivileged, has to intervene. trying to solve problems which have The reality is a bit different, OBLIGATIONS been caused by undue government though. It is true that the energy interference with more government market is fairly concentrated, and arrangement works precisely like interference, inadvertently there is surely scope for greater that, except that renewable energy providing an illustration of what competition. But the sector is more taxes are not officially called ‘taxes’, Ludwig von Mises called the competitive than it is often assumed and renewable energy subsidies are interventionsspirale (spiral of to be. Profit margins in the energy not officially called ‘subsidies’. intervention). sector are only about 4-5 per cent The most straightforward way It should be noted that they are (The Economist, 2013), so even if to reduce energy bills is to abolish not the only party falling into this shareholders could be persuaded to renewable energy obligations. These obligations do not reduce carbon emissions, since the latter At the Labour Party’s annual conference in Brighton, party leaders are already capped at the EU level announced several measures to deal with the UK’s escalating cost of through the Emissions Trading living. They plan to: Scheme (the cost of which is not included in the above figures). • address runaway housing costs by expropriating developers who All renewables obligations do is are sitting on undeveloped land (‘use it or lose it’) redistribute resources from energy • address runaway energy costs initially through a price freeze and, consumers to a politically favoured later, through tougher regulation industry. Imposing price controls while leaving these distortions • address runaway childcare costs by raising the entitlement to untouched can only lead to a free childcare (for three- and four-year-olds) from the current reduction in capital investment, 15 hours to 25 hours which will make energy price rises in the future more likely. All of these are misguided symptom treatments, which do not address the causes of the prior cost increases: The folly of reducing childcare • The housing costs escalation has been a result of decades of costs through subsidies under-building, caused by planning restrictions and ‘nimbyism’ Another key announcement was – not land hoarding. formulated by shadow chancellor Ed Balls, who plans to raise the • The energy cost escalation is mainly caused by renewable energy number of free childcare hours for subsidies, paid by consumers through their energy bills – not three- and four-year-olds from 15 to ‘excessive’ profits. 25 per week. That, of course, would do nothing to change the fact that • The escalation in childcare costs has been caused by the exaggerated the UK has some of the highest formalisation of the sector – not a lack of demand-side subsidies. childcare costs in the world. The policy would simply move the cost 35 REBUTTAL to the taxpayer so that the standard Figure 1: House price and fuel price indices in the UK, 1996-2012 of living of taxpayers in general based on data from ONS would be reduced. 350 Enthusiasts of state-funded Consumer Price Index childcare like to praise Sweden as 300 a role model, but they overlook the fact that government childcare House Price Index subsidies in the UK already match 250 Swedish levels. Balls’ proposal could Fuel Price Index well send them to the highest level in the world, especially 200 when considering the dynamic implications. 150 An entitlement to free hours is one of the least efficient ways of subsidising childcare. It is a universal 100 benefit, to which David Beckham’s children are just as entitled as the poorest children in the country. 50 Entitlement is irrespective of the parents’ work status, so it does not 0 specifically encourage parental employment. There is no co- 1996 1998 2000 2002 2004 2006 2008 2010 2012 payment for parents, who therefore have no incentive to choose a cost- effective provider. hoard land forever: they merely that increase actually occurring, are It would be much more sensible release it to the market a bit later very high. This is rarely the case in to address the rules and regulations than Ed Miliband thinks they should. a competitive market, because you that push up childcare costs so much But it remains worth considering cannot control your competitors’ in the first place, such as minimum why hoarding occurs at all. Suppose behaviour. If you hoard your asset, staff-to-children ratios, mandated you own an asset which you could somebody else with a similar asset curricula, Ofsted licensing and sell for a price of 100 gold coins might sell theirs, driving down prices inspections etc. Childcare, after all, now. You believe that there is a 50 and ruining your hoarding plan. is not a high-tech sector. If a country per cent chance that the price will That is the situation in a pays out more than 1 per cent of rise to 120 gold coins next year, competitive market. Yet the market GDP in public childcare subsidies, and but an equal chance that it will for residential land is anything parents still have to pay high user fall to 90 gold coins. The expected but competitive, because supply is charges while huge gaps in coverage value of the asset in a year’s time tightly constrained by the planning remain, something is wrong with the is therefore 105 gold coins, which, system, which is why most of the regulatory framework. if you discount it at a 5 per cent time, prices move in one direction only: upwards. Hoarding would be pointless in a competitive land THE MARKET FOR RESIDENTIAL market, but it can be viable in the UK’s artificially supply-constrained LAND IS ANYTHING BUT pseudo-market. Miliband’s proposal would do COMPETITIVE, BECAUSE SUPPLY nothing to change this. It would leave the barriers which entrench IS TIGHTLY CONSTRAINED BY THE market power untouched, so that PLANNING SYSTEM the government can then act as the white knight who stands up for Ending land hoarding is no solution interest rate, amounts to a present the little guy. It would be far more to high house prices value of 100 gold coins again. Thus, sensible to remove those barriers, Ed Miliband’s proposal of bringing you might as well sell the asset now. so that nobody needs any white down housing costs through Hoarding is pointless unless both knights, but that is not the way the threat of ‘landgrabbing’ is, the magnitude of a potential future politics works. at least, a supply-side measure, price increase, and the likelihood of Taken together, it is which contrasts positively with the commendable that the Labour Party Conservative Party’s belief that a at least recognises the existence of supply-side problem could be solved References a living-cost crisis that will not be through a demand-side intervention resolved by an economic recovery. Niemietz, K. (2012) Redefining the (the infamous Help-to-Buy scheme). Poverty Debate. Why a War on But the party has not recognised The escalation in British house Markets is No Substitute for a War that the problems it identifies prices, however, is the result of at on Poverty, Research Monograph 67, have been caused by misguided least three decades of a systematic London: Institute of Economic Affairs. government interventions. Their shortfall in housing construction. proposals will fail because they will The Economist (2013) ‘Tilting at ‘Land hoarding’ has nothing to do continue that spiral windmills. Ed Miliband’s proposals • with this, because hoarding does to cut energy bills seem likely to do not affect the total amount of the opposite’, print issue, Kristian Niemietz residential development, it only 28 September 2013. IEA Senior Research Fellow affects its timing. Hoarders do not [email protected] 36 BRIEFING

