Monday, October 27, 2008

Why did so many people stick their name on this Drivel?

On Sunday the following letter appeared in the Telegraph, it is signed by lots of people with important titles like "Chief Economist" it serves as proof that the vast pay packets they command are a sign of overdeveloped egos, not well developed brains.


Further to your interview with Alistair Darling, we
would like to dissent from the attempt to use a public works programme to spend
the country's way out of recession.

It is misguided for the Government
to believe that it knows how much specific sectors of the economy need to shrink
and which will shrink "too rapidly" in a recession.

Thus the Government
cannot know how to use an expansion in expenditure that would not risk seriously
misallocating resources.

Furthermore, public expenditure has already
risen very rapidly in recent years, and a further large rise would take the role
of the state in many parts of the economy to such a dominant position that it
would stunt the private sector's recovery once recession is past.

Occasional slowdowns are natural and necessary features of a market
economy.

Insofar as they are to be managed at all, the best tools are
monetary and not fiscal ones. It is inevitable that government expenditure and
debt naturally rise in a recession but planned rises in government spending are
misguided and discredited as a tool of economic management.

If this recession has features that demand more active fiscal policy, which is highly
disputable, taxes should be cut. This would allow the market to determine which
parts of the economy shrink and which flourish to replace them.

Dr Andrew Lilico, Europe Economics; John Greenwood, Chief
Economist, Invesco; Richard Jeffrey, Cazenove Capital Management; Dr Ruth Lea,
Economic Adviser, Arbuthnot Banking Group; Trevor Williams, Chief Economist,
Lloyds TSB Corporate Markets; Dr Nigel Allington, University of Cambridge; Prof
Philip Booth, Institute of Economic Affairs; Prof Tim Congdon, Author, Keynes,
the Keynesians and Monetarism; Prof Laurence Copeland, Cardiff Business School;
Prof Kevin Dowd, University of Nottingham; Prof Kent Matthews, Cardiff Business
School; Prof Alan Morrison, Said Business School; Prof Sir Alan Peacock, Former
Chief Economic Adviser, Dept of Trade and Industry; Dr Mark Pennington, Queen
Mary College, London; Prof David B. Smith, University of Derby; Prof Peter
Spencer, University of York



So, why is it drivel? That relates to the fantasy economics of paragraphs 2 and 3 and the belief that the economy involves entirely naturally. Anyone with half a brain can look at the economy and see that where the government has intervened the economy has adapted around it. It doesn't matter whether the government interferes in a free economy or not, the economy adapts to fit.

To back up this assertion, take a look at the South Korean steel industry, POSCO is the worlds third largest steel producer and a symbol of national pride among Koreans, it was originally created as a state owned enterprise by the Korean government. Now Korea has a gigantic steel industry, all as a result of a good government decision.

Rather than look at a public work and examine it from a pragmatic point of view: Will it be useful? Will there be a demand for it? Will it stand the test of time? Questions any business person would consider essential when considering a business venture these people have chosen to sacrifice pragmatism at the altar of free market ideology.

I would question whether this free market ideology actually has any benefit at all, once again Korea has grown massively over the past 50 years in spite of government intervention on a large scale. Furthermore, the idea that there is a natural tendancy for the free market to assert itself and create economic activity where it's needed seems flawed. In many developing countries where farming has collapsed there has been no rise in alternative economic activity to replace the collapsed industry. In the developed world we the market is now in 2008 giving us signals that the expansion of credit derivatives was a bad thing several years after the event. The market is no better at planning economic activity that the government.

In my view then, it's not a good letter it makes lots of spurious claims about the role of government in the economy. It makes suggestions based on ideas with a questionable factual basis and it deserves not the slightest consideration by the government.

2 comments:

Hugo said...

I am afraid it is your blog post that doesn't get economics.

Fundamentally, economics is about opportunity cost. We could spend capital on one thing that is good. But we might have spent it on something else which is even better.

So:

Yes, private agents adapt to every other agent, including the government. But that doesn't mean that government intervention helps the economy. Yes, private individuals can adapt to government intervention, but they'd still be better off without it.

You don't actually engage with the letter's claim that government intervention misallocates resources. Governments don't have to pay attention to prices, because they don't have to make a profit, because they can collect taxes. For example, the government can choose to allocate capital to producing more of a particular good than would be produced in a free market. This means that the capital does not go towards producing something more valuable (valued more by the market).

The government is an agent like any other (just much bigger and with special legal privilege), so it can make good decisions. The difference is that if it makes bad decisions we have to pay for them. And if there are lots of independent agents, at least someone makes a good decision, and bad decisions get filtered out much quicker.

"look at a public work and examine it from a pragmatic point of view: Will it be useful? Will there be a demand for it? Will it stand the test of time?" Not quite. You should really ask, "Will it be *more* useful than the opportunity cost?". This is encapsulated in "will it make a profit?". And if it does, there is no need for government action.

POSCO may well be a good goverment decision. But one lucky hit doesn't excuse all the misses. And who knows what the capital they used to start it up could have been used on instead?

You say "Korea has grown massively over the past 50 years in spite of government intervention on a large scale." Correct, it has. And it would have grown even faster without the government intervention. The growth is not the result of intervention.

"In many developing countries where farming has collapsed there has been no rise in alternative economic activity to replace the collapsed industry." Yes, because they don't have well-enforced property rights. That's why they never got beyond subsistence farming in the first place. And that is the true role of government: creating a market, by e.g. enforcing property rights, and then backing off.

"The market is no better at planning economic activity that the government." Read some Hayek. You use one miss and ignore all the hits. Economic growth is correlated with lack of government intervention.


(One last quibble: "It doesn't matter whether the government interferes in a free economy or not, the economy adapts to fit." If the government interferes, the economy is no longer free.)

Andreas Paterson said...

Hi Hugo

I've responded in a separate post here.

Andreas