Sunday, July 27, 2008

A Response to Daniel Earwicker

I got into an argument over at Sadie's place with a chap who seems to think my views that the city is in need of a good dressing down are some kind of mad rant. Here's his argument and my response.

..SNIP explanation of basic trade and capital flow..

Similarly, global currency trading performs the service of adjusting exchange rates. The US had a trade deficit for along time, spending dollars on foreign products. But as a result, the world is now awash with dollars, so the value of a dollar continues to fall compared to other currencies - dollars are easy to get. The result is that US goods appear cheaper, so American exports are booming, automatically fixing the original problem. This can only happen because currencies are traded so that we discover their real value.

Your original comment also mentioned the idea of a "real economy", compared to which financial services are supposedly like a barnacle or leech. In fact the economy consists of masses of interdependent sectors, none of which would make sense by themselves, so this quality of being dependent on something else does not in any way prove that one sector is somehow false or not legitimate.

Then there are the solutions you propose, which all feature the word "restriction" - somewhat ironic as we are on the brink of recession, meaning that economic activity is already starting to restrict itself. What problem are they intended to solve? There is almost no economic situation in which they would have a positive effect, but certainly against the backdrop of today's world economy, they would be severely detrimental, making it much harder for the economy to stay out of recession, and more likely to stay stagnant for longer - less able to borrow money to fund growth, less able to move money to where it would do the most good, less able to serve customers wherever they happen to be found.

Or are you merely recommending them as ideas that would be popular? No doubt they would indeed "go down quite well" with many voters. But that says more about economic awareness than it does about any positive effect such ideas would have. This is the main reason I'm glad you're not in charge, but the sad truth is that you'd make an excellent politician. Don't bother to think about whether an idea would do any good! Just think about whether it would make your supporters bay for more blood.

The central problem all those suggestions have, beside being solutions for problems that don't exist, is that they are based on the notion that politicians are special people who have an ability to decide things that far exceeds that of the millions of ordinary people who share those decisions today. Politicians, you think, can choose the right amount of lending, the right size for a bank, the right amount of currency to allow in and out of the country, and so on. The truth is they have been repeatedly proven to be unable to solve those problems, and the reason is simple: they are without the information needed to make the decisions.

The thing that would really help would be some kind of regulation on the growth of government spending, which in the end we all have to pay for (at exactly the same rate, whether rich or poor) due to the resulting inflation a few years later - precisely the problem we face now


Ok, moving goods around, trade, generally a good thing. Tea is pretty much worthless unless it's in close proximity to tea drinkers. Makes sense for other goods as well. So how about logically extending it to money? Again this makes plenty of sense, money needs to go where the good ideas are, where there's a need for a service that people want and are willing to pay for, again that's a nice sensible idea, no objections there.

Where I have a problem is the whole liberal world view that these things should not be restricted or regulated, my view of the financial sector is that it is needed, but that it has grown beyond being a healthy middle man for money into something altogether more worrying. Money is freely loaned to private equity companies who then proceed to load those companies up with massive debts, share prices no longer bear any reseblance to reality and Unrestricted lending of money has caused a massive surge in house prices. In addition to this,we have the credit crunch, caused by the irresponsible packaging up and selling on of mortgages. Financial institutions have moved way beyond simply acting as a source of funding to business.

As to whether there is a problem, Britain has not had a positive balance of payments figure for 26 years, the service industries that replaced manufacturing did not replace the lost exports. As a result, the British economy has been sustained on debt. This debt will one day need to be repaid. In addition there is the question of inequality, financial liberalisation has massively increased inequality, something I view as very negative.

I feel that both of these problems need to be solved and I feel that part of the solution is far stricter regulation on finance, which I believe has played a huge part in causing inequality. I think the revival of British manufacturing will also need to play a part.

On the whole individual choices point, I think this is basically dogmatic free market bullshit. Indiviual choices only lead to a short circuit decision, not any kind of perfect choice. The idea that politicians were "repeatedly proven to be unable" is incorrect.

For example, if I compare the GDP per capita growth of the developed world in the more regulated period from the 60s to the 80s (3.2%) with the same figure for the 80s to the noughties (2.2%) we can see clearly that the more regulated period delivered superior growth. Japan and East Asia adoped hugely interventionist policies relating to trade and finance after WWII, the results speak for themselves. The truth is that government intervention in the economy works.

2 comments:

Daniel Earwicker said...