BRIEFING: Summarising and signposting essential reading we’ve seen elsewhere...

MARGINAL TAX CAPITAL MARKET RATES AND INTEGRATION and WAGES INCOME: Though some economists like to cite the exceptions, most agree that free trade increases wealth. There is more controversy, however, about whether New time series openness to capital flows always benefits a developing country. This paper, one of the authors of which is a former Obama advisor who has an impressive evidence career trajectory as an economist, demonstrates the clear advantages of The debate over top tax rates has countries opening up capital markets. The authors point out that, due to the been raging in political circles in opening up of a number of countries in the 1980s and 1990s, we have an the last three years. Until recently, unprecedented body of data which can be used to examine whether capital there was a consensus in favour market liberalisation leads to higher wages. In theory, it should. In developing of a top rate of 40 per cent in the countries labour is often plentiful and capital scarce (though China, of course, UK (relatively low by post-war has a very high savings ratio). Capital market liberalisation should therefore standards). The rate was then raise wages and reduce the rents that can be received by owners of capital. In increased to 50 per cent by the last a sample of 25 emerging economies, which had significantly increased capital government. Despite the fact that flows after liberalisation between 1986 and 1996, the authors’ estimates show the now opposition Labour Party that the growth rate of real wages jumped from 1.8 per cent per year in the regarded that increase as temporary, pre-liberalisation period to an average of 5.7 per cent in the year of liberalisation they objected when the coalition and the subsequent three years. Of course, there are a large number of potential government reduced the rate to data problems in this analysis. However, the authors find strong evidence for 45 per cent. It is also worth noting the argument that it is capital market liberalisation that causes increases in real that there is also little sign that wages. For example, labour productivity also increases along with the import of the current government wishes capital goods in those countries that liberalise. Capital market liberalisation also to reduce the top tax rate back to promotes the diffusion of technology into developing countries. 40 per cent. A further matter of The authors conjecture – though do not investigate this further – that the contention is whether it was wise for increase in wage inequality in developing countries might be partly explained George Osborne to begin his fiscal by the more complex technologies that are employed in production processes consolidation by increasing taxes. due to the import of capital goods. This paper by Karel Mertens is important for these debates. ANUSHA CHARI, PETER BLAIR HENRY AND DIEGO SASSON Mertens’ results show that reductions American Economic Journal: Macroeconomics 2012, 4(2): 102–132 in tax rates for the top one per cent http://archive.nyu.edu/bitstream/2451/31604/3/pbh%20%20capital%20 increase pre-tax incomes for that market%20integration.pdf group; this is not simply caused by reduced avoidance. There is also an increase in national income following JUVENILE INCARCERATION, HUMAN cuts in top marginal tax rates as well as an increase in incomes for CAPITAL and FUTURE CRIME: the lower paid. This suggests that increasing taxes on those on higher Evidence from randomly assigned judges incomes is likely to reduce national In the US in 2010, nearly 0.25 per cent of all 10-19 year olds were in prison. This income and reduce the incomes of is a rate out of all proportion to that experienced in any other country. A stay of the less well off. Unsurprisingly, the 12 months in prison costs the taxpayer about £50,000 in the US. In this research, author shows that increasing taxes the authors examine the impact of the use of juvenile detention (imprisonment) on the top one per cent of income on future outcomes. Using a database of 35,000 people over ten years, they find earners will reduce inequality. that, for those for whom the decision to detain is marginal, there is a decrease in Regarding the fiscal consolidation high school completion and an increase in the likelihood of adult imprisonment issue, the author comments: “The if the individual is imprisoned. It therefore appears that, for the individual, results imply that raising marginal juvenile imprisonment undermines human capital accumulation and increases tax rates to resolve budget deficits the probability of a person pursuing crime as an adult. The authors point out comes at a high price and that a that there are effective alternatives to juvenile detention. The most obvious are proportional across-the-board tax properly monitored and enforced curfews and electronic monitoring. It could be cut provides successful stimulus that objected that, though these results suggest that imprisonment should be used does not necessarily lead to greater less and would reduce future crime, it is possible that strict punishments might income concentration at the top”. deter other juveniles and also that, whilst incarcerated, juveniles cannot commit crime and thus imprisonment may have a direct effect on crime. The authors KAREL MERTENS argue that the first objection at least is likely to be of marginal significance. Cornell University NBER Working Paper 19171 (2013) ANNA AIZER AND JOSEPH DOYLE www.economics.cornell.edu/ NBER Working Paper No. 19102 (2013) km426/papers/MTRI_article.pdf www.mit.edu/~jjdoyle/aizer_doyle_judges_06242013.pdf 37 idealog

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38 IDEALOG STATISM ReBRANDed?

