Autumn 2014 £3.75 YOU and YOUR STUDENT LOAN From the Institute of Economic Affairs

IN THE DOCK: Market failure

BITCOINTHE FLIPSIDE OF MONEY

Meet PLUS MATT Analysis RIDLEY Reviews the Comment RATIONAL ...and the best of OPTIMIST OUR BLOG

AUTUMN 2014

On the Cover

4 Foundations 10 Précis Why the Is Bitcoin the term money of “market the future? failure” is a false Inside indictment 3 From the Editor 7 Rebuttal 18 Interview 20 Insight Philip Booth Deconstructing Danny …with Why the on the first Dorling on UK housing acclaimed student EA of the author and loans new journalist system is academic Matt Ridley the worst of years all worlds

14 Rebuttal 2 24 Fads & Fallacies 26 Outlook 30 Interview 2 Challenging Are politicians above self- Why the world is a much …with the Chang’s interest and greed? better place than ever before man behind views on the Taylor capitalism Rules

32 Perspective 34 City view 38 Legends 42 Viewpoint What do Marx, Mises and Old wounds, Tributes to a Examining Margaret Minsky have in common? reopened trailblazing Thatcher’s industrial legacy economist

46 Reviewed 48 Campus 52 Idealog 56 Soundbite & Revisited Climb on board the Best of the IEA blog Economics Roadshow …on computer- Recommended works, savvy kids, old and new global cities 51 Briefing and more Essential reading we’ve seen elsewhere

Editor Philip Booth Creative Director Glynn Brailsford Design Marian Hutchinson Review Editor Andre Alves Editorial Adviser Richard Wellings

IEA 2 Lord North Street Westminster SW1P 3LB 020 7799 8900 www.iea.org.uk

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Tel: 01280 820186 Email: [email protected] www.buckingham.ac.uk/economics FROM THE EDITOR WELCOME … to the first EA of the new academic year. Three of the main articles in this issue take a very clear look at the future. Our cover story (p10) asks whether Bitcoin – or other digital money – provides a realistic alternative to the current monetary system. On page 20, we take a critical look at the student loans system – something that’s sure to loom large for you in the months ahead. And, on a much more positive note, we meet author and journalist MATT RIDLEY (p18) to discuss why he sees the world as a much better place than ever before – and why life on the planet will continue to get better. Elsewhere, we meet one of the current greats of economics, Professor JOHN TAYLOR (p30) and, on page 38, we pay tribute to Professor GARY BECKER – a truly remarkable and innovative thinker who died earlier this year. Another sad death I would like to note is that of JOHN BLUNDELL, former Director General of the IEA. Under his leadership, the IEA established its student/teacher programme with a large grant from the Templeton Foundation. John will be remembered by many teachers, and there is a longer tribute to him on the IEA blog: www.iea.org.uk/blog/john-blundell-rip Throughout this issue, you’ll see we’ve highlighted films and interviews you can watch on ieaTV. We’re adding insightful new material all the time, so be sure to check it out at www.iea.org.uk/tv In the meantime, I hope you find this latest edition of EA truly stimulating●

Professor Philip Booth Editorial and Programme Director IEA [email protected]

facebook.com/pages/ @iealondon Institute-of-Economic- Affairs 03 IN THE DOCK: Market failure

IEA Editorial and Programme Director PHILIP BOOTH on why “market failure” is a false indictment...

f somebody were to start an then call those deviations “market made in 2003: engineering textbook by saying failures” because they imply that “In meeting our objectives in that the maximum theoretical all opportunities for welfare a manner consistent with the speed of a perfect car was the maximisation have not been taken2. principles of good regulation, speed of light1 and that a car This is despite the fact that it is we have adopted a regulatory Ithat travelled at any speed lower impossible to have a perfect market, approach based on correcting than that was a “failed car” or just as it is impossible to have a market failure…There are, however, suffered from “car failure”, you “perfect car”. numerous cases where unregulated would probably think that it was Because markets are deemed financial markets will not achieve an unhelpful way of presenting the to fail according to the textbook the best outcome due to some form topic – and you would be right. model, the concept is then used of market failure, making action on Yet, a common approach in to justify different forms of our part necessary.” economics teaching is to lay out government intervention. For The word “necessary” is especially the preconditions of a so-called example, consider this statement interesting in this statement perfect market (full information, no by the former regulatory body for because all markets suffer from transactions costs, no externalities financial markets, the Financial the problem of market failure as and so on) and then to look at Services Authority (the body that defined in the textbooks – just as how markets, in practice, deviate presided over financial regulation all cars travel at less than the speed from that textbook model. We at the time of the financial crash) of light – and thus there would

1 This analogy is not original – I believe it was first suggested by David Friedman. 2 This can all be related to the textbook model of perfect competition and the assumptions that underlie it. However, I shall follow a slightly different track in this article. 04 FOUNDATIONS appear to be no limit on the extent Austrian economics suggests that, in A-level and undergraduate of regulatory intervention that the if a market is “imperfect” in some economics syllabuses. However, we FSA believed it needed to use to try way, governments and regulatory do not know what that tax should to perfect the market. The market bureaus simply cannot know what be. How can a government minister failure doctrine is not simply a the outcome of a perfect market know the social cost caused by a problem in economics textbooks, it would have been had it existed. pollutant? People’s preferences is used to determine public policy. For these reasons and others, for different economic goods governments cannot perfect are only revealed by the prices Government failure? markets and the concept of they pay in market transactions. In some A-level syllabuses, the “government failure” is just Different people will have different concept of market failure is as unreasonable as that of preferences. Some people might balanced by that of “government “market failure”. have a strong preference for clean failure” – the idea that, for various air; others might prefer dirty air reasons, the government might not Achieving better outcomes, not if allowing more pollution allows be able to perfect markets through perfect outcomes them to be a little bit more wealthy regulatory intervention. However, The obsession with the market in other ways. The government though this provides balance, it failure approach to policy analysis could only have the information is not a helpful phrase to use. is relatively new and can probably to work out the optimal tax if it We cannot expect governments be ascribed to Pigou. The obvious had all information about the costs to perfect markets – it is simply example, coming from Pigou, is the and benefits of all potential uses of beyond their capacity. As such, idea of the optimal tax to deal with economic resources. If it had that governments do not fail if they do pollution. If a factory owned by one information, then centrally planning not perfect markets. The lessons individual pollutes the air or land the economy more generally would of public choice economics tell us that regulators may act in their own interests, or may get “captured” by the industries that IT IS IMPOSSIBLE TO HAVE A PERFECT they are trying to regulate so that MARKET, JUST AS IT IS IMPOSSIBLE the actions of regulators do not contribute to increasing overall TO HAVE A PERFECT CAR welfare and improving market outcomes. Regulators might be risk averse and over-regulate of other individuals, the argument work. And yet we know that central markets or they may have cognitive goes that the problem can be solved planning is a catastrophe. biases that lead them to regulate with an optimal tax on the factory’s There is a better way of dealing markets through “rule writing” activities to bring marginal social with these problems. Instead of which simply raises costs without costs into line with marginal social focusing on market imperfections improving outcomes. Furthermore, benefits. Again, this is reflected and government regulation and taxation to correct those imperfections we might think about which set of institutions and policies generally produces the best result KEY LESSONS – not a perfect result but the best result. In the case of externalities • No market will ever be a “perfect we might want to consider the set of policies that will lead to the market” as defined in the textbooks parties causing harm and the parties who are harmed coming • Markets cannot be perfected by to an agreement that leads to better outcomes. government action – it is simply impossible Let us take land-use planning as an example. At the moment, people • As such, both the terms “market failure” in the South East of England tend to oppose more development because and “government failure” are unhelpful it reduces their environmental amenities, leads to more road • Economists should look at how markets congestion and so on. On the other hand, people regard new houses are impeded from increasing welfare and in the South East as incredibly valuable compared with other uses suggests ways in which those for the same land such as farming. impediments can be removed Land with planning permission for building is worth about 100 times • This will often involve extending markets land with planning permission only for agriculture. So there is a conflict: rather than regulating them, though in builders want to build and existing residents want to prevent building. some situations governments may well be There is a social cost from building involved in facilitating this process more houses but a huge potential welfare gain too. Since 1948 we have resolved 05 FOUNDATIONS this conflict by giving powers to regulators in local government to take decisions about development using a bureaucratic process that is influenced by interest groups. This leads to some perverse outcomes, one of which is that houses that might have a minor impact (minor social cost) on nearby villages do not get built even though the private gains might be huge. If only those who gained could compensate those who lost, there could be much better outcomes. Instead of this process of regulators trying to dictate who should and should not have permission to build, what if we were to bring those parties that gain together with potential parties who might lose? Builders, who gain hugely from turning agricultural land into building land, reflecting the value their customers put on new houses, could use some of that gain to directly compensate those who lost their environmental amenities3. This could be done at a very local level as the number of people affected by housing developments is normally quite small. Localities that valued their environmental amenities highly might refuse compensation, and the builder can build near people who value their environmental amenities less. to extend markets so that economic is no market in environmental agents have a good chance of amenities. If I get some benefit Good, better, best – but not perfect taking into account the costs and from the farmland at the back of There are many more examples of benefits of different courses of my house, is that a property right how we might improve economic action. As in the planning example, of mine or not? Under our current outcomes by looking at the this might involve better definition land-use planning regime, it is in institutional framework rather than of existing property rights so that a kind of limbo. On the one hand the farmer cannot simply build on his field without permission. On the other hand, he cannot be THE LESSONS OF PUBLIC stopped from building once he CHOICE ECONOMICS TELL US has permission. In lots of areas (for example, land-use planning, fishing THAT REGULATORS MAY ACT rights, environmental pollution) the problem is that property rights do IN THEIR OWN INTERESTS, OR not exist in the relevant resource so nobody has an incentive to use MAY GET “CAPTURED” BY THE the resource efficiently or come to agreements with others to INDUSTRIES THAT THEY ARE compensate them for the “social costs” of their actions. TRYING TO REGULATE Failure to treat this subject properly is a major impediment to looking to regulators to pull levers, parties can work out a solution in economics being useful in solving but what is the general approach a way that best takes account of public policy problems• that should be taken? costs and benefits. The outcome We should do two things. may not be perfect, but it will be Philip Booth Instead of saying: “this is a market better. Secondly, so-called market IEA Editorial and failure, we should give power to a failures are not generally failures Programme Director regulator to pull the lever marked of markets. They normally involve Professor of Insurance and ‘X’ to perfect the market” we incomplete markets. In the planning Risk Management should look to improve institutions, example, under current law, there [email protected]

3 In fact, the cost might be borne by the owners of the agricultural land the price of which will go down reflecting the extra cost to the builders of providing compensation. 06 REBUTTAL

DECONSTRUCTING the ARGUMENT IEA Senior Research Fellow KRISTIAN NIEMIETZ critiques DANNY DORLING’s All That is Solid: The Great Housing Disaster (Penguin Books)

et us start with the his political opponents. Dorling national health service would good aspects of Danny is the type of left-winger only help the weak to survive Dorling’s All That is who genuinely imagines his and breed” (ibid). Solid. The book is quite opponents to think and act good in describing the like the villains in a Batman There are enough bedrooms Lsymptoms of the UK’s housing comic. The coalition parties, for for everybody crisis, and of the social example, “want the children As for the bad parts, it would problems that follow from it. of the rich to be given more be wrong to claim that the Dorling’s critique of the ‘Help space in the city, and they want book fails to identify the to Buy’ scheme is spot on, and the children of the poor to go” causes of the under-supply of his attack on the bedroom tax is (p187). Those who do not share housing. It is worse. This book well worth a read. Those parts Dorling’s idolisation of squatters categorically denies that there of the book are solid. But they are likened to “the Victorian is an under-supply. “[O]ne of are all that is solid. regressive who believed that this book’s central premises Also on the plus side, various hunger was a far more effective [is] that the fundamental passages are unintentionally weapon than the overseer’s problem in Britain […] is not funny, especially when Dorling whip” (p283), and to “the 1930s a shortage of homes” (p108). speculates about the motives of eugenicists who believed a Dorling says that building new 07 60 supply by the number of rooms. This might work for some countries, but definitely not for the UK. In a major international 50 study of housing markets and housing conditions, Evans and Hartwich (2005) show a British peculiarity: when European 40 countries are ranked by the number of rooms per dwelling, the UK comes out on top of the 30 list. But when they are ranked by average room size, the UK comes out at the very bottom. Dorling’s supposed abundance 20 of rooms is simply an artefact of the fact that British homes tend to be subdivided into lots of exceptionally small rooms. 10 Too many bedrooms, not enough square metres? So, if we are interested in 0 housing space, why not measure it directly? Figure one UK Italy Spain Cyprus France Malta shows the average residential SwedenIrelandAustria Finland Greece Denmark Germany Portugal Belgium floor space per capita in Netherlands Luxembourg Western Europe. The UK Figure 1: Residential floor space (in m2) per capita, 2008 comes second to last. All this Source: Entranze/Enerdata (2014) http://www.entranze.enerdata.eu/ housing space that Dorling wants to redistribute is simply homes might become necessary ever had before. But a few not there. Irritatingly, Dorling in the future, if high levels of have been taking far more himself briefly alludes to the net immigration continue for than their fair share” (p313). fact that ‘lots of rooms’ does a long time. But, for now, it is Dorling’s solution, then, is not not automatically mean ‘lots of wholly unnecessary, because to build new homes – an option space’ (p195), but then chooses “everyone in Britain could be he repeatedly dismisses – but to ignore this distinction. adequately housed within the to redistribute the existing existing housing stock” (p100). housing stock: Kick the rich out Small houses in the The problem, Dorling believes, of their homes, and put the wrong place is purely a distributional one: poor into them. The supply side problem of the UK housing market is vastly greater than this graph suggests. ALL THIS HOUSING SPACE THAT The housing stock is inadequate DORLING WANTS TO REDISTRIBUTE in total, but much of it is also in the wrong place. For more IS SIMPLY NOT THERE than three decades, the UK has been building fewer new homes per 10,000 inhabitants than “[T]his book is […] concerned For the first two thirds of the any other country in Europe not with an absolute lack book, Dorling simply repeats (Eurostat, 2010). The spatial of housing, but with the his assertion that there is an distribution of the housing stock problem of how that housing is abundance of housing which therefore does not reflect the distributed” (p.65). Or: “What is just poorly distributed. It is southward shift of economic is reducing the chances of […] only then that he provides the activity which has taken place in the badly housed, most is not ‘evidence’ for this claim, on the same period, it is still built government’s failure to ensure which his whole book depends, around the economic geography that houses are built, but rather in the form of a graph which of decades ago. other people’s overconsumption shows the number of rooms per Dorling is also wrong to of housing” (p209). And capita. This number has gone treat supply side issues and elsewhere: “We have already up from around 1 in 1911 to distributional issues as entirely built enough homes. We have 2.5 in 2011. separable. In reality, constraints more bedrooms than we have So Dorling measures housing on the total supply can also 08 REBUTTAL

During that period, the share of households renting privately fell from 89 per cent to 9 per cent; it has since recovered to 18 per cent. Rent controls are rejected by virtually every • Dorling claims that there is no undersupply of economist currently alive, housing in the UK. There are more than enough including economists such as homes, they are just poorly distributed. The Paul Krugman who position basis for this claim is that there have never been themselves firmly on the so many rooms per person in the UK. political left. Dorling also • The solution, therefore, is not to build more claims that markets only work houses, but to redistribute the existing housing when we can opt out of them stock through state rationing. entirely, which is why housing • Yet the only reason for this apparent abundance could not be left to the market. of rooms is simply that British houses have been By that standard, we should subdivided into ever-smaller rooms. also have state rationing of • Looking at floor space rather than the number food, clothing, and other goods of rooms points in the opposite direction. for which we do not have the • There is a lack of supply, and it is exacerbated by ‘none of the above’ option. the fact that much of the existing housing stock What is perhaps most is in the wrong place. frustrating about the book is • The reason is that over the past three decades, that it completely ignores the the UK has built fewer new homes (per 10,000 whole empirical literature on inhabitants) than any other country in Europe. the determinants of housing • All of the literature points to planning market performance (for an constraints as the main impediment to overview, see Niemietz, 2012, development. Rather than redistributing the pp.74-80). This is a well- shortage, we should therefore liberalise researched topic, but is ignored. planning, and give way to a sustained In a sense, though, Dorling construction boom. has no choice. Most of that literature points to building constraints and supply-side lead to a more inefficient use purpose-built owned retirement issues as the problem and of that supply. In the UK, the homes. […] Britain’s planning these do not fit the conclusion same planning constraints controls […] make it extremely at which Dorling wishes to which prevent the construction difficult for developers to build arrive. In housing markets, of sufficient numbers of houses the sort of housing that older demand curves really do slope also prevent older people from people would like to move to. downwards and increases in downsizing, and freeing up supply do reduce prices•

Kristian Niemietz FOR MORE THAN THREE DECADES, IEA Research Fellow THE UK HAS BEEN BUILDING [email protected] FEWER NEW HOMES PER 10,000 INHABITANTS THAN ANY OTHER COUNTRY IN EUROPE References The Economist (2014) ‘Don’t move, old some of the housing space people! Planning laws make it harder Conclusions for retirees to downsize’, print edition, that is already there. As The Dorling’s attempts at economic 4 January 2014. Economist (2014) explains: reasoning simply do not stack Eurostat (2010) ‘Housing statistics in If old people could be up. He claims that “[o]ld rules the European Union 2010’. persuaded to sell up, the young that worked so well in the Evans, A. and O. Hartwich (2005) would benefit. Many want past and that still work well ‘Unaffordable housing. Fables and to. According to polling by elsewhere today include rent myths’, London: Policy Exchange Demos, a think-tank, 58% of controls” (p70), apparently and Localis. older people are keen to move oblivious to the fact that rent Niemietz, K. (2012) Redefining the and one in four is interested controls have failed wherever poverty debate. Why a war on markets in the idea of a retirement they have been tried. In the UK, is no substitute for a war on poverty, property. But they have few Research Monograph 67, London: rent controls were introduced Institute of Economic Affairs. options. Britain has just 106,000 in 1915 and liberalised in 1989. 09 BITCOINTHE FLIPSIDE OF MONEY