Where I have a problem is the whole liberal world view that these things should not be restricted or regulated

That means you have a problem with anarchists, not the financial status quo. There are such people as David D. Friedman (son of Milton) who in 'The Machinery of Freedom' argued for absolutely everything to be privately owned and run, with no government at all. Firstly I think that's a ridiculous idea, and secondly it should be fairly obvious from the huge concentrations of government power existing today that he is not a very influential thinker.

Unrestricted lending of money has caused a massive surge in house prices. In addition to this,we have the credit crunch, caused by the irresponsible packaging up and selling on of mortgages.

The background to that is indeed appalling. It was made possible by stupidly low interest rates. The interest rates in the US and UK are set by supposedly independent committees. But in order to target low inflation, first you have to decide how to measure it. Both the UK and US currently make a special point of not including house prices in their inflationary measure. In the US they switched to using an estimated "rental value" in 1983, and the UK simply started ignoring house prices altogether some years ago. As a result, the inflation rate appeared much lower than (perhaps even half of) its true value. So interest rates were kept low, and a bubble was created in the housing market.

The key point is that there was (and still is) no need to introduce some kind of special "restriction" on lending. It just needs to be priced based on a realistic measure. The controls that already existed would have worked, had they been used properly. Instead the governments of the day have manipulated the situation, using an unrealistic measure to keep interest rates down, because in the short term the resulting inflation cons people into thinking that they're all getting rich from rising house prices. But eventually the inflation spreads out into other sectors of the economy and no one is any better off, because there hasn't been any real extra economic growth.

I expect soon the government will suddenly decide that house prices should be included after all, and maybe food should be excluded, from the inflation measure. Anything that is dropping in price will be included, and anything rising will be excluded. Because politicians are crooked.

As to whether there is a problem, Britain has not had a positive balance of payments figure for 26 years, the service industries that replaced manufacturing did not replace the lost exports.

Our deficit is tiny as a proportion of GDP - we export almost as much as we import, and in the past where we've been a net exporter, the positive gap was similarly tiny.

Ironically, financial services is one area where we've earned far more from the rest of the world than we paid out in recent years.

The idea that we swung from massive industrial exports to having no exports isn't true at all. If it was, our currency would be weak. If we overdo the imports, our currency will weaken and so our imports will fall and our exports will rise. So I can only refer you back to what I said last time, which you quote above, although apparently without reading it. When a country imports a lot, it weakens its own currency, which makes its products more attractive, so exports rise, so the problem goes away. This is currently happening to the US. It isn't happening to the UK because we're not actually running a very large deficit.

In addition there is the question of inequality, financial liberalisation has massively increased inequality, something I view as very negative.

Inequality has certainly increased, and social mobility decreased, in the last decade. During that period, there has not been a marked degree of "financial liberalisation". On the contrary, there has been an unprecedented huge rise in public spending, specifically targeted at providing public services to supposedly "level the playing field" for the less well-off. There's certainly something very unfortunate going on, but there is no evidence to suggest that it is being caused by financial liberalisation. One possible theory is that there are pockets of persistent welfare dependency continuing for several generations and causing social breakdown.

I think the revival of British manufacturing will also need to play a part.

It may be that you suffer from the standard delusion that Britain was an industrial powerhouse up until... oooh, say, 1979, when the whole thing was wrecked by the evil Tories, throwing all the workers in towns like Corby "on to the scrapheap." That's what my geography teacher told me in 1987. (He also told me in private that he wanted to turn us all into good little socialists but he may have been joking.)

Why did the UK steel industry require twice as many workers to do the same job as in competing countries? How did our mass market cars get an international reputation for being badly designed and made? And why did all these industries need to have billions of pounds of public subsidy poured into them to keep the facade from crumbling? And how come the unemployment rate in Corby returned to the national average about 17 years ago? Could it be that, in fact, we didn't really need to artificially maintain a "manufacturing base" by pouring public money into it?

On the whole individual choices point, I think this is basically dogmatic free market bullshit.

"Dogmatic" is a very useful accusation to throw around, because obviously anyone you disagree with can be described as dogmatic, whereas anyone you agree with is just being sensible.

Labeling it as "dogma" conveniently avoids the trouble of thinking about what a free market is, how much you benefit from free markets, how much they are an intrinsic part of your life, how much you'd lose if they were eradicated. The funny thing is that you undoubtedly make a hundred personal economic choices every day, without really noticing, and you are operating in fairly free market, and if you were stopped from doing so, you'd complain as much as anyone that it was an absurd and unnecessary intrusion on your life.

Indiviual choices only lead to a short circuit decision, not any kind of perfect choice.