For as long as I can remember, the Jones or Russell Brand do nothing Free-market liberalism, in herbal schnapps Jägermeister has to update the rhetoric of Arthur contrast, is quite able to absorb and had a reputation for being an old Scargill, Michael Foot or Tony learn from real-world experiences man’s drink. Benn. They just lend them an air of which are widely seen as failures of So when I moved to the UK, I youthfulness. ‘neoliberal’ policies, justified or not. was amazed to discover that here, There is a slight difference with There are, for example, excellent Jägermeister was considered trendy Jägermeister, though: there is ‘neoliberal’ contributions on the and ‘cool’ among teenagers. It would appear that, in the UK, the company was simply lucky to find THE STATISM OF THE 1970S IS trendy ‘early adopters’, who then became multipliers. CURRENTLY EXPERIENCING A The realm of political ideas, too, follows fads and fashions, and the JÄGERMEISTER EFFECT statism of the 1970s is currently experiencing a Jägermeister effect. nothing inherent in herbal schnapps causes of the 2008 financial crash, For a while, free marketeers were which makes it either old-fashioned on the problems with British benefiting from the fact that crude or trendy. But the previous fall from railway privatisation in the 1990s, statist ideas were simply considered grace of crude statism was more and so on. old-fashioned. Price controls, wage than a matter of changing fads. It It is rather fortunate that controls, public ownership, bloating had been the dominant ideology Jägermeister never changed in the public sector, deficit spending, for a long time and failed. And substance, because it has always idolising unions, punitive top tax bloating the powers of the state been a fine liqueur, long before rates, interventionist industrial did nothing to ‘empower’ working a travesty like mixing it with an policy – those terms used to sound people. Statism only empowered energy drink would have occurred so 1970s, even to people who, like the state and its cronies. to anyone. me, have no personal memories of It would be one thing if those of In contrast, no matter how ‘cool’ those years. They used to stand for the Jones/Brand ilk acknowledged the command-and-control statism of the bad old days, for a past that few those past failures, and came up the old left becomes, in substance it people wanted back. with a reason why things will turn remains as wrong as ever• But like Jägermeister, these out differently this time. But what ideas have become trendy again they really do is simply to ignore all Kristian Niemietz without any reworking or even past experience with the kind of IEA Senior Research Fellow a rebranding. The likes of Owen ideas they are advocating. [email protected]

Full version at: www.iea.org.uk/blog/the-j%C3%A4germeister-effect-without-a-change-in-substance- 1970s-style-statism-has-become-trendy-aga 39 Productivity Puzzle

There was a time when it was has become cheaper in real terms. per worker should be resumed, and normal for the productivity of But at the same time, the with it the secular growth of labour labour in the UK to be rising year upheavals in the banking system productivity and real wages. by year, and for money wages since 2008 have made it very hard Nevertheless, the above could increases to reflect this by forging for businesses to raise funds to well fail to provide a complete ahead of price increases. invest in capital equipment. Under explanation of recent developments, The last few years, however, seem these two influences, the normal since increasing capital per worker to have turned these norms upside process of increasing capital per is not the exclusive determinant down. Has the economy hit an worker leading to increasing output of productivity growth. That iceberg, or just an unusually strong per worker, and so to increasing real also depends upon the flow of headwind? wages, has evidently ceased innovations of various kinds which The case for believing the latter, to operate. enable more output to be produced and thus for hoping for better Or has it just been suspended? from given quantities of capital things in due course, takes off from It is reasonable to suppose that and labour. The American economist Robert J. Gordon has recently assembled HAS THE ECONOMY HIT AN evidence for the USA from about 1900 which appears to indicate ICEBERG, OR JUST AN UNUSUALLY what he calls “faltering innovation”, and his paper poses the question STRONG HEADWIND? “Is U.S. Economic Growth Over?” Since the influence of the the fact that businesses have lately the effect of the upheavals in the innovations he studies is much been coming to rely more on the banking system was essentially wider than the USA alone, his use of labour in their productive that of a shock whose impact, hypothesis implies what has recently processes and rather less on capital with the passage of time and been happening to productivity in equipment of various kinds. the aid of reforms to the system, the UK could be rather more than This unusual shift in ‘factor will sooner or later fade. As the just an episode• proportions’ has occurred partly blockage it applied to the flow of J. R. Sargent because, under the pressure of funds for investment turns out to Honorary Professor of Economics, unemployment, money wages have be temporary and diminishing, the University of Warwick risen less than prices, so that labour normal process of increasing capital [email protected]