In a new IEA publication, New Private Monies – a bit-part player, author KEVIN DOWD examines the prospects for new forms of private money – and asks whether innovations such as Bitcoin will be the money of the future PRÉCIS

itcoin is very much in the thinking behind Bitcoin in an email spend. The solution is then verified news these days, and announcing its launch on February by the network. The process is opinions about it are 11, 2009: designed in a way that ensures that divided. “The root problem with the amounts produced are almost B Its proponents see it as conventional currency is all the trust exactly known in advance. Anyone the money of the future with far- that is required to make it work. can mine for Bitcoin, but the rules reaching implications, not just for The central bank must be trusted are constructed so that the money, but for the broader social not to debase the currency, but the total amount ‘mined’ can never order and especially the balance of history of fiat currencies is full of exceed 21m. power between the individual and breaches of that trust… the state. Sceptics see it as a modern Bitcoin’s solution is to use a BITCOIN AS TRANSACTIONS MONEY day tulip mania, a bubble that is peer-to-peer network to check for The first Bitcoin trade occurred bound to burst. double-spending…the result is a on April 25th, 2010 and the first So what is all the fuss about? distributed system with no single Bitcoin price was three cents. Early Bitcoin is the most successful point of failure.” prices and quantities were low but of a new type of currency known once it got going, the market price as crypto-currency, a form of rose strongly and went from peak anonymous computer currency to peak, after each of which it fell based on the use of strong back. The last big peak was almost cryptography to control the IT IS ALREADY $1,200 late last year and it is now creation and transfer of money. WIDELY USED IN trading at about $450. Thus, the It was invented in 2009 by an price has risen enormously since anonymous programmer using the THE KREUZBERG the market started but has also name Satoshi Nakamoto. Its key been very volatile. innovation is that it is completely AREA OF BERLIN One source of demand for Bitcoin decentralised and has no central was the online illegal drugs market authority or organiser whatsoever. AND IS RAPIDLY Silk Road, famously described as Bitcoin is a type of e-cash system the “Amazon.com of illegal drugs”. in which there is no central body GROWING IN This market used Bitcoin as its to authorise or track transactions; currency and operated on the dark instead, these tasks are carried out POPULARITY web, making it difficult to shut BITCOIN down. Silk Road was finally closed collectively by the network itself. AROUND THE THE FLIPSIDE OF MONEY Transactions are carried out using down in October 2013 after its a digital ‘coin’ that uses public- owner became careless, but within key cryptography. When a coin is WORLD a short time a new Silk Road 2.0 transferred from A to B, A adds B’s was operating and providing the public key to the coin and digitally same service as its predecessor. And signs the coin using a private key. B MINING BITCOINS doubtless, should Silk Road 2 fail, then owns the coin and can transfer Bitcoins are created in a process Silk Road 3.0 would soon arise in it further. The network collectively known as ‘mining’. This process its place. maintains a public list of all previous uses computer power to search Bitcoin is being used for transactions and before any coin for solutions to pseudo-random ordinary legal transactions as is processed, it is checked by the number computational problems well. It is already widely used in network to ensure that the user in a way analogous to a gold miner the Kreuzberg area of Berlin and hasn’t already spent it. This prevents looking for gold. Finding solutions is rapidly growing in popularity a user from illicitly spending the is not easy, but when a Bitcoin around the world. Reasons for same coin over and over again. ‘miner’ hits upon a solution, he using Bitcoin include it having Nakamoto explained the is rewarded with Bitcoin he can lower transactions costs and being

IS BITCOIN IN A BUBBLE? The price of Bitcoin has risen from 3 cents on April 25th, 2010 to about $450 today – an annualised rate of increase of about 300 per cent. It is therefore difficult to deny that Bitcoin is in a bubble. However, it is a bubble unlike the tulip one. At the height of the tulip mania one could reasonably say that a tulip was not worth a fortune in Amsterdam real estate and hence the market was over-priced. With Bitcoin, on the other hand, there is no ‘natural’ benchmark to tell us whether it is over- priced or not. The reason is because Bitcoin has no other use-value – unlike a tulip. This, in turn, means that whilst the price of tulips was never going to fall to zero, the price of Bitcoin might – and eventually probably will. However, if it becomes widely used for transactions, its value may hold.

11 Table one: BITCOIN and the FUNCTIONS of MONEY crypto-currencies that were able to achieve stable purchasing power through elastic but fully automatic Function How does BITCOIN measure up? supply schedules that accommodate demand changes, and which also Bitcoin can be used quite widely have the ability to maintain state- Medium of exchange but is by no means universally of-the-art security. Such crypto- accepted currencies would also avoid the boom-bust cycle to which Bitcoin Bitcoin’s value fluctuates widely, is prone. The purchasing power of though this may change if the Bitcoin varies according to demand demand for Bitcoin becomes more arising for various different reasons A store of value stable. Bitcoin does not have a – including speculation. A currency tendency to systematically fall in the supply of which was designed value like government money to stabilise its purchasing power is more likely to become generally The fluctuating value of Bitcoin acceptable. Means of deferred payment makes it difficult to use as a means of deferred payment BROADER IMPLICATIONS OF BITCOIN Bitcoin can easily be used as a Bitcoin and associated innovations A unit of account unit of account or be converted also have broad implications. into other units of account Bitcoin has no regard for international borders and can be used by anyone with access to the cheaper for retailers than credit computing technology are surely internet. As one blogger put it: cards. There are also Bitcoin ATMs, inevitable, but Bitcoin automatically “As long as my encrypted which exchange dollars for Bitcoin, corrects for improvements in [Bitcoin] wallet exists somewhere and companies are starting to pay cryptographic technology or in the world, such as on an email their employees in Bitcoin. Even computational power. Routine account, I can walk across national some universities now accept fees in improvements in computational borders with nothing on me and Bitcoin. You can also use Bitcoin to power should therefore pose retrieve my wealth from anywhere donate to organisations that no problem. in the world with an internet the government does not like, such Nonetheless, in the longer run, connection.” as Wikileaks. Bitcoin is almost certain to fail – and This gives Bitcoin great potential as an internationally mobile store of value that offers a high degree of security against predatory IN THE LONGER RUN, BITCOIN IS governments. Indeed, Bitcoin now ALMOST CERTAIN TO FAIL – AND

THIS IS NO BAD THING Kevin Dowd

More generally, it is interesting this is no bad thing. The pioneers in to consider whether Bitcoin fulfils any industry are rarely the ones who the functions of money as normally last longer term: who remembers New Private understood by economists. Bitcoin Betamax from the early days of the certainly has at least some of the video industry? Bitcoin might have Monies characteristics that are required been the first successful crypto- – a bit-part player of money: it is scarce, divisible, currency, but it is not yet clear portable and acceptable (at least to whether being the first mover in this some extent). But, does it fulfil the area is an advantage in the longer functions of money? This issue is term. After all, major design flaws in considered in Table 1. the Bitcoin model are set in concrete and competitors can learn from RISKS TO BITCOIN them. The crypto-currency market is Bitcoin is however vulnerable to also an open one and a considerable threats. One source of threats number of new competitors have is cryptographic. Modern already entered the field. Most cryptographic systems depend on of these will probably soon fail, the assumption that an attacker but, as competition in the market develops, no-one can predict which would need a very long time – New Private decades in fact – to decrypt a crypto-currencies will be best suited Monies – a bit-part message, and it has been argued to the market and achieve long-run that this could change in the face success. My guess is that Bitcoin player? can be downloaded of future advances in technology will eventually be displaced by for free at (for example, the development other crypto-currencies with www.iea.org.uk/publications/ of quantum computers) or superior features. research/new-private-monies- in mathematics (such as new The ideal – the gold standard in a-bit-part-player algorithms). Major advances in this area – would be one or more 12 PRÉCIS

fulfils the role once met by bank would carry on. AJP Taylor put it: secrecy – the ability to protect one’s For a long time now, individual “Until August 1914 a sensible, financial privacy. freedoms have been subject to law-abiding Englishman could pass In this context, it is useful to more and more exceptions: there through life and hardly notice the note that the designers of crypto- were exceptions to counter money existence of the state, beyond the currency sought to create, not laundering, terrorism, offshore post office and the policeman... just a new currency, but a new financial centres that offered low He could travel abroad or leave his anarchist social order, a crypto- tax rates and payments to whistle country for ever without a passport anarchy in which: blowers and organisations on or any sort of official permission. He “the government is not government blacklists. We have could exchange his money for any temporarily destroyed but gone from a situation where privacy other currency without restriction… permanently forbidden and – including financial privacy – was Substantial householders were permanently unnecessary. It’s respected, to one where it is now occasionally called on for jury a community where the threat openly repudiated. service. Otherwise, only those of violence is impotent because Strong cryptography offers the helped the state who wished to violence is impossible, and violence potential to swing the balance of do so.” is impossible because its participants power back toward the individual. So is Bitcoin the money of the cannot be linked to their true Censorship, prohibition, oppressive future? Probably not. But crypto- names or physical location.” taxes, financial repression and currencies might be • There is no easy way in which repression generally, are being the government can prevent the undermined as people increasingly Kevin Dowd use of Bitcoin to evade government escape into the cybersphere Professor of Finance control. The combination of where they can operate free from and Economics anonymity and independence government harassment. Durham University means that governments cannot If this sounds extreme, it was Business School bring down Bitcoin by conventional perfectly normal a century ago. As [email protected] methods, although they may occasionally catch individuals and organisations that are careless. They cannot bring Bitcoin down by taking down particular individuals or organisations because the system is not dependent on any individual or organisation: there is no single See our interview with point of failure. They could shut author Kevin Dowd at: down any individual sites they www.iea.org.uk/multimedia/ wanted, but the Bitcoin community video/bitcoin-the-flipside-of-money

13 Why they don’t tell you

about

MARK PENNINGTON critiques PROFESSOR HA JOON CHANG’s 23 Things They Don’t Tell You About Capitalism (Penguin Books)

Professor Ha Joon require rules in order to function liberal market economy. Some Chang has become effectively – laws to enforce economists would see Hayek something of a hero to contracts, for example. as having gone too far, others those who champion Anyone who has even not far enough, but there is no heterodox economic cursory familiarity with Nobel contradiction between the way Ptheory and who rail against the Prize winning ‘free market that Hayek argues for specific supposed intellectual hegemony economists’ such as Ronald policies and his overall defence of ‘neo-liberalism’. His books Coase, James Buchanan and of the free market. Most free are often recommended pre- F. A. Hayek – none of whom market economists are not reading for economics students, are cited or mentioned in 23 anarchists. especially his best seller Things – would know that To suggest that there is no such 23 Things They Don’t Tell You they have never denied that thing as a ‘free market’ because About Capitalism. However, markets depend on institutions there is no strictly objective throughout 23 Things, Chang and rules.* Indeed, much of way to define the boundaries misrepresents his opponents’ their work involves explaining of the state and the market is views and spends much of his the institutional context in equivalent to saying that there time knocking down “straw which markets can operate is no such thing as democracy men”. If students wish to successfully. because no ‘pure’ form of understand the case against There is legitimate scope democratic organisation has open market policies, a better for disagreement on the ever existed or is ever likely book would be One Economics, appropriate extent of the to exist. We don’t have, for Many Recipes by Dan Rodrik market and the precise role of example, electronic popular (2007: OUP). Readers should the state. All economists can do voting on every single political think twice before taking is to use their theoretical tools issue. We elect representatives Chang’s popular books to offer some general guidance using various systems of voting too seriously. about the effect of drawing the at regular elections. boundaries one way or another. Do “free” markets exist? In The Constitution of Liberty, Chang on free trade, markets One of the first ‘myths’ that for example, Hayek sets out a and development Chang sets out to correct is the range of government actions, Summarising his work in very idea of a ‘free market’. He including basic social security Kicking Away the Ladder and argues that the ‘free market’ measures, educational provision Bad Samaritans, Chang tries doesn’t exist because all markets and environmental controls to debunk the claim that are embedded in political and which he judges compatible free trade and open markets institutional relationships and with the basic principles of a are the key to prosperity in

* Editor’s note: I regularly drink coffee out of a mug with a quotation from Coase: “Without appropriate institutions no market economy of any significance is possible.” 14 REBUTTAL 2 developing countries. He claims central planning. Free trade ‘infant industry’ protection did that, historically, free trade is especially important for not experience strong growth. was rarely – if ever – practised smaller countries in extending The US overtook Britain in the by developed nations such the benefits of good domestic nineteenth century largely by as Britain and the US. To the policies. However, countries can increasing labour productivity extent that they prescribe free often grow to a reasonable level in the service sector – and not trade for today’s developing of prosperity from a situation through gains in protected nations, therefore, free market of extreme poverty simply from manufacturing sectors. Similarly, economists and their political good domestic institutional high growth in Argentina and supporters are guilty of a ‘do as I reforms. The fact that Britain and Canada in the late nineteenth say, not as I did’ hypocrisy. What the USA had varying degrees of century was largely due to the developing world needs protectionism in place during growth outside protected industries. Protection in Britain – notably the Corn Laws – slowed TO PUT IT MILDLY, CHANG industrialisation. OFFERS A HIGHLY SELECTIVE VIEW Reading Chang’s book one is left with the impression OF THE EVIDENCE that Europe and the United States during the Victorian is the freedom to pursue the industrialisation does not imply era were models of Keynesian protectionist industrial policies that it was the protection that interventionism, even though that Chang himself favours. caused the growth – this is they had government The economic success stories of elementary. Nineteenth century expenditures between 5 and East Asia owe their prosperity America was a large country that 10 per cent of GDP, minimal to high levels of state benefited from the creation regulation and virtually intervention and not to ‘neo- of an enormous internal free non-existent welfare states. liberalism’, he argues. trade zone. Europe and America of today, To put it mildly, Chang offers Significantly, Chang fails to by contrast, are depicted as a highly selective view of the mention any empirical literature practitioners of rampant laissez evidence. But, firstly, few if any that shows protectionism causes faire – even though government free market economists have development relative to other spending runs at between ever claimed that Britain or the factors. Douglas Irwin and 40 and 60 per cent of GDP US were historical paragons Stephen Broadberry have shown alongside escalating regulation. of free trade. At most they convincingly that the sectors Chang’s analysis of East have suggested that, relative of the US economy that were Asian development is no more to previous historical eras, supposed to benefit most from impressive. Though it is true nineteenth century America and especially Britain benefited from a broad package of market- THE MARKET… oriented policies of which free trade was a part. Similarly, such ACCORDING TO CHANG economists have been foremost in attacking the residual “The free market doesn’t exist. Every market has protectionism that exists in the some rules that restrict freedom of choice” developed world today – for 23 Things: 1 example, the European Union Common Agricultural Policy. “If there is nothing sacred about any particular Secondly, Chang misrepresents market boundaries that happen to exist, an attempt the place of free trade in the overall package of institutions to change them is as legitimate as the attempt to and policies supported by defend them” free market economists. The 23 Things: 8 classical liberal case has never been that international trade “Recognising that the boundaries of the market is the engine of development are ambiguous and cannot be determined in an per se but that free trade offers objective way lets us realise that economics is not an extension of the benefits a science like physics or chemistry, but a political provided by good domestic policies such as improvements in exercise. Free market economists may want you to the security of property rights, believe that the boundaries of the market can be largely private ownership of scientifically determined, but this is incorrect” industry and a broad reliance 23 Things: 10 on competition rather than

15 that South Korea and Taiwan occurs in chapter 15 where to fully understand. Thus, there pursued protectionist policies Chang claims that ‘they’ – the are often advantages from during the 1960s and 1970s and ‘free market economists’ - restricting individual choice in experienced strong growth, attribute lack of development order to reduce the complexity their performance was eclipsed in poorer countries to the of the problems people face. by that of Hong Kong and absence of entrepreneurial One way to do this is to rely Singapore which operated much spirit. From Peter Bauer in on administrative hierarchies, closer to a free trade model. the past to William Easterly such as firms, which operate on China post 1978 meanwhile, in the present, free market internal command and control though it is far from a laissez economists have argued that procedures. The existence of faire economy, has undergone entrepreneurship is a universal corporate firms which ‘plan’ one of the most significant aspect of the human condition. their activities demonstrates, according to Chang, that so called ‘free market economies’ CHANG SEEMS TO ASSUME, are to a significant extent ‘planned’ – and that the IMPLICITLY, THAT POLITICIANS existence of such hierarchies DO NOT SUFFER FROM THE SAME demonstrates that ‘planning’ is often superior to more BOUNDED RATIONALITY THAT decentralised structures. Similarly, rules and regulations EVERYBODY ELSE SUFFERS FROM that limit choice can result in better decisions. Just as economic liberalisations in world In poor countries, productive consumers who have limited history – a liberalisation that entrepreneurship is held back attention spans often simply buy has promoted unprecedented by poor institutions. Social well-known brands rather than economic growth. Not and political institutions need investigate unknown products, surprisingly, Chang is quick to channel entrepreneurship rules and regulations can reduce to claim that the continuing towards voluntary exchange and the complexity of the choices existence of industrial policies positive sum games rather than people face and limit the things and active government rent-seeking activity focused that may go wrong. From involvement in the financial on the predatory transfer of this Chang concludes that we sector are the cause of this wealth. The primary obstacle should see greater government growth. Yet, as Jasheng Huang to the poor in much of the regulation not as an inhibitor of has shown, the growth that developing world is the absence economic growth but as a way started the Chinese economic of secure title to property and a of reducing uncertainty. boom had little to do with such maze of regulatory restrictions Unfortunately for Chang, ‘free policies – it was the result of which confine people to the market economists’ have already a huge boost in agricultural ‘informal sector’ and which anticipated these arguments. productivity following Deng’s benefit predatory elites. Chang Indeed, the development of the massive programme of rural offers no account of how these idea that firms are important privatisation in the early 1980s. obstacles would be addressed by for planning within hierarchies Insofar as the Chinese have protectionism and regulation. was cited in Ronald Coase’s developed successful industrial Indeed, protectionism gives Nobel prize acceptance speech. companies (such as Lenovo) more power to the elites in The foundational paper was these have been Chinese in poor countries and entrenches published nearly 80 years ago! name alone and have tended their position. Hayek and Vernon Smith have to be foreign or Hong Kong done more than anyone to owned or registered. Far from Chang’s very examine bounded rationality China’s system of financial bounded rationality and the role of hierarchy controls being the cause of their In chapters 16 and 19, Chang and rules as social ordering success it has been the ability asserts that free market mechanisms. The key issue is of entrepreneurial start-ups to economics rests on the view not whether there should be exit from these restrictions and that actors are fully rational and planning but who plans what to re-enter China on the more that individuals always know and how is it decided? liberal terms granted to ‘foreign what is in their best interests More subtly, Chang misses investors’ that has been critical. when deciding to buy, sell and the point that, under bounded invest. However, drawing on rationality, there is uncertainty Is it their fault that they Herbert Simon he argues that about what types and levels of are poor? people often do not know what hierarchy and which rules are Perhaps the worst they are doing because the desirable. Market competition misrepresentation of free limitations of the human brain plays a key role in determining market economics in 23 Things make the world too complex how much hierarchy, and what