That's just silly. They only lead to short circuit decisions? They never incorporate information that is only possessed by the individual, which no centralised process could ever tap into? Are you quite sure that someone else would be better at deciding on your behalf what you should have for breakfast tomorrow? And that's just one relatively trivial minor example. Would you rather have your job allocated to you by a central committee? Wouldn't you find it ridiculous if civil servants decided what a packet of biscuits should cost? That would be dogmatic. Freeing individuals and individual companies to make their own decisions is the absence of dogma.

And it's equally ridiculous to criticize individual decision making on the grounds that it is not perfect. It isn't necessary for it to be perfect in order for it to easily outperform centralised bureaucratic long-term planning.

The idea that politicians were "repeatedly proven to be unable" is incorrect. For example, if I compare the GDP per capita growth of the developed world in the more regulated period from the 60s to the 80s (3.2%) with the same figure for the 80s to the noughties (2.2%) we can see clearly that the more regulated period delivered superior growth.

That's really funny. Can you think of anything else that happened around that time, such as the rapid emergence of a whole new world of industrial powerhouses, which the established western exporters had to then compete with? Might that have had an effect? And what kind of economic systems did those competitors operate? (See below).

And even then, the difference in the average growth rates is just 1% per year! What does the graph look like if you look at it in more detail, instead of dividing it up into two chunks, each of two whole decades? What if you consider the impact of things like the oil crisis, or inflationary cold war spending, or the fact that Europe started from a very low base after the war and so was growing rapidly in recovery from that, just as developing countries are growing more rapidly than us today?

Japan and East Asia adoped hugely interventionist policies relating to trade and finance after WWII, the results speak for themselves. The truth is that government intervention in the economy works.

The problem with a statement like that is that you don't say anything about the type of intervention. The question is, should the government intervene to try and set up and sustain a free market economy (answer: obviously yes!), or should it intervene on a continuing detailed basis by trying to actually make economic decisions and pull the levers itself? (answer: obviously not!)

Look up the history of Taiwan, which has grown steadily by about 8% a year for an incredible three to four decades. The government did indeed intervene massively at the start, but it did so specifically to create a free economy, allowing a population initially dominated by half-starved subsistence farmers to transform itself, through individual decision making, into an economic miracle, wealthier than some European countries, in a matter of decades, with no oil or natural gas to draw on. Just people, churning out cheap exports. Look at China, which has gone from being the home of probably the worst famines in human history to being the country with the most internet users in the world, by gradually introducing liberalising economic reforms and various forms of free market since the late 1970s. Try comparing the economic performance of various African countries based on their style of economic policy.

Or try watching this.

Andreas Paterson said...

On government power, I would argue that governments have far less power than they have had in the past. While governments still enforce the law, control over the economy in developed countries has weakened considerably. The trend for a long time has been towards privatisation and liberalisation and a reduction of government control. My opinion is that the government has given up too much of it's control.

On the credit crunch, I really don't see how it can all simply be attributed to interest. I heard talk of interbank lending seizing up due to things called structured investment vehicles and collateralised debt obligations being worth far less than imagined. I heard talk of the Bank of England expanding the range of assets it would accept as security and talk of central banks pumping liquidy into the system. I find the idea that it could all be governed simply by the interest rate with no further funding absurd, the only thing such an idea seems to be good for is increasing banking profits.

On your point on balance of payments and it's relation to inflation, I think it should be noted that the relationship is not that simple. Inward currency flows are split between assets and goods, I would suggest that much of the inward flow has gone on assets, mitigating the decline due to negative BoP on goods. This fit's with the general perceptions of the level of foreign investment in the UK. I accept your point that the BoP deficit is quite small, but it seems to me that even a small deficit is likely to build up over time to cause a longer term problem.

On manufacturing I'd accept that British manufacturing in the 70's was poor, I would put this down to uncooperative unions and lack of inward investment. German industry at the time was far more productive due to the far superior equipment and machinery available as well as it's far superior union relations. Germany and Japan demonstrate that it is possible for a developed nation to maintain it's manufacturing base provided it remains efficient and competetive.

I'm not arguing in favour of a 100% centrally planned economy, I'm simply arguing in favour of a more interventionist state that shapes the behavoir of a free market. My point on intervention was to demonstrate that politicians can and have shaped the economic destiny of a country, often quite succesfully when they have made the right decisions. While it can be viewed as a good thing for a developed country to liberalise to some degree, it is still worth maintaining some political control. Decisions left to the market are often made with a view towards profitability rather than a more general measure of what is in the interests of the many, the advantage of higher levels of political control (when it is democratic) is that everyone's say is weighted equally. Pricing signals just follow the money.