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40 IDEALOG

The British energy industry all domestic energy consumers renewables up to three-and-a-half has gone from nationalisation could switch supplier for the first times more expensive than the to privatisation and back to time and then wholesale markets cheapest methods of generating government control in the space were liberalised, allowing energy electricity. As a result, we get of 25 years. companies to source the cheapest carbon reduction but only at an In the 1970s and early 1980s, forms of energy. unnecessarily huge cost. the consumer got a raw deal Privatisation was a great success. As part of its environmental because long-term investment Instead of investment policy strategy, in a strange echo of the plans and contracts promoted being dictated by the whims of 1970s, the government has signed by the government required government and interest groups, a long-term contract for nuclear electricity companies to use it became dictated by long-term power to be supplied at twice the expensive indigenous coal. commercial considerations. From current price of electricity. Government planning also 1986 to 1997, domestic gas bills fell The UK once had an inefficient dictated the development of by an average of 2.6% a year in and expensive energy industry. a nuclear programme that real terms – a very large cumulative After privatisation, costs is probably one of the most reduction. From 1990 to 1999, plummeted as the industry expensive government project electricity charges for domestic served the consumer rather disasters in history, losing £32bn. consumers fell by 26%, with a than the mining unions and The energy industry is, once larger fall for industrial users. pro-nuclear interests. again, controlled by the state. The same underlying drivers dictate policy in the new WHEN THE STATE CONTROLS THE world of state control. It is not rational economic thinking and ENERGY INDUSTRY…IT IS VESTED public-interested civil servants INTERESTS THAT GET THEIR WAY that determine policy, but interest groups. AND THE CONSUMER WHO PAYS Going back 30 years, it was the coal industry – both management The trend towards liberalised Today, after a decade or more and unions – and the nuclear markets, rising efficiency and lower of increasing state control, we industry that dictated policy. bills then reversed. In the first have an industry that serves vested Today, it is green pressure place, there are carbon reduction interests rather than the consumer groups, EU parliamentarians and targets. Even if carbon reduction interest once again. Electricity commissioners and, often, the is deemed desirable, it could prices before taxes are now 15% energy industry itself that are have been achieved through the higher than the average of major loading burdens on to consumers. emissions trading scheme. developed nations. Electricity could When the state controls the Alternatively, a simple carbon be around 50% cheaper without energy industry, whether through tax could be charged. A carbon government interventions. the back or the front door, it is tax would allow energy businesses We must liberalise again vested interests that get their way and consumers to reduce carbon and not complete the circle by and the consumer who pays. emissions in the most efficient returning to nationalisation. In the late 1980s and early 1990s, way for them. A longer version of this the industry was entirely privatised. But the government has added article appeared in the Observer It was recognised that there were to the emissions trading scheme a newspaper• natural monopoly elements and carbon price floor, a requirement so prices in these areas were to allow households to produce Philip Booth regulated. At the same time, the their own electricity and sell it IEA Editorial and regulator was given a duty to back, and an obligation to produce Programme Director promote competition. From 1998, energy using incredibly expensive [email protected]

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41 xxx REVIEWED

A fascinating WHY introduction to free-market CAPITALISM? thinking Allan H Meltzer OUP USA 2012

Allan Meltzer is one of the with public deficits, it is much greatest economists of his harder to find supporters for generation. I have admired old-school fiscal stimulus today – Meltzer since I started studying other than Paul Krugman. economics in the early 1990s, But, it has to be admitted that, and his work on monetary in many high-school economics theory has had a very significant courses, Krugman is often treated impact on the development of as if he is a mainstream voice my own views. who has credibility in the field of His books on the history of monetary economics and public the Federal Reserve and the finance. Meltzer’s summary of reinterpretation of Keynes are the alternative position will be a among the most important books useful counterweight. on monetary thinking written Meltzer’s fear of inflation, in the past 50 years. So it was however, does seem hard to justify. with some excitement that I was I would argue that the biggest looking forward to Meltzer’s risk to both the US and Europe book Why Capitalism?, which was is deflation. Indeed, Meltzer published in 2012. rightly warned against the risks Why Capitalism?, however, left of deflation in Japan in the 1990s me with mixed feelings. For free- and, in line with other monetarists market economists there is little such as Milton Friedman, he to disagree with in the book – at advocated large-scale quantitative least in the general sense. Meltzer economics courses. easing. There is a striking contrast argues strongly that the present The strongest chapter in the between that advice and warning crisis is not a result of the failures book is Meltzer’s discussion of about high inflation re-emerging of capitalism and, instead, that the welfare state and regulation, as a result of the Federal Reserve’s the causes of the crisis are to be where I particularly found his quantitative easing programme found in government failure. discussion of moral hazard in the over the past five years. Whilst I do not disagree with global financial system insightful My main criticism of Why Meltzer, a leftist or a centrist and convincing. Meltzer provides Capitalism? is that it gives the would not be convinced by his an excellent summary of his own impression that Allan Meltzer, arguments. Furthermore, rather work on the Asian crisis and how like many other proponents of than explaining why a free- this related to the 2008 global free-market capitalism, had grown market system is so effective, crisis. Indeed, this part of the overly confident after the fall in the way that Adam Smith, book could usefully have been of communism and the success Hayek and Friedman did, Meltzer much further extended given of capitalism around the world. focuses on criticising government Meltzer’s experience. We felt that we had won the intervention. There is nothing The chapter on foreign aid is intellectual battle and, when the wrong with his arguments, but useful and is a policy topic still crisis hit in 2008, we were badly the critics of the market will not under discussion in many Western prepared to defend capitalism. be convinced. countries. The undergraduate Why Capitalism? is not that defence. However, whilst this might student should probably go Nevertheless, for the student not be the book for the staunch straight to William Easterly’s White who is starting to study economics, critic of a market economy or Man’s Burden, rather than reading it will provide a decent and for university students who have Meltzer’s quasi-review of Easterly’s highly readable introduction and already read Hayek and Friedman, work. But the sixth form student a critique of some of the poorly there is much in the book for the who is relatively new to economics formulated arguments of the left high-school student approaching can benefit greatly from reading that so often pervade reading lists the subject for the first time. Each Meltzer’s summary. at this level• chapter is well-written and easy to The third chapter on public Lars Christensen read. The areas chosen by Meltzer deficits and the fifth chapter Danske Bank do not necessarily fit into a on why Meltzer thinks we are Author of the Market logical structure but each of them going to have high inflation seem Monetarist blog: provides an overview of important to fight yesterday’s war. Even marketmonetarist.com/ areas studied in high-school though countries are struggling [email protected] 42 xxx REVISITED