16 REBUTTAL 2 rules we should have. As Coase government planning is imposed regulators. As Jeffrey Friedman said in his Nobel address: “To on all. The scope for learning is has shown in some detail, the have an efficient economic diminished because we do not problems that afflicted the system it is necessary not only to have price signals to indicate financial sector arose in large have markets but also areas of which models are successful part from the inability of policy- planning within organisations of and which are unsuccessful. makers to comprehend the the appropriate size. What this When governments plan, they combined effects of the maze mix should be we find as a result have to determine the right of inter-connecting regulations of competition”. (716). model in advance. Chang seems that have accumulated over the Chang may not believe to assume, implicitly, that last fifty years. Regulators are as that these things are best politicians do not suffer from subject to bounded rationality determined by competition the same bounded rationality as anyone else but, with their but in 23 Things he gives no that everybody else suffers from. unique powers of coercion and explanation as to why and, immunity from competition, more seriously, no indication The financial crisis they have the capacity to do to his readers that his points Not surprisingly, Chang argues enormously more harm. Before have already been considered that the financial crisis was the crash, central banks kept in some depth by ‘free market caused by intrinsic problems interest rates at excessively economists’. in financial markets and that low levels; regulators induced In a market economy certain complex financial government-backed mortgage voluntary co-operation enables products should be banned. companies to relax lending people to develop a range There are many different requirements for low income of competing institutional views of the causes of the families; international capital structures and to discover which financial crisis. However, it is regulations encouraged banks are best suited to different certainly arguable that the to securitise risky mortgages and tasks: big firms, small firms, major lesson is not the need invest in complex products; and owner-managed firms, joint for more regulation but for deposit insurance and implicit stock companies, partnerships, greater competition between bail-out guarantees reduced mutuals and cooperatives all different forms of regulation in incentives to avoid excessive risk. compete for workers, sales and order to reduce the risks arising In all these ways – and others investment capital. By contrast, from the bounded rationality of – coercive government rules induced all manner of disastrous unintended consequences. When it comes to complex CAPITALISM WITHOUT THE financial products, market participants can adopt an easy CARICATURES: ‘rule of thumb’ when faced with USEFUL READING FOR decision-making complexity – ‘if you don’t understand it, STUDENTS OF ALL AGES then don’t buy it’. This is not an option they face when Douglas A. Irwin, Free Trade Under Fire, Princeton dealing with centrally imposed University Press: regulations and mandates. http://press.princeton.edu/titles/9027.html Conclusion William Easterly, The Tyranny of the Experts: If we are to understand free economists, dictators, and the forgotten rights of market economics, then it is best to read some of the original the poor, Basic Books: authors. Chang has done some http://williameasterly.org/books/ respectable work in economics. However, his popular works, Alan H. Meltzer, Why Capitalism?, OUP, USA: such as 23 Things, would serve http://global.oup.com/academic/product/why- a better public educational capitalism-9780199859573?cc=gb&lang=en& function if they made a greater effort to present what ‘free Eamonn Butler, Foundations of a Free Society, market economists’ actually Institute of Economic Affairs, available free online: argue rather that resort to crude and simplistic caricatures• www.iea.org.uk/sites/default/files/publications/ Mark Pennington files/IEA%20Foundations%20of%20a%20Free%20 Professor of Public Policy Society%20web%2029.10.13_0.pdf and Political Economy King’s College, London [email protected]

17 MATT RIDLEY is one of the country’s leading authors in the fields of science and economics. His recent book, The Rational Optimist, has been widely admired and his Times columns are a weekly “must read”. Matt won the 2014 IEA Free Enterprise Award. In this interview with IEA Editorial Director, PHILIP BOOTH, Ridley discusses why he believes the economic future is bright and how we could undermine economic progress

the RATIONAL OPTIMIST

You are the winner of the IEA’S jeans had been cut by two thirds. specialization, driving innovation 2014 National Free Enterprise I became a bit evangelical on and encouraging collaboration Award and you are a champion of the topic, because I could see that between people as they work for enterprise, though coming from young people were still being told each other. a scientific rather than economic that no matter how much better background. Can you give us some life had got, the future was still Your most recent book was called idea about the extent of human relentlessly bleak. There seemed The Rational Optimist. That progress over the last 200 years? to be almost a conspiracy to avoid presumably suggests you think What key statistics sum up that talking about positive trends. “It progress will continue. What makes progress? is the long ascent of the past that you so confident? What scientific I realised a few years ago that gives the lie to our despair”, said and economic processes are the key all the relentless pessimism I had H G Wells. “On what principle is to future progress? been fed by so-called experts when I was student – about the inevitability of economic, ecological I WANT YOUNG and humanitarian disaster before the century was out – had been PEOPLE TO DARE wrong. In my lifetime, globally, per capita income had trebled, lifespan TO BE OPTIMISTS had increased by a third and child mortality had fallen by two-thirds. it that, when we see nothing but Good as things are today compared The world was becoming steadily improvement behind us, we are to with any time in the past, this world and measurably healthier, happier, expect nothing but deterioration is still a vale of tears compared with cleaner, kinder, safer, more peaceful before us?” said Lord Macaulay. So what it could be, and probably will and more equal. Yes, really: when I want young people to dare to be be in the future. That, by the way, I looked up the data, that’s what I optimists. is why my rational optimism is the found. Forests were expanding, rare I call my optimism “rational” very opposite of what Voltaire’s Dr species were coming back, famines because it’s evidence-based, not Pangloss believed. He went around were getting less frequent, poverty built on mere hope. And because saying all is for the best in the best was disappearing. And the time it behind it lies a persuasive rationale of all possible worlds – that the took for a person on the average for why it happens – through world is perfect and cannot be wage to earn the price of a pair of the growth of exchange and improved. That’s what the word 18 INTERVIEW

“optimist” meant, when coined by the population has risen in recent achieved by the use of fertiliser on Voltaire. He was mocking theodicy, decades. Why did that happen? improved varieties of crops. Africa which argued that since God made In my lifetime the population of has yet to experience the same the world it must be “optimal”, the world has doubled, which many change, and its yields have hardly and even suffering must be a predicted would lead to ever more improved over the same period. good thing, and improvement is famines, shortages and price rises. In So just getting fertiliser, tractors, impossible. That’s what pessimists fact the price of wheat has halved in pesticides and better seeds to that believe today, especially those in the that time, and the calories available huge continent would be a huge green movement, who reject new per person have increased on green revolution. technologies lest they make the every continent. The cause is yield But we could, and almost world worse. improvements caused by synthetic certainly will, experience another I see two chief reasons fertiliser, tractors replacing oxen, step change now we can use genetic that improvements to living better crop protection through modification to generate salt- standards will continue. One is chemical pesticides, better varieties tolerant, drought-resistant, pest- the inexorability, the inevitability through plant breeding and genetic resistant, nitrogen-efficient crops. of progress. There was only one modification – and more trade, We can also improve the quality, year since 1945 when the world meaning regions can specialise in rather than just the quantity, economy failed to grow – 2009 – crops they grow best. of food by fortifying crops with and it shrank by just 0.9 per cent. It is astonishing to realise that vitamins, minerals, micro-nutrients It grew by 5 per cent the following we need 65 per cent less land to and omega-3 oils. It is a genuine year. People raise each other’s grow the same quantity of food crime that the environmental living standards by profiting from as we did when I was born – that movement has prevented these delivering improvements for other is a calculation done by Jesse improvements in Europe and people, and although chiefs, priests Ausubel of Rockefeller University elsewhere with devastating and thieves are quite good at based on the yield improvements humanitarian and ecological consequences.

THERE WAS ONLY ONE So, if you were an 18 year old reading this magazine, am I right in YEAR SINCE 1945 WHEN saying that you would expect to be better off than your parents? THE WORLD ECONOMY I like to quote two statistics to FAILED TO GROW – 2009 – illustrate how much better off a teenager is today compared with his AND IT SHRANK BY JUST 0.9 PER parents or grandparents. The first, which I got from Don Boudreaux, is CENT. IT GREW BY 5 PER CENT THE that on the average wage it takes 41 minutes to earn the price of a pair of FOLLOWING YEAR jeans. In 1982 it took your parents 1 hour and 50 minutes to earn enough money on the average wage to buy stopping them, they just cannot in each the world’s main crops. He an equivalent pair of jeans. keep up. It is getting harder and thinks we may now have reached The second, which I calculated harder for them. They cannot turn “peak farmland”, meaning we from a study by the economist the internet off; they cannot shut can actually reduce the acreage William Nordhaus, is that it takes down world trade; they cannot devoted to growing food while half a second to earn enough stifle curiosity. A thousand years continuing to feed a growing and money to turn on a lamp with a ago, in a simpler world, predators ever more affluent population. compact fluorescent bulb for an could kill commerce altogether, In some countries we are already hour. In 1950, it cost eight seconds’ and often did. It’s much releasing land from agriculture for of work – 16 times as long – for harder now. nature reserves, forests and other your grandparents to earn the The second reason why I think “wilderness” uses on a large scale. same amount of light from an we “ain’t seen nothing yet” is incandescent bulb. because innovation comes from the Could we have a new green And then think of all the things recombination of ideas and there revolution? What might stop it? that your parents and grandparents is no limit on the number of ideas. The green revolution of the 1960s never had, from search engines to Therefore all the limits to growth turned India from a starving country mobile phones, from budget airlines that have been identified – running dependent on aid and imports to to carbon fibre, from genetic out of energy, or water, or minerals a grain exporter despite a huge testing to Skype. It’s an ever more – make no sense, because we can, increase in population. It was wonderful world• and do produce innovations that reduce the need for materials. We use less steel in buildings, we substitute glass fibre for copper, we cut the weight of cars. The energy consumed per unit of GDP growth is going down all the time. “Growth” often means doing more with less. Hear more from Matt Ridley at: www.iea.org.uk/multimedia/video/ One interesting fact is the extent interview-with-matt-ridley to which food prices have fallen as 19 your

the WORST of ALL WORLDS The new student loans system is hugely complex. It is likely that future taxpayers will face high costs as a result of large sums being written off. In addition, graduates will face high marginal tax rates. In many respects, the system combines the worst features of a graduate tax and a loans system, says NEIL RECORD

tudents tend to dislike to provide subsidies to those economic problems when it the idea of student prepared to delay starting to comes to students obtaining loans, often believing earn in return for the value to finance on commercial terms. that higher education society of a highly-educated The first problem is that should be “free” elite. It is argued that this elite higher education augments Sor paid for by the taxpayer. will, on average, contribute a student’s “human capital” Whilst economic arguments can disproportionately to national – in other words the future be made for certain forms of income and to the Treasury earning-power of the student. subsidy to higher education, for through tax revenue, and However, unlike when most students higher education generally enrich the economy borrowing money to buy a has significant investment value and society. house, students cannot easily in the form of higher lifetime In these debates, economists provide the bank with collateral average earnings. tend to take a middle ground. for student loans. It is difficult, This supports the argument Economists recognise the therefore, for banks to manage that students should not investment value of higher the risk of loans for higher receive government support, education. They also appreciate education. and should pay for tuition that the government might The second problem is that themselves, obtaining wish to subsidise, to some there is a significant element commercial loans from banks extent, some students because of chance in future graduate if necessary. of the benefit of a highly earnings. So banks face the On the other hand, society (in educated society. However, same uncertainty as each the form of the state) may wish there are two particular individual does when he or she 20 INSIGHT starts out on his or her career. New student loans by academic year This is compounded by the £m; English domiciled students only bank’s lack of knowledge of 10,000 each individual’s willingness to repay – by definition, student 9,000 loans are extended to a group 8,000 with no credit record. Tuition loans The first argument can be 7,000 Maintenance loans used to justify a government- 6,000 guaranteed student loans 2013-14: 5,000 £6,025m system. The second argument £m can be used to justify some 4,000 form of graduate tax. Neither argument addresses the 3,000 decision as to how much (if 2,000 2013-14: any) the state should provide in £3,483m higher education subsidy. 1,000 To some extent, the 0 government’s current student 2001-2 2003-4 2005-6 2007-8 2009-10 2011-12 2013-14 loan system in England tries Figure 1: New student loans by academic year Source: Student Loans Co. to achieve the best of all worlds – a government guaranteed loan system with volume of tuition student loans and negotiated the tuition a graduate tax repayment both granted and outstanding fees were labouring under schedule, and a 30-year write has expanded enormously (see competing pressures. off which turns out to be a Fig 1). The £9,000 cap came Universities were struggling substantial subsidy. into force for all students to make ends meet with block But I argue here that in beginning their courses from grants from the government. practice it combines the worst, 1st September 2012. In practice, These grants had not kept not the best, features of a loan nearly all universities set their up with up student numbers: and grants system. fees at exactly £9,000. Loans hence income and spending per student had fallen dramatically in real terms. At the same time, THE INSTITUTE FOR FISCAL STUDIES politicians wanted to ensure that the financial means of REPORT ESTIMATES THAT AN a family were not a barrier to university entry. This was AVERAGE OF £21,780 PER STUDENT against a backdrop of hugely IN 2014 PRICES WILL BE WRITTEN increased higher education participation, up from 14 per OFF BY THE GOVERNMENT cent of the cohort in the early 1970s to more than 40 per cent in the mid-2000s. The English student are also available to students to A solution was sought that loans system fund maintenance costs. was a compromise between Government-sponsored student The tuition loan amounts asking the general taxpayer to loans have been available in one granted each year will continue subsidise the higher education form or another in the UK since to grow strongly for another of the privileged half of the 1990. In the early years of the year (i.e. to 2014-15), and population who attended scheme, the loans were small and then flatten out as the third university and charging made available at low interest anniversary of the fee-rise runs individual students and their rates. The loans scheme was off, and the whole student families the full cost of their expanded in 1998 when a tuition body is paying £9,000 per higher education. fee cap of £3,000 per annum was year fees. The situation for There were two feasible introduced with loans to fund Scottish and Welsh students is general approaches to this the tuition costs which were rather different (and bizarrely problem. One was a “graduate repaid gradually once earnings complex) and not covered in tax” whereby students paid reached a pre-set level. this analysis. a given proportion of their A further expansion took earnings to the government on place in 2012 then the tuition Balancing the interests graduation. This would ensure fee cap was raised to £9,000 of students, universities that the risk of attending per annum. As a result of the and taxpayers university and not obtaining a 1998 and 2012 reforms, the The politicians who proposed well-paid job was spread across

21 the student body. The second is such that most have only changed regularly in the 20 general approach was a loans a hazy idea of how student plus years that they have been system where students repaid loans are repaid and no idea in existence, and the current loans to the government. The at all of the interest rates that system can hardly be regarded government guarantee deals will apply to their debt. The as a model of coherence and with the problem of lending current system involves interest clarity that is likely to be stable. against investment in human rates calculated as the sum So there is a further risk that capital identified above. The of year-on-year RPI inflation the whole system will change. chosen solution was a loans plus a variable ‘real’ rate Most of today’s students system with graduate tax (between 0 per cent and 3 per will face marginal tax rates of features. cent per annum) that depends around 41 per cent (20 per cent on earnings. This makes the income tax, 9 per cent loan Is today’s solution fair actual future rate of interest repayment and 12 per cent or effective? unknowable. When they enter employees’ national insurance) Students are given loans for the labour force, subject to when they start earning. their fees and also to cover earning above a threshold, When their earning rise above part of their maintenance students, in effect, pay a 9 £42,000, they will have a costs. That loan is forgiven per cent additional marginal marginal tax rate of 51 per after 30 years and interest tax rate for around 30 years. cent. Those who have been out of the labour force for a while (say, looking after children) will THE CURRENT STUDENT LOAN have an even more complex situation and might wish to SYSTEM IS A BAD SYSTEM... wait until their loan is forgiven after 30 years before returning IT IS BEING MIS-SOLD to full-time work given the high marginal rates of tax they is charged according to a However, whether they pay will face. complex formula. It is difficult this depends on their earnings to argue that the chosen and, furthermore, the impact Cost to the taxpayer solution is fair. Students face this has on reducing the capital The Institute for Fiscal Studies a maze of complexity. There is of the loan depends on the (IFS) has recently published a the inherent uncertainty that interest rate they are charged report (Crawford and Wenchao, students do not know the likely which varies with earnings. 2014) in which they looked in return from the course they The terms of UK Government- detail at the distribution of enter. However, the system sponsored student debt have repayments across the income range, and consequently at the amount of debt likely to be written off under the 30-year forgiveness rule. In summary, the report estimates that an average of £21,780 per student in 2014 prices will be written off by the government under this rule. Since the report assumes that the average debt starts at £44,035 in 2014 prices, this represents an average write- off of nearly 50 per cent of the real value of the debt. So, in summary, students are subjected to all the rigour of borrowing large amounts of money, and the subsequent rolling-up of interest, only to discover that, in fact, on average, half of the debt turns out to be a grant from the taxpayer. In aggregate terms, this hits the taxpayer very hard indeed. Taxpayers are led to believe 22 INSIGHT

£

that money lent to students, indeed possible) because the tax with a partial exemption and repaid out of payroll to loans will not be a burden to for the higher-paid. Lower HMRC, will indeed be repaid. them as they will only face and average earners will pay However, if the IFS is even close repayment once they earn more the tax until they reach about in its modelling, and the loan than £21,000 per annum (i.e. 50 years of age. By contrast, structure stays the same (which to students what seems like the highest fliers will pay the is unlikely), then the amount a good salary). But neither loan off fast, and, as a result, of today’s loan book that the government will have to write off in 2014 money will LOWER AND AVERAGE EARNERS probably be about £28 billion. This will rise rapidly as the WILL PAY THE TAX UNTIL THEY average loan rises from around REACH ABOUT 50 YEARS OF AGE £13,000 to over £40,000 per student as the higher tuition fees from September 2012 of these claims are accurate will pay substantially less. affect the cumulative loans reflections of reality. Graduates who choose to work outstanding. University students will not abroad are likely to pay little pay their own way - on the or nothing. Summary basis of the IFS model and Sometimes it is possible The current student loan system forecasts, taxpayers will find to develop policies that is, in my opinion, a bad system. themselves paying for about combine the best features It is bad not because students half of student maintenance of two different systems. are particularly hard done and tuition, but will only Sometimes, by contrast, similar by, or, alternatively, that they realise that this is so about compromises can lead to the are overly-subsidised. Its flaw 30 years later. worst of both worlds and this is instead lies in its design and By contrast, graduates will what seems to have happened its labelling. In summary, it is find the student loan system with the UK government’s being mis-sold. turns out to be, in practice, a student loan system• The government claims to 9 per cent additional graduate the electorate that students Neil Record are now paying their way Economist and Specialist by taking out loans for their References Asset Manager education (with the implication Crawford C. and Wenchao M. J. (2014), (In his spare time he gives that they will have to repay Payback Time? Student Debt and Loan talks to sixth forms on personal Repayments: What Will the 2012 them). It simultaneously Reforms Mean for Graduates? Institute finance, is a school Governor, claims to students that higher for Fiscal Studies, London, UK. and supports Teach First.) education is affordable (and [email protected] 23 The POLITICS of GREED It’s a fallacy to suggest that politics is free from competition, greed and self-interest, say CHRISTOPHER J. COYNE and RACHEL L. COYNE

t is often suggested that, because improvement. While markets are deciding how we would best like the pursuit of self-interest in inherently self-serving and unfair, to allocate our scarce resources. markets can lead to undesired politics is presumed to be the This logic applies to entrepreneurs, outcomes, we should give more opposite. Politics, it is assumed, is humanitarians, and, even supposedly power to politicians to able to rise above the narrow short- “publicly spirited” politicians Iregulate the economy. However, sightedness of markets in support and bureaucrats. The late James what happens when politicians are of the longer-term public interest. Buchanan won a Nobel Prize for also partly motivated by self-interest Nothing could be further from his insights into the workings of and greed? the truth and basic economics can competition in the political process. Many associate markets with explain why. Recognising that self-interest self-interest and greed whilst Economics is the study of and competition is ubiquitous has associating politics with other- purposive human action whenever important implications for the regarding, publicly-interested there is choice. The need to engage way we think about politics. While behaviour. Perhaps nowhere is this in choice is the direct result of politicians are fond of saying that view more prevalent than in the scarcity, which exists because they are motivated by the desire speeches and writings of politicians there are more human wants than to protect consumers from the who continually emphasise the resources available to satisfy these self-interest and greed of markets, importance of government for desires. Given limited resources, the reality is that their policies protecting citizens against the greed decisions need to be made regarding are the result of a competitive of markets. As Vince Cable, the how to best allocate them among political process. It is true that this UK Secretary of State for Business, an array of alternative uses. To competitive process is different Innovation and Skills said in a illustrate this, think about your own than that which occurs in markets. speech in 2010: “Markets are often life. There are 24 hours in a day. In markets, entrepreneurs must irrational or rigged. Why should Each person, no matter their level of constantly compete for the scare good companies be destroyed by wealth or education, has to decide income of consumers. They do this short-term investors looking for how to best allocate their scarce by attempting to offer a good or a speculative killing, while their time each day. Should you spend service that consumers value. In accomplices in the City make fat your time with your family, working, politics, in contrast, competition fees? Why do directors sometimes or resting? This same logic applies to occurs for the control of policy forget their wider duties when a all other scarce resources. and budgets. Politicians make an cheque is waved before them? The key implication of the appeal for votes and campaign I want to protect consumers… and prevalence of scarcity in our contributions by offering policies keep prices down and provide a level daily lives is that there is always that will favour certain interests or playing field for small business.” competition. Most people associate groups of voters over other interests The implicit assumption in this competition with markets and or groups of voters. In the UK, for and similar quotations is that profits, but this is far too narrow example, Conservative politicians people in politics are not subject to an understanding of the concept. tend to offer land-use planning the motivations that characterise Competition exists whenever, and policies that favour current home people operating in markets. If they wherever, there is scarcity and owners over those who cannot were, giving power to politicians choices have to be made. The yet afford to buy their own home. to interfere in markets would reality is that we can never avoid Labour politicians offer policies that not be guaranteed to lead to an competition and the process of tend to favour public sector trade 24 FADS & FALLACIES union members over taxpayers. 3.5 There are two undesirable outcomes. Groups will invest significant resources to lobby politicians with the goal of influencing policy to 3 achieve their own self-interested goals. This competitive, dog-eat-dog lobbying is zero-sum (or negative sum) in nature. When one group 2.5 secures part of the budget for their pet project or policy, another group cannot secure that same part of the