Spotlighting The CONSTITUTION a seminal work on freedom of LIBERTY Friedrich A Hayek University of Chicago Press/Routledge & Kegan Paul, London,1960

Does liberty need a constitution? Probably the most controversial Or, what might at first glance sections have become the sound even more paradoxical, ones addressing social security, does it need a framework of where he, after weighing rules for a free society to be different arguments, proposed a established and to flourish? programme for “limited security”, F. A. Hayek’s Constitution as opposed to the welfare state’s of Liberty addressed precisely “absolute security” utopia. His this question, which has been programme included “equal fundamental for classical minimum income for all” (p. 259) liberalism ever since its as well as, intriguing for today’s very inception. debates in the US, compulsory The book was published a health insurance, within which few months after Hayek’s 60th the citizens can decide which birthday and is sometimes of the competing agencies they perceived as his most profound would insure with (p. 286). treatise on social philosophy. I am This general idea is already in agreement with this notion. contained in chapter 9, Already in 1935 when debating “Security and Freedom”, of collectivist economic planning, he The Road to Serfdom. distanced himself from “complete Even though not a bestseller laissez faire in the old sense” due to its academic character and proposed instead to start a and style, The Constitution of search for “the most appropriate economics or of any other single Liberty received some prominent permanent framework” for discipline” (p.3). And indeed, the reviews by close acquaintances competition, which had been treatise is not about “technical of Hayek such as Henry Hazlitt, “sadly neglected by economists” economics” and it has a truly Jacob Viner, Lionel Robbins and over the preceding decades. interdisciplinary character. Ludwig von Mises. Although they Very similar statements are Its 24 chapters are divided were generally positive, they did contained in chapters 1 and 3 into three parts: “The Value criticise some important issues, of The Road to Serfdom, as well of Freedom”, “Freedom and with Mises being rather harsh as in Hayek’s two presentations the Law”, and “Freedom in precisely on Part III. to the Mont Pèlerin Society in the Welfare State”, the level Hayek’s impressive treatise April 1947. In the mid-1940s of abstraction declining in the shows to me that, even if liberals he wrote to Henry Simons and course of the book. often agree on fundamental Walter Eucken that he was In Part I, Hayek established principles, there are different intending to conceive a “positive his conceptual basis, by defining possible ways of applying these complement” to his previously meticulously not only his notion principles to the policy issues of expressed critique of socialism of liberty, but also of progress, the real world. and interventionism: whereas, reason, tradition, responsibility, One debate within the liberal until then, Hayek had expressed equality, value and merit. community was directly invoked what he opposed, his positive In Part II, both historically and by the famous postscript “Why programme would be about theoretically, he argued for the I Am Not a Conservative”. This what he actively proposed. absolute indispensability of the has ignited debates, for example, By 1953 such plans started to Rule of Law: rules being the only about the political tradition of take shape. liberal way to circumscribe one Margaret Thatcher. Was she to What is the basic outline of individual’s sphere of liberty vis-à- be seen as a Tory or rather, in the book? After an introduction vis those of his fellow citizens. Hayek’s opinion, as a Whig? A in which Hayek explained that, In Part III, Hayek applied the debate which, to my knowledge, although he still regarded himself principles of the first two parts was unfortunately never resolved “as mainly an economist”, he to various fields of economic in a definitive manner• had more and more realised that policy, ranging from trade unions, at that point in time the task social security, taxation and Stefan Kolev of an economist should be “the redistribution, money, housing, Wilhelm Ropke Institute recognition of principles that lie natural resources to education Erfurt, Germany outside the scope of technical and research. [email protected] 43 SoundbiteSoundbiteSoundbiteSoundbi teSoundbiteSoundbiteSoundbite Sound nbiteSoundbiteSoundbiteSoundbiteSo SoundbiteSoundbiteSoundbiteSoundbi teSoundbiteSoundbiteSoundbite Sound biteSoundbiteSoundbiteSoundbiteSoun SoundbiteSoundbiteSoundbiteSoundbi teSoundbiteSoundbiteSoundbite Sound biteSoundbiteSoundbiteSoundbiteSoun SoundbiteSoundbiteSoundbiteSoundbi teSoundbiteSoundbiteSoundbite Sound biteSoundbiteSoundbiteSoundbiteSoun SoundbiteSoundbiteSoundbiteSoundbi teSoundbiteSoundbiteSoundbite Sound biteSoundbiteSoundbiteSoundbiteSoun SoundbiteSoundbiteSoundbiteSoundbi teSoundbiteSoundbiteSoundbite Sound biteSoundbiteSoundbiteSoundbiteSoun