S billions 2 budget. Lobbying can be found in all political systems and is clear evidence of the competition and self-interest inherent in political systems. Consider 1.5 the trends for lobbying in the US for the 1998-2008 period as illustrated by Figures 1 and 2.1 Figure 1 shows that lobbying 1 expenditures more than doubled 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 over the ten-year period from $1.45 Figure 1: Total Lobbying Expenditures in the U.S. ($ billions), 1998-2008 billion in 1998 to $3.3 billion in 2008. Figure 2 shows that the number the regulation will incur the full cannot be avoided, focus must be of registered lobbyists increased cost of the new laws, while the placed on the institutions and rules from 10,406 in 1998 to 14,193 in benefits will be dispersed among that channel competitive behaviour 2008. A similar dynamic exists in the many consumers. The result is that into positive-sum outcomes. The UK. According to a 2007 study, the the affected businesses have an competitive market free from UK government lobbying industry incentive to lobby the government political manipulation and influence employs approximately 14,000 people to influence the specifics of the satisfies this criteria better than the and is valued at £1.9 billion.2 These regulation. Economists call this alternatives. In markets, competition figures suggest not only that political “regulatory capture” which refers is driven by the incentive to satisfy competition exists, but that it is a to situations where a regulatory consumer wants and demands. thriving and profitable industry. agency is influenced and controlled Whilst consumers can discipline A second, and related, outcome by the parties they regulate. This businesses by going elsewhere, it is of competition in politics is that can lead to the regulation not very difficult to discipline politicians. citizens often end up being harmed. fulfilling its intended purpose and, Elections are fought infrequently This is counter-intuitive to many also, the industry will often lobby on a huge range of issues and people precisely because they are for the regulation to raise costs to individual voters have a tiny used to associating politics with the potential competitors to the benefit chance of influencing the outcome “public interest”. To understand of incumbent firms. compared with the lobbyists. Not how average citizens can be The main point of this analysis only does self-interested competition harmed by political competition, is straightforward: competition exist in politics, but it often makes consider a scenario in which is an unavoidable part of life. consumers worse off and threatens government declares that it will Politics does not, and cannot, the entrepreneurial dynamism of the pass new regulations to protect transcend the realities of scarcity market system by fostering cronyism: consumers. The industry subject to and competition. Since competition that is the uncomfortable lesson for Vince Cable• 16,000 Christopher J. Coyne 14,000 F.A. Harper Professor of Economics George Mason University 12,000 [email protected]

10,000 Rachel L. Coyne Senior Research Fellow 8,000 F.A. Hayek Program for Advanced Study in Philosophy, 6,000 Politics, and Economics George Mason University 4,000 [email protected]

2,000 References 0 Parvin, P. (2007), Friend or Foe? 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Lobbying in British Democracy, Hansard Society, UK Figure 2: Total Number of Unique, Registered Lobbyists in the U.S., 1998-2008

1 Source of data for both figures: https://www.opensecrets.org/lobby/index.php 2 See Parvin (2007) page 10. 25 CHALKING UP SUCCESS MARIAN L. TUPY and DALIBOR ROHAC on why the world is getting better…

here is a constant stream important trends and argues of doom and gloom about that improvements in human the world – especially well-being have been linked to since the financial crisis. In the advancement of market- one of many statements friendly institutions and economic Tby Pope Francis, for example, globalisation. he said: “While the income of a minority is increasing The good news exponentially, that of the majority Average life expectancy at birth is crumbling”. Environmentalists hovered around 30 years from the and others echo this pessimism. Upper Palaeolithic Age to 1900.1 However, the world is a much Even in the richest countries, such better place than it used to as those of Western Europe, life be. But although the state of expectancy at the beginning of humanity has greatly improved, the 20th century rarely exceeded progress cannot be taken for 50 years.2 Two-thousand years ago, granted. Indeed, if we listened to annual incomes per person around the policies of the doomsayers, the world ranged from $1,073 to progress would be reversed. This $1,431 (see footnote4). As late as article reviews some of the most 1820, average global income was

26 OUTLOOK

still only poverty which is without precedent $1,274 per person. in human history (see figure In the last 200 years, there has 3). According to Brookings been a transformation. Average life Institution’s Laurence expectancy in the world today is 71 Chandy and Geoffrey years.3 In 2010, global per capita Gertz, “between 2005 and income stood at $13,037 – over 10 2010, the total number of times the level two centuries ago.4 poor people around the It is not only income and life world fell by nearly half expectancy that are improving. The a billion, from over 1.3 world’s daily calorific intake per billion in 2005 to under GLOBAL person is increasing too – this is 900 million in 2010.”10 an important indirect measure of While Africa under- PROGRESS well-being. It has increased from an performed relative to average of 2,600 in 1990 to 2,840 the rest of the world in 2012. In sub-Saharan Africa, the during the 20th century, daily calorific intake increased from African incomes REPORT 2,180 to 2,380.5 Furthermore, more increased by 41 percent children, including girls, attend between 1960 and schools (see figure 2), at all levels of 1999.11 Moreover, LIFE EXPECTANCY: education and, in wealthy countries, between 1999 to the wage gap between the sexes is 2010, African incomes INCOME: UP UP declining.6 rose by a further 36 Our lives are also healthier. The percent.12 Although prevalence rate of HIV/AIDS has the improvements WELL-BEING: UP been stable since 2001and deaths in longevity were from the disease are now declining hampered by the DISEASE: due to the increasing availability of spread of AIDS, DOWN anti-retroviral drugs. Some cancer countries that were rates are declining in industrialised less affected by the VIOLENCE: DOWN countries despite the fact that epidemic recorded cancer tends to be a rich country significant WORK HOURS: DOWN disease because its incidence improvements. increases with age. Life expectancy Workers tend to work fewer in Ghana, hours7 and suffer from fewer for example, injuries.8 We also enjoy more increased from 28 political freedom and are less likely years in 1921 to 64 years in 2011.13 to suffer from physical violence The hockey-stick nature of (see figure 3).9 progress and the fact that many In the recent decades, the places around the planet are still rise of economies in Asia – most desperately poor should remind significantly of China and India – us that there is nothing inevitable has contributed to a fall in global about progress. Even the modern

GDP, per person, 1990 international dollars GDP per person

Figure 1: GDP per person (1990 international dollars): United States and average of 12 Western European countries Source: www.humanprogress.org

27 Primary school enrollment rate, women, percentage

105 104 103 102 101 100 99 98 97 96 95 94 93 1992 1994 1996 1998 2000 2002 2004 2006 2008 Primary school enrollment rate, women World

Figure 2: World female primary school enrolment Source: www.humanprogress.org

history of the Western world is from the Industrial Revolution of and a new organisation of replete with examples of large the 18th and 19th century, which workplaces. These made possible the setbacks – including two World spread from England and the Low mass production of manufactured Wars, the Great Depression of the Countries throughout the entire goods. Simultaneously, productivity 1930s, and the most recent economic Western world. Neither can they growth in agriculture has been able calamity, triggered in 2008 by be dissociated from the rise of the to sustain larger non-agricultural the collapse of Lehman Brothers. increasingly globalised markets in populations. Furthermore, differences between the performance of different countries show how important good policy is for human progress. IN THE LAST 200 YEARS, THE WORLD

Sources of progress HAS EXPERIENCED PREVIOUSLY Explaining the forces behind progress is the single most UNIMAGINABLE IMPROVEMENTS IN important question of the social STANDARDS OF LIVING sciences. The large literature, extending from development economics, growth theory, goods, services, capital and labour These economic shifts were economic history, analysis of of recent years. accompanied by sociological institutions, to other fields, cannot The Industrial Revolution changes, including the growth possibly be reviewed here. However, involved a cluster of innovations of cities and of the working- the advances in the human relying on the use of raw materials, class population, and – more condition cannot be dissociated new energy sources, new machines importantly – by political shifts that

People living on $1.25 a day, adjusted for inflation and PPP, millions People living on $1.25 a day, People living on $1.25 a day, adjusted for inflation and PPP

Figure 3: Number of people living on $1.25 or less a day in China Source: www.humanprogress.org 28 OUTLOOK led to the emergence of modern improvements have taken place representative democracies. The in the last 20 years. Attracting the Notes transformation the Industrial attention of the public to these 1 Revolution represented could improvements through projects such See, e.g., Kaplan et al. (2000). probably not have occurred without as the Cato Institute’s new website, 2 Prentice (2006). certain institutional and cultural www.humanprogress.org, does not 3 United Nations (2012). United prerequisites, including limited imply painting a rosy picture of the Nations World Population government, the protection of state of humanity, but a realistic one. Prospects 2012 Revision. private property, and a climate that We should compare the imperfect 4 See Bolt and Zanden (2013) who is supportive of entrepreneurship provide an update of Angus and innovation. The improvements in human THE WORLD IS Maddison’s dataset. Their data, condition have been also linked to originally in 1990 dollars, are globalisation. Besides exploiting A MUCH BETTER adjusted for inflation. gains from trade, globalisation 5 See Food and Agriculture allows consumers to benefit from PLACE THAN IT Organisation of the United more efficient production methods Nations (2013). and transfers of technology. Mass USED TO BE 6 Organisation for Economic production, relying on the more Cooperation and Development efficient modes of production leads present with a much more (2013a). to cheaper goods and services, imperfect past, rather than with an 7 leaving households with more money imagined utopia. More importantly, Organisation for Economic to spend on non-essential items and our efforts to address the world’s Cooperation and Development raising global living standards. imperfections should be informed (2013b). This first era of globalisation by the fact of the huge progress 8 Bureau of Labor Statistics (2013). ended with the outbreak of that has been achieved through 9 Pinker (2011). the combination of competitive World War I and the concomitant 10 Chandy and Getz (2011). disruption of world trade. By some markets, innovation, and trade • 11 estimates, globalisation did not Marian L. Tupy and Dalibor Rohac Kaplan et al. (2000). reach its pre-World War I levels Centre for Global Prosperity 12 Ibid. until the 1970s or even the 1980s. The Cato Institute 13 Gapminder (2013). The 1980s marked the beginning [email protected] of a new period of globalisation. [email protected] Spurred by pro-market reforms both in the West and in the emerging economies, trade liberalisation, References Organisation for Economic Cooperation improvements in transport and Bailey, Ronald (2013). “Seven Surprising and Development (2013a). OECD information and communication, Truths about the World.” Reason, http:// Factbook 2013. http://www.oecd-ilibrary. globalisation got a new lease on reason.com/archives/2013/07/15/seven- org/economics/oecd-factbook-2013/ life and led to huge improvements surprising-truths-about-the-world. gender-wage-gap_factbook-2013- graph275-en in living standards amongst the Bolt, J. and J. L. van Zanden (2013). The world’s poorest people, including First Update of the Maddison Project; Organisation for Economic Cooperation those in China and India. Re-Estimating Growth Before 1820. and Development (2013b). OECD Stats Maddison Project Working Paper no. 4. Extracts. http://stats.oecd.org/Index. aspx?DatasetCode=ANHRS No Utopias Bureau of Labor Statistics. (2013). In the last 200 years, the world has Workplace Injury and Illness Summary. Pinker, Steven (2011). The Better Angels experienced previously unimaginable http://www.bls.gov/news.release/osh. of Our Nature: Why Violence Has improvements in standards of nr0.htm. Declined. Viking. living, largely unreported and Chandy, Laurence and Geoffrey Gertz Prentice, Thomson (2006). Health, underappreciated by the general (2011). Poverty in Numbers: The History and Hard Choices: Funding public. A large proportion of those Changing State of Global Poverty from Dilemmas in a Fast-Changing World. 2005 to 2015. Brookings Global Views World Health Organisation. http:// Policy Brief No. 2011-01. www.who.int/global_health_histories/ seminars/presentation07.pdf Food and Agriculture Organisation of the United Nations (2013). Food United Nations (2012). World Population Security Indicators. http://www.fao.org/ Prospects: The 2012 Revision. http://esa. economic/ess/ess-fs/ess-fadata/en/#. un.org/unpd/wpp/index.htm U0V7oqhdV6g United States Department Agriculture Gapminder (2013). Gapminder World. (2013). Estimated Calorie Needs per Day http://www.gapminder.org/data/ by Age, Gender, and Physical Activity Level. Center for Nutrition Policy and Hillard Kaplan, Kim Hill, Jane Lancaster, Promotion, United States Department and A. Magdalena Hurtado (2000). Agriculture. http://www.cnpp.usda. “A Theory of Human Life History gov/publications/usdafoodpatterns/ Evolution: Diet, Intelligence, and estimatedcalorieneedsperdaytable.pdf Longevity.” Evolutionary Anthropology 9 (4): 156–185. World Bank (2013). World Development Indicators. http://data.worldbank. org/indicator/SE.PRM.ENRR/ countries/1W?display=graph

29 The GREAT RECESSION and beyond

JOHN B. TAYLOR is one of the world’s leading macro-economists. In 2012, he was listed by Bloomberg as one of the 50 most influential people in the world in the field of policy, markets and ideas. His ideas helped shape a global revolution in monetary policy in the 1980s – specifically with regard to the adoption of “Taylor Rules” by central banks. His latest book is First Principles: five keys to restoring America’s prosperity. In this interview with IEA Editorial Director, PHILIP BOOTH, Taylor discusses the changes in macro- economic policy in the 1980s, the Great Recession and its aftermath.

There are some who regard the such as transportation and energy. good. When policy deviated from years after the Second World War as Lower prices and more innovation the rule, performance was bad. But a Keynesian golden age. However, were the result. you do not have to use a specific things began to go wrong by the Taylor Rule to see this. As you late 1970s and policy changed You are perhaps most famous for suggest it is a shift from unstable significantly during the 1980s. the development of the “Taylor discretionary policy to stable rule- How did these changes affect Rule”, a concept that is widely like policy that is important. economic performance? discussed within central banks when The significant changes in economic setting monetary policy. To what Can you give an indication of how policy in the 1980s and 1990s extent was stability in monetary widespread this change in approach improved economic performance policy responsible for the change in to monetary policy was around greatly. The inflation rate and the macro-economic performance? the world? Could we call it a unemployment rate both came I place a great deal of emphasis on “global revolution”? down, following large increases the changes in monetary policy. The changes were quite widespread. during the 1970s, and productivity In the United States, for example, In many countries—including the growth eventually picked up. The monetary policy in the late 1960s UK—the change took the form of shift in policy was largely away and 1970s was characterised by a move towards inflation targeting from the interventionist Keynesian an erratic series of go-stop shifts of some kind. The idea was that, monetary and fiscal actions which which eventually increased both by focusing mainly on the goal had become popular in the 1960s. In inflation and unemployment. In the of price stability, monetary policy both the US and the UK monetary early 1980s—under Paul Volcker’s would become steadier and less policy became more steadily focused leadership—policy became much interventionist, and the stability on price stability. The Keynesian more rule-like and predictable, and of the general price level would in stimulus packages of the 1970s went the economy improved. Many have turn be good for economic growth. out of style after many economists shown that you can detect this shift Economists have shown that this found them to be ineffective. by looking at how closely US Federal shift can also be described in terms There was also an important shift Reserve decisions can be described of policy rules, such as greater towards less economic regulation by the Taylor Rule. When policy was adherence to the Taylor Rule. But I and intervention in specific markets, close to the rule, performance was believe it was part of an improved 30 INTERVIEW 2 understanding of monetary business cycle history that followed liberalism as the people tried to economics and the advantages of recessions associated with financial wrest control of economic life from rules – following the ideas of crises. These were recoveries from vested interests. Today, the equality Milton Friedman and Friedrich the recessions that started in 1882, movement is largely dominated by Hayek – that spread around the 1893, 1907, 1913, 1929, 1973, 1981 people wishing to move to higher world. It was part of a broader move and 1990. The average growth rate taxes and to increase discretionary toward the principles of economic in the eight quarters starting with regulation still further. Do you think freedom that I wrote about in my the trough of the previous recession this would bring about a cure that book First Principles. Yes, it was a averaged about 6 per cent per year would be worse than the disease? global revolution. in these recoveries. The growth rate I see no evidence that an increase over a comparable period in the in income inequality caused Of course, things seemed to go current recovery is about 2 per cent the financial crisis. Indeed, the wrong in 2008 – or perhaps before. per year. So the weak recovery from extraordinarily good performance in A period of great stability gave rise the deep recession of 2007-2009 is a the 1980s and 1990s occurred during to a “Great Recession” which – in clear exception. a time when many have documented the UK at least – has been worse an increase in inequality. Some argue than the Great Depression in What are the reasons for that that the recent slow recovery can be some respects. What in your poor performance? traced to income inequality because view were the main causes of the In my view, the story is similar to people with high incomes save more financial crisis? the story of what got us into the than people with low incomes, I believe that the main cause was crisis. Except for monetary actions thereby raising the saving rate and that economic policy deviated from what was working well in most of the 1980s, 1990s and until recently. I THE MAIN CAUSE WAS will focus on the crisis and the Great Recession in the United States which THAT ECONOMIC POLICY I know best. Firstly, it is clear that in the period DEVIATED FROM WHAT from 2003 to 2005 monetary policy deviated from the earlier policy WAS WORKING WELL IN strategy by holding interest rates MOST OF THE 1980s, 1990s AND too low for too long. You can see this in the deviations from the Taylor UNTIL RECENTLY Rule and also in other ways. For example when the inflation rate taken during the heat of the panic lowering aggregate consumption. was near 2 per cent in 1997, the in 2008, policy has continued to But the saving rate is lower than in federal funds rate was 5.5 per cent. deviate from the basic principles of the strong expansion in the 1980s in When the inflation rate was near 2 economic freedom. This is certainly the United States. per cent in 2003, the federal funds true in the case of monetary policy rate was 1 per cent: a very different which has continued with the And, how would you deal with policy. These low rates caused a unusual interest rate policies that poverty and inequality? search for yield, excessive risk taking, began before the crisis, and added In my view the key here is improved and added to the boom in housing in other unconventional policies. access to good education and markets, which eventually led to But I think it is also evident in the other opportunities which are not the bust. While not every country outbreak of Keynesian stimulus now available to all, in many cases had the same problem, you can packages, and the resulting increase because of the vested interests you see similar developments in other in debt and concerns about policy mention. In the highly integrated countries as well. uncertainty as they are unwound. In world in which we now live, the Secondly, there was a deviation the United States we have also seen basic economic freedoms are from sound regulatory rules. This a large increase in regulatory and even more important than in was quite evident in the risk taking other interventions, especially in the the nineteenth century. And we allowed by government supervisors health care and financial sectors. know from the experience of the in the case of Fannie Mae and past thirty years, especially in the Freddie Mac in the United States, There is much concern about emerging markets, that more but it also occurred in the large inequality in the Western world. economic freedom works. It has money centre banks. One can argue Some even see it as one of the brought hundreds of millions of that the regulations were not causes of the crisis. Back in people out of poverty. We need to sufficient, but in my view the main nineteenth century England, match up the equality movement problem was not enforcing the the equality movement was with the free-market movement: existing regulations. Effectively, as a movement for free-market economic freedom for all• in the case of monetary policy, the rules were broken. View John Taylor’s IEA Hayek How poor has economic Lecture on Policy deviations performance been since the and economic growth – lessons financial crisis compared with from the Great Recession for the previous similar events? US and the UK at: The recovery is much slower than one www.iea.org.uk/multimedia/ would expect from earlier events. video/2014-hayek-memorial- Again, consider US history: there lecture-prof-john-taylor were eight recoveries in US recorded 31 MARX MISES MINSKY the ODDFELLAS Despite their differences, Marx, Mises and Minsky all believed that the problems caused by boom-bust periods were inevitable once the boom had been created. This is quite different from the modern Keynesian or neo-classical view, says IEA Education Drector, STEPHEN DAVIES.