46 SoundbiteSoundbiteSoundbiteSoundbi SOUNDBITE teSoundbiteSoundbiteSoundbite Sound nbiteSoundbiteSoundbiteSoundbiteSo CitiesSlicker SoundbiteSoundbiteSoundbiteSoundbi teSoundbiteSoundbiteSoundbite Sound biteSoundbiteSoundbiteSoundbiteSoun

It is commonplace to think, as innovation is happening in cities it estimates that, by 2025, 136 new SoundbiteSoundbiteSoundbiteSoundbi Adam Smith did, of the wealth and sub-national regions, not at the cities will join this list – all from of nations. Now we should also level of national governments, let developing countries. Of the new focus on “cities and the wealth of alone in international forums such entrants, 100 will come from China teSoundbiteSoundbiteSoundbite Sound nations”. More than ever, cities are as the UN, EU and G20. alone. the lifeblood of the global economy. Policy-making is more flexible What are the ingredients that The competitiveness of cities – what and practical the closer it is to the make cities more productive? makes them more productive and citizen. And this is more conducive to Some vital municipal policies are biteSoundbiteSoundbiteSoundbiteSoun successful – increasingly determines all-round learning and adaptation: parochial: urban planning and the wealth of nations, regions and cities emulate each other and adopt zoning, housing, water, sanitation, the whole world. best international practice often policing and so on. The map of the global economy better than nations do. But the most successful cities, like SoundbiteSoundbiteSoundbiteSoundbi most of us have in mind is one of the most successful nations, also nation-states connected to each have the following: stable and solid other via flows of trade, capital, HONG KONG public finances; low, simple and people and technology. That is still competitive taxation; simple and teSoundbiteSoundbiteSoundbite Sound highly relevant. But throughout AND SINGAPORE transparent business regulation; history the most intensive cross- strong and impartial rule of law; border economic transactions have ARE THE ROLE openness to international trade and biteSoundbiteSoundbiteSoundbiteSoun been between cities – mostly cities MODELS… THE foreign investment; a welcoming located on coastlines. environment for “foreign talent”; So think of a different map of BENCHMARKS good “hard connectivity” – roads, the global economy: one of cities transit systems, ports, airports; and SoundbiteSoundbiteSoundbiteSoundbi connected across land borders, seas FOR OTHERS TO good “soft connectivity” – education, and oceans through the exchange skills and technology diffusion. of goods and services, foreign EMULATE Like nations, cities with limited investment, migrants and – but effective – government and teSoundbiteSoundbiteSoundbite Sound short-term workers, and border- This is true of cities and state competitive markets do better hopping technology. governments in the USA while than cities with big, inefficient Unprecedented levels of Washington DC remains gridlocked. government and distorted markets. urbanisation make this city-based In the EU, national governments The city-states of Hong Kong and biteSoundbiteSoundbiteSoundbiteSoun map especially relevant. Three years and the EU institutions are stuck Singapore are the role models. ago, for the first time in history, in sclerotic political cartels with They are the benchmarks for others over half the world’s population failed policies. Can Europe’s cities to emulate. SoundbiteSoundbiteSoundbiteSoundbi lived in cities; they account for over break out of this straightjacket and Cities were at the heart of 80 per cent of global GDP. unleash long-delayed reforms? the medieval and early modern According to McKinsey Global However, this century’s story of European Miracle. Stadtluft macht Institute, as of 2007, 1.5 billion cities and the wealth of nations will frei – city air makes you free – was teSoundbiteSoundbiteSoundbite Sound people (22 per cent of the world’s be scripted mainly in the emerging the refrain of the day. population) lived in the world’s 600 world – outside the West. Cities are now at the heart of the most populous cities and accounted Over the next two decades, about Asian Miracle. Richard Cobden and for a GDP of $30 trillion – well over 170 million people will move to Jane Jacobs had a vision of cities as biteSoundbiteSoundbiteSoundbiteSoun half of global GDP. cities in developed countries – but the best available political-economic The top 100 cities, with a GDP 2.6 billion people will do so in units to promote prosperity, of $21 trillion, accounted for 38 developing countries. freedom and peace. Will this vision per cent of global GDP. In 2025, Asian cities, stretching from India come closer to realisation in the McKinsey reckons that the top 600 to China and north-east Asia via twenty-first century?• cities will have 25 per cent of the south-east Asia, will be the main Razeen Sally world’s population and nearly 60 players. McKinsey Global Institute’s Director, European Centre for per cent of global GDP. list of the top 600 cities contains International Political Economy Most productive policy 220 from developing countries. But [email protected] 45 incomes the hardest. While better off families can either move house in search of a better school or DEFENDINGDEFENDING purchase private tuition, those on low incomes who live in poor areas are forced to accept their local FREEDOMFREEDOM inin government school, irrespective of how it performs. Government intervention has EDUCATIONEDUCATION therefore had the opposite effect from the one that was originally intended. In fact if I had to design a system of education which cost over £50 billion a year, but which still managed to penalise and restrict the poor, then our system is exactly the system that I would choose. It is a sorry sight to see a Chief Inspector of Schools attempting to shift the blame from his own organisation’s failure onto a handful of private and independent schools who have simply been minding their own business. However, let’s be clear – social divisions and barriers in education are primarily a result of the way In October 2013, Sir Michael private and voluntary schools in which all previous governments Wilshaw, the Head of OFSTED, across the country, leaving only have subsidised the sector, which has accused some of our leading a small number of established denied parents their fundamental independent schools of living private schools, many of which right to choose, crowded out the in “isolation” and preferring to were founded long before the vast majority of private alternatives educate “those whose parents have introduction of parliamentary and penalised those families living deep pockets” rather than local democracy and the civil service. As in poor areas. This is government disadvantaged pupils. previously noted by Frédéric Bastiat, failure on a massive scale and it has As many independent schools the shoe industry would fail very nothing to do with any private or were established with the quickly if the government decided to independent institutions. express purpose of providing an education for the poor, Sir Michael demanded that these schools BECAUSE OF THE WAY IN WHICH should now renew and deepen that commitment. SUCCESSIVE GOVERNMENTS HAVE The head of OFSTED has lost his way on this issue and needs to be FUNDED EDUCATION, THEY HAVE reminded of some home truths. The government initially CREATED A SYSTEM THAT PENALISES intervened in education in the late 19th century to help support DISADVANTAGED CHILDREN disadvantaged pupils living in deprived areas. The sole purpose give everyone shoes free of charge. Politicians and civil servants of this intervention was to focus The government and its army of should remember that their primary on helping those most in need and school inspectors became the new purpose is to serve the public and to not to disrupt or interfere with self-declared champions of the poor. protect their fundamental freedoms. the already flourishing private, As a result, the surviving private They should also take note of the voluntary and religious sectors schools were left with no choice but well-known dictum ‘an Englishman’s which were already educating the to change and adapt their schools home is his castle’, which refers to vast majority of children. to cater for the minority of parents an English legal tradition dating What followed was a comedy who could now afford to pay for back to the seventeenth century that of errors and broken promises. their children’s education twice – recognises a person’s home as their Local officials directed all local once through taxation and again own private domain where they are taxes to their new government through school fees. free from external interference. This schools despite the fact that this Because of the way in which applies to all private institutions and was challenged in Parliament as it successive governments have funded not just the home. was seen as penalising the poor by education, they have created a system There is not much freedom left restricting their choice of school. that penalises disadvantaged children in our education sector. We must When these schools failed to attract – the very same disadvantaged defend what remains• children, more taxes were handed children that the government initially out to enable them to reduce fees intervened to help. James B. Stanfield until they became free of charge. Any system of education that E.G. West Centre, This subsequently forced the restricts the freedom of parents University of Newcastle closure of thousands of fee paying to choose will hit those on low [email protected] 46 SOUNDBITE