arl Marx, Ludwig von Mises economics is why we see episodes in an increase in economic activity and Hyman Minsky make an which the level of economic activity while spells of colder weather, such odd trio. Marx was the great departs sharply from the long-term as the 14th century or the first two critic of capitalism, Mises the average level and trend. Sometimes thirds of the 17th century, led to a staunch defender the departure is in the direction decline – often severe. In this case the Kof that system and Minsky was a of more rapid growth (a boom) cause of the economic fluctuations post-Keynesian who put forward sometimes that of a significant was exogenous, from outside the proposals for radical change to decline in activity (a bust or slump). economic sphere. aspects of capitalism. Depending on the answer to this The more interesting question Despite this, their diagnoses of question, and given any particular arises in the case of modern what happens in an economic crisis understanding of economics, the economies in which there is a long in a modern economy and of the secondary question of what, if run tendency for sustained growth content and immediate cause of anything, can be done about the and the climate is largely irrelevant. booms and busts are remarkably problem can be addressed. Here the issue is that of how far similar - though their prescriptions Historically, major declines or departures from that long-term are very different. Underlying this upticks in economic activity usually trend are endogenous. They are is a shared way of thinking about had natural causes such as climactic driven by forces and processes that economics, despite their many and fluctuations. Generally speaking are internal to the economic life of profound differences. episodes of unusually warm weather, society and therefore in some sense One of the big questions in such as the 12th century, produced spontaneous or ‘natural’. 32 PERSPECTIVE

Until the 1930s, the dominant in which many productive resources they actually were. What Marx view among economists was that were not reallocated or even used pointed out was that this effect was business cycles (booms and busts) at all and consequently there would concentrated in particular sectors were an inevitable feature of a be high levels of unemployment. In or geographical areas. The second dynamic economy. In this view, other words, it was possible to have harmful effect was the creation of a there was a natural tendency for a decline produced by the natural kind of speculative mania in which entrepreneurs and investors to economic process and then be stuck herd effects and a kind of manic become excessively optimistic when in that situation. over-optimism led many investors to things were going well. This led them There are two key features of abandon normal prudence. to make more high-risk investments this way of thinking, which remains There were three further points of and create more productive capacity enormously influential. The first agreement. As a consequence of the than there was a need for (because is that, while slumps were seen boom, there would be an enormous they anticipated a future demand as problematic, booms were not amount not just of over-investment for products that then failed to seen as problematic to the same (that is, too much of something materialise). This resulted in a degree. In some ways the goal that is inherently useful to some misallocation of productive capital became that of keeping boom degree) but of “malinvestment” and labour towards the growth conditions going or returning to where productive resources are put sectors. There was a problem, in them as swiftly as possible. Secondly, into activities that will never make other words, of over-investment. while the fluctuations were seen a return and are in some sense The correct response was to as endogenous, it was argued that completely wasted. Furthermore liquidate this investment and move there was a possible response on – and this point of agreement is the resources to other areas. This the part of government. This was most closely associated with Minsky process of correction was painful but to lift economic activity out of the – eventually there will be a moment necessary. In this view booms and depressed or stagnant level on which where the unjustified optimism busts were simply a feature of the it had settled by boosting demand via suddenly vanishes and the result is cyclical development of the economy a combination of cheap money and a panic marked by a dramatic crash and the main goal of policy was to government spending. in the value of the assets that are manage the corrections so that they the focus of the malinvestment (a were as quick as possible. The three Ms “Minsky Moment”). This classical ‘liquidationist’ view By contrast with these dominant Perhaps most importantly, the ideas, the ‘three Ms all had a Three Ms all agreed that the crash different take on the question of and the subsequent liquidation of the MARX, MISES how to understand the business cycle malinvestment is both unavoidable and what to do about it. Despite and necessary. Trying to put it off will AND MINSKY ALL their very different perspectives they only make the eventual sorting out agreed on the following: of the problems caused by the boom THOUGHT THAT • They all thought that the boom even more painful and drawn out. THE BOOM WAS was where the real problem lay Of course, they all disagreed and that this was where the about a great deal. For Mises WHERE THE REAL damage was done. the cause of the problem was • All three thought that, while government meddling while for PROBLEM LAY booms could have natural causes Marx it was the logic of the class or be driven by factors internal to interest of capitalists. For Minsky AND THAT THIS the economy, they were the problem was the inherent logic enormously exacerbated by factors of the money and banking system. WAS WHERE THE that could be thought of as Consequently their solutions in DAMAGE WAS external, in particular government the longer term for avoiding the action. problem differed: for Marx it was socialism, for Mises principled laissez- DONE • The principal aggravating factor faire, for Minsky strict regulation of was an enormous increase in the financial sector. could be combined with the neo- credit, in the widest sense. For both However, while all three disagreed classical idea of a self-equilibrating Marx and Mises this was about the longer-term remedy, they economic system developed by engineered primarily by the all thought that, in the short term, economists at the end of the political apparatus, through once the boom has ended there 19th century, above all by Walras. central banks or other agencies of is no alternative to a painful but Schumpeter, for example, could government policy, while for hopefully swift adjustment. This accept that the cycle of boom and Minsky it was an inherent feature is quite different from both the bust was endogenous (that is, of the banking and credit system, neo-classicals and the Keynesians. internal to the economic system) and which he saw as in some sense The former believe that the bust can ultimately self-correcting. However, in independent of the rest of the dissipate quickly and the latter that later years, the increasingly dominant economy (and ever more so as the the problems of the boom can be tendency, typified by Keynes, Hicks boom intensified). avoided by an astute handling of the and Kaldor, was to see slumps and They all thought that this increase bust. In short, Keynesians believe that declines in economic activity as in credit had damaging effects. the hangover is the problem whereas problematic. They still saw them The first of these, particularly for the three Ms believed that the as being produced by endogenous Mises, was that the price signals to drinking binge is the problem and forces, particularly the investment investors (above all interest rates) the hangover the inevitable result• cycle, but argued that the system were systematically distorted so Dr. Stephen Davies was not self-correcting. Instead it that many business opportunities IEA Education Director was possible to have an equilibrium seemed much more profitable than [email protected] 33 SHADOW BOXING Exchanging blows on inflation, monetary policy and exchange rates... CITY VIEW

elentless intellectual It stayed at about 5 per cent for (which are banks’ assets) necessarily embattlement was a the next three years. But Lawson, led to rapid growth of their deposit hallmark of economic undoubtedly one of Thatcher’s liabilities. Deposits are money, policy in the 1979–1990 most able and articulate political because people can write cheques Thatcher premiership associates, had succeeded Howe against them and thereby make Ras the consensus thinking of the as Chancellor of the Exchequer in payments. In the year to March 1988 preceding 30 years was rejected. 1983. He was determined to combat the growth rate of the M3 money Although the key events are now a inflation by a fixed exchange system measure was 20.9 per cent and in generation ago, the battle of ideas under European auspices rather than the year to March 1989 it was much continues – the events of that time by explicit money supply restraint. the same at 21.1 per cent – see chart have important lessons for today overleaf. and are still debated. A case in point Exchange rate targeting and the Let us remember the Treasury’s was a recent exchange in the letters rise of inflation words in 1980. Not only is “a clear pages of Standpoint magazine Targets for control of the M3 money relationship between the growth between Nigel Lawson, the former measure were dropped in 1985. of the money stock and the rate Conservative Chancellor of the In March 1987 Lawson started a of inflation” to be expected “in Exchequer, and John O’Sullivan, policy of “shadowing the DM”, the medium term”, but also “the one of Thatcher’s speech-writers. which involved manipulating both proposition that prices must It recalled bitter disagreements interest rates and foreign exchange ultimately respond to monetary between Thatcher and Lawson about intervention to keep the pound-DM control holds whatever the the role of the exchange rate in exchange rate in a narrow fixed adjustment process in the shorter monetary policy. band. The consequence was that term may be”. How can two years interest rates had to be kept down of annual money growth of more Monetary control and the battle to to a level not too different from that than 20 per cent be reconciled over reduce inflation Famously, Thatcher believed in 1979 that inflation should be reduced THE THATCHER GOVERNMENT by curbing the rate of monetary growth, and not by imposing ADHERED TO DOMESTIC interventionist controls on individual wages and prices. The Treasury was MONETARY CONTROL. INFLATION familiar with her doctrines, which were widely labelled “monetarism”. DID COME DOWN. THE ANNUAL In 1980 it gave evidence to a House of Commons committee INCREASE IN THE RETAIL PRICE mentioning “a clear relationship between the growth of the money INDEX FELL FROM 21.9 PER CENT IN stock and the rate of inflation in the medium term”. Indeed, it MAY 1980 TO UNDER 5.5 PER CENT warned that “the proposition that prices must ultimately respond to in Germany. (If the exchange rate the medium term with 5 per cent monetary control holds whatever between two currencies is given, inflation? The answer is that they the adjustment process in the shorter a speculator can make a profit cannot be. term may be”. effortlessly by borrowing in the Once an economy suffers from a Lawson, Financial Secretary to low-interest-rate currency and grossly excessive monetary stimulus the Treasury in 1980, was certainly re-depositing in the high-interest- of the 1987 and 1988 variety, two aware of these views. However, he rate currency.) forecasts are easy to make. Firstly, was far from agreeing with them. Unfortunately, the interest rate the exchange rate will have sooner In an earlier column in the Financial suitable for Germany, which had a or later to weaken, whatever Weekly newspaper Lawson had somewhat larger economy than the misleading short-term buoyancy it advocated that Britain should reduce UK, was too low and inappropriate may have. Secondly, regardless of inflation by joining the European for the UK. The British financial the foreign exchange markets, too Monetary System (EMS). By fixing system had been liberalised in the rapid money growth invigorates such the exchange rate between the early 1980s, and banks were keen domestic inflationary forces as rising pound and the deutschemark (DM), to expand their balance sheets and asset prices, notably rising prices German monetary discipline would profits. The practice of “shadowing of shares, houses and commercial be enforced on the UK and would the DM” lasted for a year, until, in property. In both 1987 and 1988 break Britain’s entrenched inflation March 1988, Thatcher prevailed over house prices and commercial habits. In June 1981 Lawson wrote Lawson after a furious public row property values were soaring, while a long note to the then Chancellor and instructed the Bank of England in 1988 aggregate demand jumped of the Exchequer, Geoffrey Howe, to let the exchange rate rise above more than in any other year in the developing these arguments and the 3DM limit. In that year banks late 20th century. proposing early accession to the EMS. took advantage of the low interest The truth is that Lawson’s policy Howe did not take Lawson’s rates and grew their stock of loans of shadowing the DM had been advice and for some years the to the UK private sector by 21 per responsible for a credit bonanza, Thatcher government adhered to cent. The credit boom remained highly inflationary rates of money domestic monetary control. Inflation unchecked into the autumn of 1988, growth and a more general boom1. did come down. The annual increase which saw a peak rate of increase in By mid-1989 it was obvious that “the in the retail price index fell from banks’ loan books of almost 25 per adjustment process in the shorter 21.9 per cent in May 1980 to under cent, and persisted even into 1989. term” would be vicious. A drastic 5.5 per cent in every month in 1984. The rapid growth of banks’ loans lurch to monetary restriction had

35 1 As I forecast would happen before these events: see Congdon (1992). CITY VIEW Money growth and inflation in the Thatcher Money growth and inflationpremiership, in the 1979Thatcher - 1990 premiership, 1979-1990 Data are quarterly: RPIXData is theare quarterly;retail prices RPIX index is the retailexcluding price index mortgate interest costs excluding mortgage interest costs

30

M3 -– annual annual % % rate rate of ofchange charge

25 Annual change change in in RPIX, RPIX, % %

20

15

10

5

0 123412341234123412341234123412341234123412341234 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990

AfterAfter initial initial difficulties, difficulties, both moneymoney growthgrowth and and inflation inflation were werereduced reduced in the in first the half first of the half of the Thatcher premiership, in line with the monetarist principles to which the government had made Thatcher premiership, in line with the monetarist principles to which the government had made commitments in the 1980 medium-term financial strategy. But money growth accelerated sharply in 1985commitments and 1986, and in the after 1980 a big medium boom-term in 1987 financial and strategy.1988 inflation But money also growth started accelerated to increase. sharply A large rise in inflationin 1985 and was 1986, avoided and afteronly aby big a boomdoubling in 1987 of interestand 1988 rates inflation in the also 18 started months to increase.to October A large 1989. rise in inflation was avoided only by a doubling of interest rates in the 18 months to October 1989.

trouble ahead, resigned a few weeks responsible for the disaster. No HERE WAS after the announcement of the 15 doubt the participants in this per cent base rate. debate will defend their positions AN EXTREME Retail price inflation had already robustly. Much is at stake, since the by then accelerated to over 7 per setbacks of 1989 and 1990 ruined BOOM-BUST cent and in 1990 it was to exceed the Thatcher government’s record 10 per cent. Sure enough, inflation for economic competence, and UPHEAVAL did not return to 20 per cent, but culminated in her own departure only because the British economy from office in November 1990. THAT UPSET underwent a severe recession. But one point surely is clear, that THE FINANCIAL Whereas domestic demand had the Treasury of 1980 was correct climbed by 8.6 per cent in volume to identify and emphasize a clear PLANS OF terms in 1988, it dropped by 2.4 per correlation between money growth cent in 1991. Here was an extreme and inflation over the medium term• MILLIONS OF boom-bust upheaval that upset the financial plans of millions of Tim Congdon PEOPLE people, and in its bust phase was International Monetary accompanied by the trauma of Research lost jobs and the destruction of [email protected] to be implemented to stop annual small businesses. per cent inflation rate moving back towards the teens. Clearing bank Conclusion base rate, 7.5 per cent in May 1988, References The dispute in Standpoint between doubled to 15 per cent in October Congdon T. (1992), Reflections Lawson and John O’Sullivan was 1989 and stayed at this crisis figure on Monetarism, Edward Elgar, about the extent to which the for a year. Lawson, well aware of the Cheltenham, UK. shadowing of the DM had been 36 NOW SHOWING...