Imagine a tax that took 30 per cent of the income of the poor but took only 15 per cent from the rich. Imagine further that this tax was popular with anti-poverty STEALTH BOMBER campaigners and that many of those who oppose the market economy wanted it to be levied at an even more punitive rate. There is no such single tax, but the figures above represent the combined impact of ‘sin taxes’ and VAT on the top and bottom fifth of households as measured by disposable income. Over many decades, the burden of indirect taxation has crept steadily upwards. Tax now makes up 79 per cent of Declaring war the price of an average bottle of whisky, more than 80 per cent of a budget brand pack of cigarettes, ON SIN TAXES half the price of a bottle of wine and around 60 per cent of a litre of petrol. VAT, which was originally set at 8 per cent, has climbed to 15 per cent, then 17.5 per cent, and now stands at 20 per cent. As the state has grown fatter, politicians have increasingly relied on stealth taxes to fund their spending. These taxes fall disproportionately on the poor. If exceed the costs of maintaining back into the pockets of the someone in the bottom income the road network by £30 billion, British people and improve work quintile drinks moderately, smokes but also exceed the environmental incentives considerably. Of course, and drives a car, they will spend costs associated with driving. The this is another way of saying a staggering 37 per cent of their £2.7 billion a year that smoking is that the state would have £20 disposable household income on said to cost the NHS is paid for four billion less to spend. But, with the VAT, motor fuel duty, tobacco duty times over by tobacco taxes and government spending close to 50p and alcohol duty. Forget the cost of in every pound, the state should the products themselves: that is just cut spending and consider carefully the tax. SIN TAXES IN which taxes to cut at the same time. If we really wish to lift people Of course, a large proportion out of poverty, we should not be BRITAIN FAR of state spending involves the taking so much of their money. If provision of welfare payments we halved taxes on fuel, alcohol EXCEED ANY to the very people paying and tobacco, scrapped green energy disproportionately high sin taxes. subsidies financed through higher BURDEN THAT Cutting both spending and cutting bills and reduced VAT back to 15 the taxes identified above would be per cent, it would represent a major CONSUMPTION complementary measures. step forward in reducing the cost of Those who support paternalistic living and would put money back OF THE RELEVANT sin taxes argue that people on low in the pockets of those who are in PRODUCTS PLACE incomes can avoid the taxes by greatest need. With the economy avoiding the products. Whilst this recovering, David Cameron has said ON THE STATE is trivially true, large numbers of that he wants to see “taxes cut for people on low incomes exercise a all”. This is the place to start. the £12 billion paid in alcohol duty preference to buy ‘sinful’ products Some argue that the negative comfortably exceeds the £6 billion and will continue to do so for the externalities of ‘sinful’ products spent on healthcare and policing foreseeable future, despite some necessitate Pigouvian taxation that is attributed to alcohol. of the most punitive taxes in the (taxes which represent the Cutting these taxes would bring world. There is a welfare cost when “external” or “non-private” costs many benefits. High motor fuel people change their consumption of consuming such products and/ prices hamper the economy in habits simply to avoid taxes. or which raise money to pay for the numerous ways, raising barriers to The hard reality is that these external social costs incurred by a work and increasing the price of taxes are discriminatory and highly product’s use). everything that is transported by regressive. Those who support them But a close inspection of the road. Halving taxes on alcohol and whilst claiming to be fighting a war figures reveals that sin taxes in tobacco would kill their respective on poverty are fooling themselves• Britain far exceed any burden black markets and would bring an that consumption of the relevant end to cross-channel ‘booze cruises’. Chris Snowdon products place on the state. Cutting VAT to 15 per cent Director, IEA Lifestyle Economics Taxes on motoring not only would put more than £20 billion [email protected] 47 SOUNDBITE