DEIRDRE McCLOSKEY on INEQUALITY

RICHARD EPSTEIN on Thomas Piketty

ART LAFFER on taxation

www.iea.org.uk/tv Renowned economist GARY BECKER, who died earlier this year at the age of 83, had a huge impact on the world of economics and beyond. Here are two of the many tributes that flowed in the wake of his sad death

TRIBUTES to a TRAILBLAZER 38 LEGENDS

benefit of a better job could offset THE MAN WHO WON A the short-term cost. It is impossible now to debate student tuition fees, for instance, NOBEL PRIZE FOR PARKING without reference to Becker’s ideas. rom crime to tuition fees, giants such as Milton Friedman, with Given that students increase their countless aspects of our lives whom he worked at the University earning power as a result of a are influenced by the late of Chicago. When awarding him university education, but also that economist Gary Becker the Presidential Medal of Freedom, there is a social benefit, who should Why did Chris Huhne George W. Bush described Becker as pay for it? And would tuition fees put need to go to jail for ‘without question one of the most off poorer students? Fdodging his penalty points for influential economists of the last Becker would not have been speeding? After all, as he constantly hundred years’. surprised (as others have been) that points out, hundreds of thousands of Becker’s contribution was to use the people most willing to pay tuition people have done this without giving the traditional tools of economics - fees have proved to be the least it a second thought. Yet Mr Huhne the analysis of supply and demand, well-off, and those least likely to pay would find his sentence less baffling the working of incentives, the have been the middle class. The cost if he reflected upon what happened weighing of costs and benefits - is the same for both groups but the the day that Gary Becker was late. and, for the first time, apply it to least well-off gain a greater benefit And in the days after the death social policy. because they have less to fall back on of the great professor, I think that’s Take, for instance, Chris Huhne without higher education. worth doing. and his penalty points. The former During his life Becker was often A little more than 40 years ago, cabinet minister thinks that he was accused of treating human beings Becker was driving to the oral exam sent to jail despite the fact that as factors of production and of a student when he realised that so many others commit the same purely self-interested. Yet this is a he wasn’t going to get there in time. crime and get away with it. In fact, complete misunderstanding. The Not only that, but he would have to a Becker-style analysis suggests that real significance of Becker’s work is park the car and there were parking he was sent to jail precisely because the opposite. restrictions all around the building so many others commit the same Becker won the Nobel Prize in which the exam was taking place. crime and get away with it. because he demonstrated the way Finding a car park would take ages in which economics was about and then he would have to walk. more than money. Understanding So here is what he did. He parked THE WORLD people’s incentives, and structuring in a forbidden area, dashed to the social institutions in response to meeting, made it on time and on HAS LOST ONE them, does not mean that people’s his way won the Nobel Prize for incentives are purely selfish. Economics. OF ITS GREAT People might have a preference The decision about where to for altruism, for example, or for park had, in the end, been relatively THINKERS community living. A market-based simple. The fines for parking outside system takes these preferences into the building were modest and, more If a crime is very hard to detect, the account. It’s quite wrong to equate importantly, they were unreliable. incentive to commit it is greater. The markets with narrow economic In other words, he might park in the benefit of the crime outweighs the selfishness. restricted area and not get a ticket. cost. As a result, you have to make This is relevant to the current Against this was the certain cost of the penalty greater so that, taken debate on free schools or the NHS. the car park and the professional together, the punishment and the risk Allowing competition and choice cost of being late for an important of punishment make transgression is not preferring self-interest over engagement. It seemed to him that too costly to be worthwhile. public spirit. It is simply structuring the benefit of the parking violation Becker’s work was very influential the system in line with people’s over legal parking was clear. on sentencing policy and prevention preferences, and these preferences As he left the car behind, he began of crime. Yet more influential still was may be charitable. to reflect on what he had done. And his impact on the field of economics. Becker’s work also shows why to wonder whether others weren’t Instead of being a study merely of non-market systems struggle. People doing it too. The standard theory how money moves around, it became calculate the trade-off between costs of criminal behaviour at the time a study of how people behave. and benefits. If the system gets in the was that criminals were mentally ill One of his most famous pieces of way of their preferences, they work or social victims. Becker, however, work concerned racial discrimination around it. That’s why tourists used realised that the decision he had in the American South. He to swap their jeans for hard currency made to break the law had been showed that you could measure behind the Iron Curtain. Then the entirely rational. Those who break the preference for discrimination punishments get more severe to the law balance the costs and the of employers by looking at how deter such defiance of the law. benefits of doing it. far they were willing to hire less The world has lost one of its great From this insight came Becker’s productive workers merely because thinkers. Fortunately we still have the influential analysis of crime, one of they were white. power of his thought• the ways he transformed economics He also developed and popularised and one of the reasons he became the idea of human capital, now a Daniel Finkelstein a Nobel laureate. When his death common term but very controversial Executive Editor, The Times was announced last week, Gary when Becker first used it. The [email protected] Becker was hailed as one of the professor argued that education This article was originally published most significant social scientists of could be seen as an economic in The Times on 14 May 2014 and is his generation, at least the equal of decision in which the long-term reproduced with kind permission 39 LEGENDS

GARY BECKER SHOWED US THE POWER OF ECONOMICS

ary Becker was one of pioneering approach is that wide range of settings, and applied the giants of economics. the ‘price’ that a criminal faces econometricians now routinely His work traversed at is determined by the penalty he estimate the effect of changes in least a dozen separate expects to face: the probability expected punishment on crime areas of economics, of being punished, multiplied rates. The effect has been confirmed including (but not by the subjective disutility of the empirically in many studies across Glimited to) the economics of punishment. Measures which several countries. the family and child-rearing; increase expected punishments The ideas can also be extended marriage; household production; such as higher monetary fines, and applied to situations in which the economics of crime and longer imprisonment terms, or governments attempt to enforce punishment; human capital; and greater probability of detection – regulation in labour markets, discrimination. will increase this ‘price’. Standard financial markets, and laws against The depth and breadth of principles of economics then suggest cartel formation and price fixing in Becker’s work demonstrates his that as this price rises, potential competition policy. conviction that the basic principles criminals will substitute out of crime Overall, perhaps Becker’s main of economics could and should be and into other (legal) activities. This legacy relates to the methodology of social science. These days you will never find economists shying away from applying their analytical tools PERHAPS BECKER’S MAIN LEGACY to any aspect of human behaviour. If we could summarise Becker’s main RELATES TO THE METHODOLOGY contribution in a single phrase, it OF SOCIAL SCIENCE would be that he showed us all the sheer power of economics• Alex Robson used to help us understand and is the ‘deterrence effect’. Senior Lecturer predict almost any aspect of human There is a lot more to Becker’s Griffith University, Australia behaviour and social interaction. analysis than the simple deterrence [email protected] Let’s take crime and punishment effect, but the basic idea inspired as an example. Becker’s (1968) paper a huge wave of theoretical and Read the full version of (cited when he was awarded the empirical research, which is still Alex Robson’s tribute at: Nobel Prize) assumed - contrary to ongoing. www.iea.org.uk/blog/ the usual approach of sociologists Economic theorists now routinely gary-becker-showed-us-the- and criminologists that criminals analyse criminal behaviour in a power-of-economics were rational, purposive actors, and that they maximise expected utility subject to constraints. Becker assumed that criminals were just like the hypothetical consumer and Gary Becker gave the IEA’s Hayek producer we encounter in standard Memorial Lecture in 2010. micro-economic theory. Thus was You can watch it at: born the modern economic approach www.iea.org.uk/multimedia/video/ to analysing criminal behaviour. annual-hayek-memorial-lecture- One of the simplest but most 2010-prof-gary-becker profound insights of Becker’s 40

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UNDER the MICROSCOPE: Mrs Thatcher’s Industrial Legacy Manufacturing’s share of national income has fallen from a quarter when Mrs Thatcher entered Downing Street to just over a tenth today. ANNA VALERO asks how much this long-term “rebalancing” of the UK economy should be a cause for concern

he death of Mrs dispassionate view of the data, Britain was a fifth higher than Thatcher in 2013 one thing is clear: from the late in the United States and over prompted a re- 1970s, the UK began to reverse 40 per cent higher than in examination of her a century of relative economic continental Europe. By the late economic legacy. decline. This was largely due 1970s, however, US GDP per TEconomists legitimately to ‘supply-side’ reforms which capita was 40 per cent ahead dispute many aspects of her increased competitiveness in of Britain; and France and legacy - in particular, increases labour and product markets, Germany were 10-15 per cent in inequality, high levels of and were continued and ahead. This relative decline unemployment in some areas reinforced under the Major was not accompanied by of the country and easing and then subsequent Labour absolute decline – all countries regulation on the City of administrations. grew richer, but Britain simply London. However, taking a In 1870, GDP per capita in became richer more slowly. 42 VIEWPOINT

However, over the following 160 three decades, Britain overtook USA USA WestWest Germany Germany FranceFrance France and Germany once more 140 and significantly closed the gap with the United States (see 120 Figure1). Another way to see this is in UK=100% Figure 2, which shows trends in 100 UK per capita GDP since 1950, compared again with the US, 80 % France and now the entire cent Per Germany. Each series is based at 60 1980, so that the height at any date represents the difference 40 between that date and 1980: hence a steeper line represents 20 a faster growth rate. It is clear that, in the post-war years, the 0 UK was falling behind (with 1870 1950 1979 2007 the shallowest line of the four countries). However from the 1980s onwards we see that UK Figure 1: GDP per capita 1870-2007 Source: Crafts (2012). Note: In each year the base is UK=100 and each country’s GDP per capita grew faster than GDP per capita is relative to this. So a value of US=120, for example, implies the the other countries for nearly US has a GDP per capita 20 per cent higher than that of the UK. GDP per capita is all the period. expressed in 1990 International Geary-Khamis dollars. The improvement in GDP per capita can be broken down into increases in the employment needs to be rebalanced towards too (see Figure 3). In particular, rate, and increases in labour manufacturing. these were the knowledge productivity (GDP per worker or The global financial crisis intensive Professional Services GDP per hour worked). The UK of 2008-09 certainly revealed and ICT (Information and did well in both components: a huge failure of financial Communication Technology) among the G6 countries, the regulation that is only now goods and services sectors. growth of UK GDP per hour being addressed. But it is wrong Professional services include was second only to the US in to believe that finance was law, accountancy, consultancy, the decade to 2007 (i.e. pre mainly responsible for Britain’s architecture, scientific research financial crisis in 2008), and the growth. If we focus on the and advertising, together with a number of administrative TAKING A DISPASSIONATE VIEW OF and support services (largely provided to other businesses, THE DATA, ONE THING IS CLEAR: an issue returned to below). ICT goods and services includes FROM THE LATE 1970s, THE UK manufacturing of computers BEGAN TO REVERSE A CENTURY OF and electronic equipment, publishing, broadcasting and RELATIVE ECONOMIC DECLINE IT services. The majority of these growth areas represent growth in the employment rate market sector (removing health, export sectors in which was better in the UK than in education, public administration the UK has a comparative the US. and real estate, sectors for which advantage. Productivity growth output is hard to measure), we in traditional manufacturing Balanced growth? see that productivity grew at (which consists of consumer and Despite this success, it is around 2.7 per cent per annum intermediate manufacturing claimed that the mix of during the Thatcher-Major era, and investment goods) stayed industries underlying it became and at over 3 per cent in the constant over the entire period “unbalanced”. It is argued Blair-Brown years up until the at 0.5 percentage points. that we became too reliant on eve of the global financial crisis. The contribution of “other the financial sector and that While the share of this growth production” fell substantially Britain’s strong performance attributed to Finance and and is largely driven by over the last 30 years was built Insurance services grew, and was reductions in mining productivity on an unsustainable bubble. certainly substantial at one sixth (in particular North Sea Oil). The prescription that often of the productivity growth from So the data suggest that the follows is that today’s economy 1997 to 2007, other sectors grew economic gains since the late 43 180 raw industry data suggest- but also that a productive service 160 sector is a crucial input for a 140 healthy manufacturing sector, in addition to being important 120 in its own right.

100 Manufacturing and

80 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 economic policy Even after adjusting for the 60 outsourcing phenomenon, the share in manufacturing 40 has declined substantially 20 in Britain. However, this is a common trend across the rich Real GDP per capita to 1980 0

Real GDP per capita relative to 1980 capita relative per Real GDP world in countries that have pursued different types of -20 UKUK USUS GermanyGermany FranceFrance policies over previous decades. -40 This outcome is mainly a result of globalisation as Figure 2: GDP per capita 1950-2013 (1980=100) the production of goods has Source: Conference Board data, extracted 6 May 2014. GDP is measured in US dollars, moved to low wage locations at constant prices and constant purchasing power parity, with a base year of 2013. (initially to the Asian Tigers, Note: log scale is used. and now China and India). A fall in manufacturing 1970s were real and not driven went from a quarter in 1980 to would almost certainly have only by finance. Furthermore, just over a tenth today. happened regardless of any there is substantial evidence Interestingly, the trend change in policy direction in that policies (in both the towards outsourcing over the UK after 1979. As shown Thatcher-Major and Blair-Brown time, and the accounting in Figure 4, in France, where eras) underpinned them. They consequences of this there was a much more activist included increases in product trend, makes the share of industrial policy, the fall in market competition through manufacturing activity appear manufacturing’s share (28 per the withdrawal of industrial smaller than it actually cent to 18 per cent of market subsidies; a movement to effective competition in newly privatised sectors with THE DATA SUGGEST THAT THE independent regulators; increases in labour market ECONOMIC GAINS SINCE THE LATE flexibility through restrictions 1970s WERE REAL AND NOT DRIVEN on union power and tougher conditions for receiving ONLY BY FINANCE unemployment benefits; openness to foreign direct investment and global talent; is. Research by Guiseppe economy value added) was also and sustained expansion of the Berlingieri at the Centre pretty large. And the fall in the higher education system. for Economic Performance more free-market US was the (Discussion Paper No.1199) same as in France. So it appears Accounting nuances shows that more and more that the impact of Thatcherite Nevertheless it is often argued businesses, including those policies on the decline of that, given that manufacturing in the manufacturing sector, manufacturing is much more is export-intensive, it needs outsource key functions to the modest than is usually thought. to grow as a share of the professional services sector (for But even if different policies economy. Using the same data example, office maintenance, could have increased the share from 1980 to 2007, we see IT, tax or payroll services which of manufacturing, should they that manufacturing’s share of historically were carried out in- have been implemented? British market economy value added house). The services constitute manufacturing has grown more fell from 31 per cent to 15 intermediate inputs for the high-tech and knowledge- per cent, which is certainly a firms buying them, but are intensive, which plays to our substantial fall. As a percentage accounted for as outputs for strength. And we have a of the total economy (that is, if the professional services sector. comparative advantage in many we add back the public sector This implies that manufacturing knowledge-intensive services and real estate), manufacturing is still more important than the which are also increasingly 44 VIEWPOINT

3.5 comparative advantage in Finance and the higher education sector is being harmed by government 3.0 insurance Finance and servicesinsurance services 0.5 targets of reducing net Professional services 2.5 0.2 Professional services immigration to fewer than 0.3 100,000 people a year and 0.6 Distribution Distribution services services 2.0 the cumbersome visa regime 0.6 Personal Personal services services that accompanies it (policies 0.1 0.6 driven by rising populism since 1.5 Other production 0.1 Other production the financial crisis). In the 0.6 0.1 case of pharmaceuticals, the 1.0 Manufacturing Manufacturing excluding electrical 0.5 excluding electrical proposed takeover of Astra 0.5 0.5 ICT goods and services Zeneca by Pfizer deserves 0.6 ICT goods and sservices serious attention. Assurances 0.3 Reallocation that Pfizer would retain jobs 0.0 -0.03 -0.04 Reallocation Annual average growth rates in percentage points in percentage rates average growth Annual Annual average growth rates % 1979-1997 1997-2007 and research activity in the -0.5 UK UK in the short term are not enough for a company so Figure 3: Sector Contributions to Market Economy Productivity Growth material to the UK’s economy Source: EU KLEMS data, extracted 6 May 2014. Notes: Average sectoral growth rates (Astra Zeneca carries out nearly are weighted by each sector’s average share in the market economy nominal gross a tenth of the UK’s research value added over the relevant period. The reallocation effect refers to the labour and development) and given productivity effects of reallocations of labour between sectors that have different Pfizer’s previous track record productivity levels. of streamlining operations after a takeover. Retaining exported – not just finance but A modern industrial our comparative advantage also many of the professional policy does not fixate on in cutting edge research is services which we saw above manufacturing but looks essential for ensuring our have contributed to our to where potential lies and economic prosperity into the productivity gains, in particular: constantly searches for areas of future. All sorts of policy areas law, accounting, consultancy, future growth. Governments are relevant to this situation design and marketing. need to focus on removing – intellectual property, the As China and India grow barriers to the growth of these regulation of pharmaceuticals richer, their demand will capabilities, regardless of and the tax regime, as well as switch from machine tools that whether they produce heavy company takeover rules. The power manufacturing (made in goods or ‘weightless’ services long-term impacts of policies in Germany and Japan) towards like research and teaching. areas such as these, as well as in high-value services or other Two examples of sectors other areas such as education, knowledge intensive goods. If where the UK has major infrastructure development, Britain is open, confident and current strength and future innovation and land-use entrepreneurial, this is a major potential are higher education planning must be addressed if market opportunity. and pharmaceuticals. Our the UK is to seize the growth opportunities of the next 30 years 35% • 30% Anna Valero London School of Economics 25% [email protected]

20% Footnote This article draws on In 15% Brief: Mrs Thatcher’s Industrial 10% Legacy, by John Van Reenen in CentrePiece, Winter 2013/14, 5% and the work of the LSE Growth Commission, in particular 0% Chapters 1 and 2 of Investing UK US France for Prosperity: A Manifesto for Growth. The analysis has been 1980 2007 updated where more recent data have become available since publication. Figure 4: Manufacturing share of Market Economy Gross Value Added Source: EU KLEMS data, extracted 6 May 2014. 45 REVIEWED

THE IDEALIST: Dreams, disappointment JEFFREY SACHS AND THE ...and defeat QUEST TO END POVERTY

Nina Munk Doubleday, 2013

The simplicity of Jeffrey Sachs’ Perhaps most revealing about formula for ending poverty made the “big aid” debate is that this it ideal for a successful advocacy wave of criticism of Sachs arose campaign. All the problems from accusations that there were of poverty had technological no proper evaluations. The critics fixes, the Columbia University pointed out that any positive economist argued: bed nets to trends in the Millennium Villages prevent malaria; wells to provide would have to be compared with clean water; hospitals to treat the positive Africa-wide trends in curable diseases; fertiliser to health, access to clean water and raise yields of food crops. Ending overall development. Sachs had poverty, therefore, was just a not set up the project so matter of raising enough money that this comparison could be to pay for the technical solutions. done reliably. Sachs would demonstrate his Sachs’ actual objective for the ideas by deploying these fixes Millennium Villages – to show in a dozen or so Millennium that aid could achieve the end of Villages in Africa. Success would poverty – does not even merit a build on success to scale Sachs’ mention by Sachs’ critics today. experiment up throughout This idea is regarded as not worth the continent. refuting. The big aid debate is The Idealist, Nina Munk’s really over. brilliant book on Sachs, chronicles I should say a word about how this dream fell short of my own history with Sachs. In reality. Munk, a contributing 2005, when I wrote a negative editor at Vanity Fair, follows review of Sachs’ book The End Sachs around as he tries to make of Poverty, I became identified all this happen. But she also goes for years afterwards (with rising out on her own to the the region.” But then the wells unwillingness) as the antithesis Millennium Villages. She visits ran dry altogether due to to Sachs’ thesis, a never-ending two villages repeatedly: Dertu, a drought. debate – aid can end poverty! in the ethnic Somali region of Such examples multiply in No it can’t! Kenya, and the more centrally Munk’s book, showing that Eight and a half years later, I located settlement of Ruhiira, technological answers to poverty take no pleasure in the defeat of Uganda. Munk thus makes us are not the silver bullet Sachs Sachs’ big ideas, especially as this see the villagers as real people, maintained. Technology requires failure involves the sufferings of not stereotypes. implementation by real people the people affected. And Sachs The technical fixes turn out subject to widely varying incentives does deserve some recognition to be anything but simple. The and constraints in complex social as a gifted and hard-working saga of Dertu’s water wells is and political systems. advocate for compassion illustrative. Soon the local man Munk shows successes as for those still left out of the put in charge of the wells had well as failures. Sachs’ project considerable progress that has to order a crucial part lacking spent $1.2 million on health happened in development. But for the water wells’ generator. It in the other village, Ruhiira, the idea that aid could achieve took four months to arrive, and including hiring two doctors rapid development and the end then nobody knew how to instal and 13 midwives. Many fewer of poverty was wrong. It is time it. Eventually a distant mechanic mothers in Ruhiira are now left to to debate what really does matter arrived at great expense. A couple their own resources to give birth, in development• of years later, Munk found the and the prevalence of malaria has William Easterly same problems. fallen drastically. But the difficulty Professor of Economics, A little over a year on, the achieving the successes and Co-director of Development Millennium Villages blog the frequency of the Research Institute, celebrated Dertu’s wells as “the failures contradicted Sachs’ New York University most reliable water supply within original promises. [email protected] 46 REVISITED A pioneer’s EQUALITY, THE THIRD prophetic WORLD, AND words ECONOMIC DELUSION

PETER BAUER HARVARD UNIVERSITY PRESS, 1981

Peter Bauer was a modest, new elites in former colonies”. courageous man. For many years, This debate is just as topical this brilliant Jewish refugee today as when Bauer originally from Budapest was seen as an penned those words. Every week eccentric maverick by fellow there appears to be a media economists. Yet over time his story about politicians and criticisms of state directed commentators questioning the aid to the Third World was merits of maintaining Britain’s accepted by a growing number substantial development aid of economists, both in Britain programme. and overseas. Furthermore, his Bauer argues that “foreign aid views eventually influenced the is perhaps the least questioned major multinational aid bodies form of state spending in including the World Bank whose the West”, even though “it is Berg Report, published in 1981, taxpayers’ money which goes clearly owed a major debt to to foreign governments, and Bauer in its criticism of the these are political matters”. Since interventionist policies adopted he first wrote those words his by African governments. own writings have influenced This volume collects together an increased scepticism on a number of Lord Bauer’s essays the efficacy of bilateral and on economics and foreign aid. boards accord in any way with multilateral official aid. They are well worth reading. their ostensible objectives”. Increasingly, one hears trenchant Bauer was an astute observer The people who suffered were voices arguing that it is more and undertook painstaking small-scale farmers while, as sensible to enable developing research into the operation of Bauer points out, the huge sums countries to export their goods commodity markets. Indeed, he that accrued to the government and services to the protected was a pioneer in collecting and and its various tentacles of power markets of the EU and USA. One analysing data, exemplified by “reinforced the effects of other of the more notable champions his classic study on West African state controls, especially of import of such a position is none other Trade published in 1954. licensing, in promoting large scale than Sir Bob Geldof, who now Bauer is scathing about corruption”. If the money was not chairs 8 Miles LLP, a private equity the impact of ill-conceived pocketed by politicians, it tended firm investing substantial sums in government controls imposed to be channelled into prestige businesses throughout Africa. on agricultural commodities in projects and, of course, official Bauer’s long term influence West Africa in the Second World Mercedes limousines. Bauer is likely to be strongest on the War and the post-war period. laments, “a large proportion was growing number of successful In his essay reviewing ‘British spent on projects and activities entrepreneurs and political Colonial Africa’, reproduced in that were uneconomic at best, or leaders emerging out of Africa. this collection, Bauer points out total failures, or instruments for Dambisa Moyo, the Zambian that a cluster of state export personal enrichment and political international economist who monopolies known as marketing patronage”. sits on several corporate boards boards “became the most Bauer sided with the ordinary including Barclays plc, is a good important single instrument of farmer and women selling their example. Indeed, she dedicated state economic control in British wares in street markets. His books her best seller Dead Aid to Lord Africa”. He highlights the fact demonstrate a profound respect Bauer. What finer compliment that “from their inception the for the citizens of the Third World could one wish for? Bauer, who boards withheld large sums from and he clearly bristled at the died aged 86 in 2002, was a the producer by paying them patronising tone adopted charming man who would have far less than market prices. They by many mainstream appreciated her dedication• also exercised close control over development economists. processors and traders. Neither Bauer argues that, “In effect, Keith Boyfield during nor after colonial rule state aid is a form of taxing the IEA Fellow poor in the West to enrich the did the policies of the marketing [email protected] 47 Our student programme is kindly supported by campus METRO BANK HEADING YOUR WAY: The ECONOMICS ROADSHOW Following the huge success of our 20 one-day conferences in the last academic year, we are once again packing our bags and travelling to a school near you. Our Economics Roadshow includes topics such as market failure, the Eurozone crisis, the living wage, infrastructure projects, and much more. We have a raft of top speakers lined up, including Professors Mike Wickens of the University of York, Jonathan Wadsworth of the London School of Economics, and Patrick Minford of Cardiff University. If your school would like to attend a conference or if you’re interested in hosting an event, then contact Grant Tucker: [email protected] ITINERARY 2014 Monday 6th October: Southend High School for Boys, Southend Wednesday 8th October: King Edward VI Grammar School, Louth Thursday 9th October: Portsmouth Grammar School, Portsmouth Friday 10th October: Headington School, Oxford Monday 13th October: West Buckland School, Barnstable Friday 7th November: Bromley High School, Bromley Monday 17th November: Loretto School, Edinburgh Tuesday 25th November: Whitgift School, Croydon Tuesday 2nd December: Wellington College, Crowthorne, Berkshire 2015 Tuesday 20th January: Wallington County Grammar School, Wallington, Surrey Friday 23rd January: New Hall School, Chelmsford Thursday 29th January: Dulwich College, Dulwich Tuesday 3rd February: Stephen Perse Foundation, Cambridge Tuesday 3rd March: St Swithun’s School, Winchester Friday 6th March: Bishop Wordsworth’s Grammar School, Salisbury Thursday 12th March: Haileybury College, Hertford Heath, Hertfordshire Each conference runs from 10am-4pm.

48 CAMPUS

CHOOSING FREEDOM

Future Freedom is the name of our new series of monthly events exclusively aimed at under 30s – from sixth formers to young professionals. At our launch event in June, Hugh Pym, the BBC’s Chief Economics Correspondent, talked to a packed room about his new book on the financial crisis. At our next Future Freedom event on October 27th we will screen Ronald Reagan’s Time For Choosing speech after an introduction by former US Deputy Assistant Secretary of State Colleen Graffy. If you are interested in attending Future Freedom events then visit www.iea.org.uk/events

EXPECT FIREWORKS! On Wednesday 5th November we will be holding another free Teacher’s Seminar at the IEA (2 Lord North Street, Westminster, SW1P 3LB) on the topic of “China, Globalisation and the Future of World Trade”. If you are an A level Economics teacher and are interested in attending, then please email [email protected] to reserve your place. This follows our successful seminar in March on the topic of “Debt and Monetary Policy”. INTERN-ational Appeal Speaking out The IEA has an impressive roster of speakers who visit schools, This summer the IEA brought together nearly 50 interns as part universities, and other institutions of our summer intern programme. For six weeks the interns from around the world. In the last few months France, America, Germany, Mauritius and the UK, relocated to our speakers have addressed thousands Westminster for a fun packed educational programme. It consisted of people at venues including Oxford of lectures, seminars, debates, discussions, and beer and pizza nights! University and Westminster Central Hall. During their time with us each intern produced a supervised research If you need a speaker for a talk or project mentored by one of the senior research staff at the IEA. Does debate at your organisation that sound of interest to you? If so, we have internship opportunities email [email protected] all year round, from sixth form students to recent graduates. If you are interested in joining our intern programme or just want to find out more, contact Grant Tucker: [email protected]

49 Find out all about the IEA at: www.iea.org.uk BRIEFING

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

GROWTH GROWTH and STILL GOOD POVERTY REDUCTION in FOR THE AFRICA in the Last Two Decades

POOR Whilst the raw statistics tell us that economic growth in the world’s poorest continent has been healthy this is disputed. Is economic growth Pope Francis, for example, weighs into this argument arguing that the rich are getting richer exponentially whilst the incomes of the majority do the key to helping not improve. the world’s poorest As this paper by Andy McKay at the University of Sussex shows, such assertions are simply not true. McKay looks at a range of data and several people? indicators. Average African growth from 2005-2010 was 2.9 per cent per annum and in only two countries was growth negative. There have also been It is argued by some, for example, substantial reductions in poverty. that higher economic growth in Furthermore, the growth is not simply driven by the commodities boom India has not generally benefited but is more broadly based. Interestingly, in the countries for which it can the poor. However, new evidence be measured reliably, inequality in Africa has tended to reduce too. Thus, from economists from the though the pattern is not entirely uniform, growth, poverty reduction and Brookings Institution, Yale reductions in inequality seem to be going hand-in-hand in Africa• University and the World Bank suggests that general economic ANDY MCKAY growth is overwhelmingly University of Sussex important for poverty elimination. Journal of African Economies, 2013, 22 (supp 1) Using a rich dataset, the authors http://sro.sussex.ac.uk/42783/ found a very strong relationship between overall economic growth and growth of incomes in the poorest quintile. They also found that, on average, income growth MARRY YOUR LIKE: in the poorest quintile was very similar to overall growth. As such, Assortative Mating and ensuring the right conditions for Income Inequality growth would seem to be the best way to ensure poverty reduction. There is much discussion about income inequality in developed countries. Interestingly, the authors also found However, an interesting phenomenon, rarely discussed by politicians who that specific policies that might take an interest in this matter, is that of assortative mating. be thought to have distributional As a result of a variety of social and economic trends, there has been an effects did not benefit the poor increased tendency for individuals to marry people who are more similar to beyond their effect on general them in terms of education and social class. economic growth. This paper examines the impact of assortative mating on household There might be some particular incomes. It confirms the hunch that people have been marrying spouses policies that could benefit one with a similar education to their own. However, there has also been an group rather than another in a increased dependence of incomes on education that has combined with and particular country, but the authors exacerbated the effect of assortative mating. conclude that these are difficult to In 1960, a married couple who both had post-college education would identify in advance from looking at have earned 176 per cent of mean household income. By 2005, that figure global data• was 219 per cent. At the same time, a household consisting of a couple who both had high school education fell from just above the average to 83 per cent of the average. DAVID DOLLAR, The trend in household income disparity is further reinforced by increased TATJANA KLEINEBERG labour market participation by women. Overall, a clever man is more likely AND AART KRAAY to marry a clever woman; individually their relative earnings have increased World Bank Development compared with the mean; and the woman is more likely to be earning. These Research Group are powerful forces increasing income inequality• Policy Research Working Paper 6568 JEREMY GREENWOOD, NEZIH GUNER, GEORGI KOCHARKOV www-wds.worldbank.org/servlet/ AND CEZAR SANTOS WDSContentServer/WDSP/IB/2013/ NBER Paper 19829, January 2014 08/13/000158349_20130813100137/ http://www.nber.org/papers/w19829?utm_ Rendered/PDF/WPS6568.pdf campaign=dig&utm_medium=email&utm_source=dig

51 idealog

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52 IDEALOG

BALANCING the EQUATION

There is no shortage of concern from the bank. In effect, she has a and Germany is Miss Prudent. Our about the UK’s large balance of trade deficit – she buys a greater government is borrowing about 6 payments deficit and it is often value of goods than people buy per cent of national income and suggested that Britain’s high from her (or more than they pay Germany’s government is borrowing exchange rate is the key problem. her to make). Now consider Miss nothing. The British private sector is But would a depreciation of Prudent. She has the same income, saving about 4 per cent of national sterling make any difference? spends 95 per cent on consumption income and the Germans 10 per Whether a fall in the value of and saves 5 per cent. She has a trade cent. These figures provide an (albeit sterling would help reduce our simplified) explanation for our trade deficit depends, among other balance of payments position. We are things, on the cause of the high OUR spending more than we are earning exchange rate. and the Germans are earning more It is possible that speculation is GOVERNMENT than they are spending. driving up the value of the pound. How does this translate into a The Bank of England could try IS BORROWING higher exchange rate? Borrowing to reduce the value of sterling in by British consumers and by the these circumstances by loosening ABOUT government leads to an inflow of monetary policy. However, this is capital to finance that borrowing: 40 likely to give rise to an unsustainable 6 PER CENT per cent of UK government bonds boom in asset prices and/or inflation, are owned by overseas investors. and to nullify the benefits of any OF NATIONAL This pushes up the exchange rate. devaluation pretty quickly. INCOME… This creates the conditions that lead Alternatively, Bank governor to the balance of payments deficit Mark Carney could try to ‘talk GERMANY’S which is the counterpart to the UK down’ the value of sterling. But being a net borrower. the effect of talking down the GOVERNMENT Of course, there are other pound will probably be short term factors involved as well. But we unless it is also backed by action IS BORROWING cannot ignore the fact that, if our on the monetary policy front – for government is going to borrow on example, some sort of target to NOTHING its current scale then, without huge lower sterling which is pursued by levels of private saving, we will run more QE. But this, as noted, would surplus equal to Miss Profligate’s a balance of payments deficit. The be a dangerous policy. deficit. She earns more than she government is doing our exporters Perhaps we should look more spends, and people are willing to no favours by not getting its carefully for the underlying causes. pay her, to make goods and services, borrowing under control• Consider Miss Profligate. Miss an amount of money that is greater Philip Booth Profligate spends 105 per cent of than the amount she spends on IEA Editorial and her income on consumption, and other people’s goods. Programme Director borrows 5 per cent of her income In short, Britain is Miss Profligate [email protected] Full version at www.iea.org.uk/blog/forget-fancy-schemes-government-borrowing-is-holding-back-uk-exporters‏

53 QUOTAS are BAD POLICY Economists have long been critical and a similar policy has been this is primarily on grounds of of quotas which arise in many advocated for ethnic minorities fairness or equity. To those who different contexts. in the Metropolitan Police. The might query the prioritising of Import quotas are a non-tariff justification here is that community equality of outcome rather than barrier to trade: countries, or peace – another ‘externality’ equality of opportunity, a further customs unions such as the EU, may justification is often offered. only allow in a certain number of This is that ‘diversity’ improves foreign-produced cars or textiles or organisational performance in foodstuffs. Such quotas rarely do THEY various ways. The evidence for much good. They protect particular this is, however, rather weak. producers but penalise consumers. DISCOURAGE And it begs questions about what They discourage innovation and dimensions of diversity should be necessary change. Once instituted, INNOVATION emphasised. Our company boards they are very difficult to remove. AND NECESSARY have few teenagers or religious In countries where the rule of law leaders or comedians represented: is weak, they are often CHANGE should we be concerned? the basis for corruption as well- Advocates of quotas believe that placed government insiders get capitalism suffers from a wide range access to scarce imports and can – is best served by attempting of market failures which can best exploit shortages. to manipulate representation be addressed through dictating Labour markets offer huge of different groups in policing arbitrary numerical targets. The scope for quotas too, of course. communities. Yet experience in the job of the economist is to raise Immigration is a case in point: USA and elsewhere suggests that impertinent questions about the governments claim to know that the cronyism and low performance likely effects of such quotas and to labour market requires certain types can result. Moreover, the changing point out the alternative means of of immigrant rather than other demographic composition of achieving the relevant goals• types of immigrant – a claim for cities over time presents ongoing which there is little objective basis. problems of representation. Len Shackleton We have also had religious A different justification is Professor of Economics quotas for membership of the offered for quotas for women’s University of Buckingham Northern Ireland police force, representation on company boards: [email protected]

Full version at: www.iea.org.uk/blog/quotas-are-bad-policy

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54 IDEALOG

WORKING HARDER… but not more productively GDP growth of 0.7 per cent in the This shows the fragility of the spending, we also need to reduce final quarter of 2013 confirmed recovery. There is a limit to the its regulatory role. For example, that the recovery was taking hold. extent to which employment there are clear signs of strong However, what was particularly can rise. Until we see business demand for housing in the UK, disappointing about these figures investment picking up and the but planning controls prevent was that employment had grown building of capacity, growth in the a substantial increase in supply at about the same rate, which medium term will be anaemic. (in contrast to the recovery means that GDP per person This contrasts markedly with the in the 1930s). This not only employed hardly grew at all. record after the Great Depression prevents the productive activity In other words, in 2013, five or, indeed, after post-war of house construction; it also years after the financial crash, recessions. Business investment in prevents labour and businesses we were still in the midst of a Q3 2013 (five years after its peak) from moving from low to high productivity crisis. is 24 per cent down from that in productivity areas. In the field of GDP per person employed in Q1 2008. In contrast investment in energy, regulation and subsidies 2013 was only a fraction higher the Great Depression was 3.5 per are promoting power generation than in 2012 (0.4 per cent). GDP cent up from its 1929 peak five through very-low-productivity per hour worked tells the same years later. mechanisms. And in financial story (there would appear to be a What can boost growth? services government policy is small fall in GDP per hour worked The answer lies in raising strangling bank lending through of 0.4 per cent). Output per worker private investment to improve capital regulation. to the third quarter of 2013 was productivity. The good news is that there only 0.3 per cent higher than in the This is a problem for the real is plenty of unrealised potential first 9 months of 2012. economy which cannot be solved for higher growth if policymakers So from where is the growth by monetary policy. Private decide to change course. The bad coming? People are working more, investment is also affected news is that there is little sign of a producing more and spending adversely by political uncertainty. significant change in course• more. However, unlike in recent State spending is still at historically decades, people are not increasing high levels and the budget deficit the amount they produce per and government debt are not Kent Matthews hour worked. As such, even if showing clear signs of being Professor of Banking living standards rise, given current controlled. and Finance trends, they will only be rising As well as reducing the size of Cardiff Business School because we are working harder. the state in terms of government [email protected]

Full version at: www.iea.org.uk/blog/working-harder-not-more-productively

55 SoundbiteSoundbiteSoundbiteSoundbi teSoundbiteSoundbiteSoundbite Sound nbiteSoundbiteSoundbiteSoundbiteSo SoundbiteSoundbiteSoundbiteSoundbi teSoundbiteSoundbiteSoundbite Sound biteSoundbiteSoundbiteSoundbiteSoun SoundbiteSoundbiteSoundbiteSoundbi teSoundbiteSoundbiteSoundbite Sound biteSoundbiteSoundbiteSoundbiteSoun SoundbiteSoundbiteSoundbiteSoundbi teSoundbiteSoundbiteSoundbite Sound biteSoundbiteSoundbiteSoundbiteSoun SoundbiteSoundbiteSoundbiteSoundbi teSoundbiteSoundbiteSoundbite Sound biteSoundbiteSoundbiteSoundbiteSoun SoundbiteSoundbiteSoundbiteSoundbi teSoundbiteSoundbiteSoundbite Sound biteSoundbiteSoundbiteSoundbiteSoun SoundbiteSoundbiteSoundbiteSoundbi SOUNDBITE teSoundbiteSoundbiteSoundbite Sound nbiteSoundbiteSoundbiteSoundbiteSo SoundbiteSoundbiteSoundbiteSoundbi teSoundbiteSoundbiteSoundbite Sound biteSoundbiteSoundbiteSoundbiteSoun Hey, teachers: SoundbiteSoundbiteSoundbiteSoundbi LEAVE THEM KIDS ALONE Schools need to please parents. If and assessment systems. They were were children who had very they don’t, parents won’t send their efficient engines that would convert little or no knowledge of English children to school – at least where children into identical people in and had never seen a computer teSoundbiteSoundbiteSoundbite Sound parents have an option. Schools just ten years. The predominant before. In the next five years, need to please the government as skills would be reading, writing through many experiments, I the government pays for schools. and arithmetic. Knowledge would learned that groups of children can The government wants people who be contained in books. Since books complete educational objectives by biteSoundbiteSoundbiteSoundbiteSoun are law abiding, upright citizens, are not always accessible, their themselves, using the Internet, if who, when needed, will defend salient points would be stored in you leave them alone. By 2009, it their country and be loyal and each human brain and used when was possible to ‘beam’ teachers to worthy citizens. needed. The government, major places where they could not or did SoundbiteSoundbiteSoundbiteSoundbi Schools do not try to please religions and the military decided on not want to go. I made a ‘granny employers because employers don’t these salient points. Schools would cloud’ of retired school teachers fund schools. Most employers today ensure their storage and retrieval. who would encourage children to teSoundbiteSoundbiteSoundbite Sound need to train students when they From the 1950s, computers learn by themselves. leave school because schools do were developed and the age of By 2012, teachers around the not educate them well enough. empires ended. The change was world were using SOLEs, ‘self- Schools also do not try to please the biteSoundbiteSoundbiteSoundbiteSoun children – they do not matter in the system we have developed. GROUPS OF CHILDREN LIVING IN THE But schools as we know them now are the product of an age STREETS OF INDIA WOULD LEARN TO SoundbiteSoundbiteSoundbiteSoundbi that has ended. They are out-dated and obsolete. USE COMPUTERS AND THE INTERNET Until well past the middle of BY THEMSELVES the twentieth century, the only teSoundbiteSoundbiteSoundbite Sound communications technology so rapid that there was no time to organised learning environments’, available to manage the world dismantle the old machinery. The where children would group around was the telephone. Until the schools continued to churn out Internet connections to discuss “Big biteSoundbiteSoundbiteSoundbiteSoun end of the 19th century even their identical products – parts for Questions”. The teacher would the telephone was not available. a gigantic human computer that no merge into the background and Data was written on paper and longer existed, nor was needed. watch as learning happened. processed by clerks and managers. Within a few decades, institutions We need a curriculum of Big SoundbiteSoundbiteSoundbiteSoundbi The system was perfected by the began to dematerialise – banking, Questions; a pedagogy of self- Victorians in the zenith of the the stock exchange, entertainment, organised learning; examinations British Empire. Like most things newspapers, books, money, were all where children can talk, share and designed by the Victorians, it was a strings of zeros and ones inside the use the Internet; and new, peer teSoundbiteSoundbiteSoundbite Sound robust system. It worked. Networks evolving Internet that is now simply assessment systems. People don’t of identical human computers, called ‘The Cloud’. It is already need to be machines anymore. sitting in identical buildings across omnipresent and indestructible. In a Governments will find it hard to the continents created most of the few more decades, it will probably do this, but teachers can – if they biteSoundbiteSoundbiteSoundbiteSoun world we live in today. be sentient, non-material and, stand back and let the Cloud in• In order to keep this gigantic therefore, eternal. Sugata Mitra military-industrial machine working, In 1999, I accidentally glimpsed Professor of the Victorians needed identical ‘The Cloud’ though an experiment Educational Technology people who would fit into the right often called ‘The Hole in the Wall’. Newcastle University place in the machine, anywhere on I found that groups of children the planet. Schools were designed living in the streets of India would To learn more about to produce these people. Schools learn to use computers and the Sugata Mitra’s work visit had similar curricula, pedagogy Internet by themselves. These www.theschoolinthecloud.org 57 The GL BAL City