Are LIFESAVING DRUGS all they seem? Far more patients are likely to be Dr. Preston Mason of Brigham The discerning eye will note, eligible for cholesterol-lowering and Women’s Hospital, Harvard however, that the scientific drugs called statins, if doctors Medical School, is bucking the literature is being populated with follow new heart guidelines trend. He recently presented a examples of oncology, transplant issued by the American College of paper on 36 different generic and other critical medicines with Cardiology and the American Heart versions of the most widely impurity problems like those found Association (AHA). prescribed statin, atorvastatin. by Dr. Mason – some of which make Statins are widely prescribed to The generics were procured their way to European patients. reduce the risk of heart attacks but from pharmacies in North America, Yet, impurity profiles of medicines the new guidelines recommend that Europe and Asia to “evaluate on the market are not routinely they also be considered for people the chemical purity of generic assessed by western regulators. at high risk of stroke. atorvastatin”. These generics If regulators are doing their But whether they follow these were compared with the original job properly, they should conduct recommendations there is a deeper atorvastatin (patented by Pfizer random sampling of statins (and and more pervasive controversy that as Lipitor) – and the findings were probably all medicines) sold on the no one is discussing: the quality of alarming. The “widely-available” market, and submit these products the statins we are already ingesting. generics were found to contain an to myriad tests to find problems It is far from common knowledge, impurity that could prevent them with impurities. but many cardiologists will tell you from working properly. Currently, products that receive approval may work fine at the time of assessment, including having low THERE IS GROWING CAUSE FOR impurity levels. But there is growing cause for alarm as evidence of corner- ALARM AS EVIDENCE OF CORNER- cutting mounts – particularly among Indian generics manufacturers, with CUTTING MOUNTS the products sold after approval not matching up to those that achieved in confidence that they routinely A lot of these generics are approval. Only time will tell how switch patients from a generic made in India, where quality is an lethal the consequences of this corner statin back to the brand original ongoing concern. In May 2013, cutting will be. or to another generic because of one of India’s largest companies, This is an interesting and clinical problems. Ranbaxy – the manufacturer of problematic issue. The existence of As one cardiologist put it to me generic atorvastatin – pleaded regulation can crowd out methods in view of the new guidelines “the guilty to seven felony counts related of quality control that can arise new heart recommendation may to lies about drug quality data within the market itself. However, put tens of millions of more US and was fined $500 million by the in many areas of economic life patients on statins, and this may be US government. Yet India’s drug we expect regulators to rectify the correct advice, but only if the regulator, the CDSCO, still has not problems that economists describe statins work properly”. But doctors sanctioned Ranbaxy. as “market failure”. Unfortunately, are skittish about saying these My research team has sampled rather like in the financial markets things on the record for at least thousands of medicines from India in 2008, we can see that regulators three reasons. and other emerging markets and can fail too• First, they don’t want to appear found major errors in formulations to be in the pocket of the brand- in at least ten per cent of the Roger Bate name drug companies. Second, samples. Gross failings of drug Author of “Phake: The Deadly they are confused – after all, quality are manifest in most World of Falsified and generics prescribed in rich nations emerging markets. But because of Substandard Medicine” all have regulatory approval. Third, western oversight and the threat Adjunct Scholar at the it can be difficult to spot when of litigation against corporate American Enterprise Institute many medicines fail, since clinical mistakes, most medicines prescribed Contributor at symptoms may not be noticed for in the US and Europe do not have www.searchingforsafety.net. weeks or months. obvious errors. [email protected] 48 “This book PUTS HUMAN BEINGS back AT THE HEART OF THE ECONOMIC PROCESS” Eamonn Butler, The Adam Smith Institute

A book on the COMMON PRINCIPLES behind the MARKET ECONOMY

“DAVID SIMPSON writes about KEY ECONOMIC ISSUES with ADMIRABLE LUCIDITY” Asa Briggs

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