In a previous EA column I argued functions, though under Chinese self-governing city-states have an that unprecedented urbanisation sovereignty. Singapore is a de jure advantage over London and New makes cities even more important city-state, with its own military and York. Not only can they excel at in the global economy. One type of independent trade and foreign municipal policies, but they can city is the “global city”. policies. Both Hong Kong and also have free-trade policies and A global city is where truly global Singapore outrank other cities, be exceptionally open to migrants. services cluster. Business – in finance, and indeed other countries, in London and New York do not have the professions, transport and having the best business climates, that freedom. communications -- is done in several hard infrastructure and quality Thirdly, there is the issue of languages and currencies, and across of governance. Their education geographic space. This is where several time zones and jurisdictions. systems are among the most city-states are at a disadvantage. There are only five global cities advanced. They are the most Unlike London and New York, they today: London, New York, Hong open economies in the world to do not have hinterlands within Kong, Singapore and Dubai. trade and foreign capital. Dubai is their territories where low-value The global city has a relentless another de facto city-state, though economic activity can relocate and market logic. It has to be open part of the UAE’s federal system. where people can move in search of to trade, foreign capital and It is extreme in one respect: about a lower cost of living. migrant workers. It must have a ninety per cent of its population Finally, there is the question very business-friendly regulatory of how we handle inequality and environment. Its infrastructure related social issues. Globalisation -- physical infrastructure as well has delivered unprecedented as “soft” infrastructure (such IT HAS TO BE growth and prosperity. But it has as education, skills and cultural probably played a part in increasing activities) – must also be among A HIVE OF in-country inequality, giving higher the most advanced. Above all, returns to capital and to educated, it has to be a hive of individual INDIVIDUAL skilled workers than to the unskilled freedom, where creative ideas and FREEDOM... and semi-skilled. This is most visible entrepreneurship can thrive. in the global city. But the logic of the global city WHERE CREATIVE Take Hong Kong and Singapore. runs counter to that of the “normal Now their settled populations are country”. Normal countries are IDEAS AND more sensitive to rising income more ambivalent about the market inequality. There is more pressure and less open to the world. Their ENTREPRENEURS for government to provide more citizens want to lead settled, secure affordable housing, and more lives rather than constantly having CAN THRIVE generous coverage for health care, to adapt to changing global market pensions and social security. And conditions. London and New York – there is more resistance to large- global cities that are part of normal is foreign. Singapore comes next: scale immigration. How should countries – face this contradiction about 40 per cent of its population governments respond to these all the time. The natives of is non-Singaporean. Dubai is also “normal-country” concerns without Hong Kong and Singapore are the most authoritarian global city: undermining the essential logic of no longer dirt-poor immigrants. power is centralised in the ruler and the global city? Overwhelmingly, they are settled his family. Such are the challenges of and middle-class, with increasing Now take a look at a few key the global city. But it remains a “normal-country” aspirations that issues through the prism of the hallmark of early twenty-first sometimes jar with global-city global city. century globalisation. It combines imperatives. Firstly, global cities specialise freedom and prosperity better than How do global cities rate in global services, which drive any other political-economic unit. In against each other? London and a cornucopia of ancillary local that sense we all have a stake in the New York have historic “first- services. With the exception of global city• mover” advantages, especially in Singapore, services account for having the world’s most advanced ninety per cent or more of GDP in Razeen Sally financial markets. Hong Kong is global cities. Director, European Centre for a de facto city-state, combining Secondly, there is the importance International Political Economy municipal and nation-state of openness and governance. Here [email protected]

58 SOUNDBITE HARD to SWALLOW half the ingredients for medicines, and maybe a third of the medicines themselves, come from India and China where production costs are much cheaper. Regulators in these countries are often corrupt, understaffed, underfunded and not particularly competent; businesses may not have decades of experience of legal fights that sharpen incentives for quality control. The result is that the quality of drug exports is not uniformly good. Most of the worst products find their way into Africa and other emerging markets. However, if evidence from US scientists and doctors such as Harvard’s Preston Mason, and Harry Lever of the Cleveland Clinic is correct, some may be finding their way into richer markets too. I chaired a Congressional briefing in February on this topic, and the FDA reacted very aggressively towards both Mason and Lever. In most product lines everyone discover problems more easily than It seems that the FDA does not is used to the idea that the more their independent counterparts. want the US public to be made we pay the better the product. A Perhaps one would find the same aware that the quality of imported £40,000 Mercedes is probably better effect in the UK or US. But since medicines is not always good. than a £10,000 Honda for example. the vast majority of medicines are In any other market, it would What about medicines? Some assumed to work, undertaking such be simple to deal with this issue. patients may well suspect that the an exercise would be a waste of Generics from India would not brand name original will be better money – it could cost hundreds of be expected to perform as well made and maybe work better than thousands of pounds to find any as products made in, say, Italy or a generic medicine, but I suspect samples that don’t work. Switzerland and would be priced at that most people never think about it. When people get a doctor’s prescription, they don’t ask which SHOULD WE BE ABLE TO PAY FOR generic medicine they have or for the evidence that the generic DIFFERENT LEVELS OF QUALITY IN medicine works as well as the branded original. People may well OUR MEDICINES? compare car performance figures, But maybe that assumption is a discount. Consumers, patients and but I doubt that many patients do no longer correct. Most of the doctors would be able to specify so when it comes to drugs. western medical agencies, like what generic they wanted based on Perhaps people trust, directly MHRA in the UK and FDA in the their tolerance for risk. But with the or tacitly, the regulator (and their US, spend the vast majority of their fiction that all products are equal, doctor) to ensure that all products time overseeing new products. and little choice in what generics work properly. But why should a Monitoring clinical trial data and one can take, there is no viable regulator of medicines be better approvals of exciting new products market response. than any other bureaucrat in any is where the attention is focused. This status quo will probably other field? Maybe we trust the They conduct site inspections on continue until some tragedy companies making the products plants selling “old” products and occurs, when heavy-handed – assuming that both their desire occasionally find problems, issue legislation will demand changes to please customers, and the fear warnings, levy fines, sometimes in labelling and drug sourcing. of the loss of business, or threat recall products and occasionally Till then caveat emptor• of prosecution, means that their prosecute producers. This is Roger Bate products work. assumed to ensure safety. Fellow of the American Part of my latest research The focus of their efforts towards Enterprise Institute shows that chain pharmacies in new products was based on [email protected] emerging markets have higher production systems of the 1980s and quality medicines than stand-alone 1990s, when the vast majority of Roger Bate runs the website pharmacies. The assumption is final medicines, and intermediate www.searchingforsafety.com that they take greater care over chemical products, came from the which houses many of the sources of the sourcing of their products, and US and Europe. But today well over information discussed in this article 59 NOT SO... MADMEN Advertising is one of the many been invented. As governments soon issues where economic evidence discover when they use advertising to clashes with received wisdom. encourage us to get out to vote or to The economist Julian Simon once eat ‘five a day’, it is very difficult to wrote that ‘the economic study of make people do things that they are advertising is not deserving of great not already minded to do. attention’, ruefully adding that ‘this Much of the empirical evidence is not a congenial point at which to about advertising’s effect on business arrive after spending several years is mixed. It tends to be associated working on the subject’. with profitability, but there are Very few economists have plenty of exceptions. It tends to dedicated as much time to the promote competition, but not always. topic as Simon and most ignore Some advertising works, some does it entirely because its impact on a not – and it is difficult for companies nation’s economy, though broadly to predict in advance which will work beneficial, is not thought to be and which will not. terribly important. By contrast, critics But, say the critics, if advertising of advertising – of whom there are is not very important, why do many – see it as a powerful and businesses spend so much money on malign force that allows businesses it? One answer is that they actually to exert control over the public. The don’t spend a great deal of money most common complaint is that clever on it. Advertising typically makes marketing manipulates people into up two per cent of a business’s buying products they do not really expenditure, often much less. The want while encouraging a culture of other answer is that, for all its faults, rampant consumerism. Some want advertising remains a better way advertising heavily restricted or even of communicating with the buying banned. public than any of the alternatives. The empirical evidence simply Travelling salesmen and discount does not support the critics’ view. vouchers might work for some Advertising can help develop brand companies, but to reach a mass loyalty in existing customers and it audience and develop economies of might – at best – entice us into trying scale, the mass media is required. It is because advertising shifts demand from one company to THE WEIGHT OF ECONOMIC another that it is of more interest to businessmen than economists. EVIDENCE SHOWS THAT The only people who really take advertising seriously are the ADVERTISING FOLLOWS SOCIAL academics who hate it and the advertising executives who love TRENDS, IT DOES NOT INITIATE THEM it. The rest of us learn to treat advertising messages with scepticism a particular brand, but it cannot advertising is largely defensive. from a very young age. But, make us regular customers and it As much as companies want to although marketing is a fringe issue cannot coerce us into fundamentally attract new customers, their priority in economics, its benefits to the changing our behaviour. The weight is to stop existing customers drifting consumer should not be overlooked. of economic evidence shows that off to the competition. The ubiquity It provides information, albeit from advertising follows social trends, of expensive marketing campaigns a biased source, it saves us time it does not initiate them, and in developed countries is not an by reducing search costs, and it is companies only start spending the expression of corporate power, generally associated with lower prices big marketing bucks when they are as critics claim, but of corporate and higher quality. Advertising is an confident that demand already exists. vulnerability. From their perspective, imperfect means to achieve the goals Advertising is overwhelmingly aimed we consumers are treacherously fickle of both the buyer and the seller, but at getting existing users of a product and disloyal. we would all be worse off without it• to either switch brands or stay loyal It is not that businesses would not to their current brand. Advertising like to manipulate us into buying Chris Snowdon campaigns are often described as products we do not want, only that Director, IEA Lifestyle Economics ‘aggressive’, but the business of the lever of manipulation has never [email protected] 60 For TEACHERS For RESEARCH For EASE of use…

INTERVIEW

MATT RIDLEY is one of the country’s “optimist” meant, when coined by decades. Why did that happen? improved varieties of crops. Africa Voltaire. He was mocking theodicy, In my lifetime the population of had yet to experience the same leading authors in the fields of science which argued that since God made the world has doubled, which many change, and its yields have hardly the world it must be “optimal”, predicted would lead to ever more improved over the same period. and economics. His recent book, and even suffering must be a famines, shortages and price rises. In So just getting fertiliser, tractors, The Rational Optimist, has been widely good thing, and improvement is fact the price of wheat has halved in pesticides and better seeds to that impossible. That’s what pessimists that time, and the calories available huge continent would be a huge admired and his Times columns are believe today, especially those in the per person have increased on green revolution. green movement, who reject new every continent. The cause is yield But we could, and almost a weekly “must read”. Matt won the technologies lest they make the improvements caused by synthetic certainly will, experience another 2014 IEA Free Enterprise Award. world worse. fertiliser, tractors replacing oxen, step change now we can use genetic I see two chief reasons better crop protection through modification to generate salt- In this interview with IEA Editorial that improvements to living chemical pesticides, better varieties tolerant, drought-resistant, pest- standards will continue. One is through plant breeding and genetic resistant, nitrogen-efficient crops. Director, PHILIP BOOTH, Ridley the inexorability, the inevitability modification – and more trade, We can also improve the quality, discusses why he believes the of progress. There was only one meaning regions can specialise in rather than just the quantity, year since 1945 when the world crops they grow best. of food by fortifying crops with economic future is bright and how we economy failed to grow – 2009 – It is astonishing to realise that vitamins, minerals, micro-nutrients and it shrank by just 0.9 per cent. we need 65 per cent less land to and omega-3 oils. It is a genuine could undermine economic progress It grew by 5 per cent the following grow the same quantity of food crime that the environmental year. People raise each other’s as we did when I was born – that movement has prevented these living standards by profiting from is a calculation done by Jesse improvements in Europe and delivering improvements for other Ausubel of Rockefeller University elsewhere with devastating people, and although chiefs, priests based on the yield improvements humanitarian and ecological and thieves are quite good at in each the world’s main crops. He consequences. stopping them, they just cannot thinks we may now have reached the keep up. It is getting harder and “peak farmland”, meaning we So, if you were an 18 year old harder for them. They cannot turn can actually reduce the acreage reading this magazine, am I right in saying that you would expect to be better off than your parents? THERE WAS ONLY ONE I like to quote two statistics to RATIONAL illustrate how much better off a YEAR SINCE 1945 WHEN teenager is today compared with his parents or grandparents. The first, THE WORLD ECONOMY which I got from Don Boudreaux, is OPTIMIST that on the average wage it takes 41 FAILED TO GROW – 2009 – minutes to earn the price of a pair of jeans. In 1982 it took your parents 1 AND IT SHRANK BY JUST 0.9 PER hour and 50 minutes to earn enough You are the winner of the IEA’S jeans had been cut by two thirds. specialization, driving innovation money on the average wage to buy 2014 National Free Enterprise I became a bit evangelical on and encouraging collaboration CENT. IT GREW BY 5 PER CENT THE an equivalent pair of jeans. Autumn 2014 £3.75 Award and you are a champion of the topic, because I could see that between people as they work for The second, which I calculated enterprise, though coming from young people were still being told each other. FOLLOWING YEAR from a study by the economist a scientific rather than economic that no matter how much better William Nordhaus, is that it takes background. Can you give us some life had got, the future was still Your most recent book was called the internet off; they cannot shut devoted to growing food while half a second to earn enough YOU idea about the extent of human relentlessly bleak. There seemed The Rational Optimist. That down world trade; they cannot continuing to feed a growing and money to turn on a lamp with a and YOUR progress over the last 200 years? to be almost a conspiracy to avoid presumably suggests you think stifle curiosity. A thousand years ever more affluent population. compact fluorescent bulb for an STUDENT What key statistics sum up that talking about positive trends. “It progress will continue. What makes ago, in a simpler world, predators In some countries we are already hour. In 1950, it cost eight seconds’ progress? is the long ascent of the past that you so confident? What scientific could kill commerce altogether, and releasing land from agriculture for of work – 16 times as long – for LOAN I realized a few years ago that gives the lie to our despair”, said and economic processes are the key often did. It’s much harder now. nature reserves, forests and other your grandparents to earn the From the Institute of Economic Affairs all the relentless pessimism I had H G Wells. “On what principle is to future progress? The second reason why I think “wilderness” uses on a large scale. same amount of light from an been fed by so-called experts we “ain’t seen nothing yet” is incandescent bulb. when I was student – about the because innovation comes from the Could we have a new green And then think of all the things inevitability of economic, ecological I WANT YOUNG recombination of ideas and there revolution? What might stop it? that your parents and grandparents IN THE and humanitarian disaster before is no limit on the number of ideas. The green revolution of the 1960s never had, from search engines to the century was out – had been PEOPLE TO DARE Therefore all the limits to growth turned India from a starving country mobile phones, from budget airlines DOCK: wrong. In my lifetime, globally, per that have been identified – running dependent on aid and imports to to carbon fibre, from genetic Market failure capita income had trebled, lifespan TO BE OPTIMISTS out energy, or water, or minerals a grain exporter despite a huge testing to Skype. It’s an ever more had increased by a third and child – make no sense, because we can, increase in population. It was wonderful world• mortality had fallen by two-thirds. it that, when we see nothing but Good as things are today compared and do produce innovations that achieved by the use of fertilizer on The world was becoming steadily improvement behind us, we are to with any time in the past, this world reduce the need for materials. and measurably healthier, happier, expect nothing but deterioration is still a vale of tears compared with We use less steel in buildings, we cleaner, kinder, safer, more peaceful before us?” said Lord Macaulay. So what it could be, and probably will substitute glass fibre for copper, we BITCOIN and more equal. Yes, really: when I want young people to dare to be be in the future. That, by the way, cut the weight of cars. The energy THE FLIPSIDE OF MONEY I looked up the data, that’s what I optimists. is why my rational optimism is the consumed per unit of GDP growth is found. Forests were expanding, rare I call my optimism “rational” very opposite of what Voltaire’s Dr going down all the time. “Growth” species were coming back, famines because it’s evidence-based, not Pangloss believed. He went around often means doing more with less. were getting less frequent, poverty built on mere hope. And because saying all is for the best in the best Hear more from Matt Ridley at: was disappearing. And the time it behind it lies a persuasive rationale of all possible worlds – that the One interesting fact is the extent www.iea.org.uk/multimedia/video/ took for a person on the average for why it happens – through world is perfect and cannot be to which food prices have fallen as interview-with-matt-ridley Meet wage to earn the price of a pair of the growth of exchange and improved. That’s what the word the population has risen in recent MATT PLUS 18 19 Analysis RIDLEY Reviews the Comment RATIONAL ...and the best of OPTIMIST OUR BLOG

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