One day a lemming will fly

16/10/2018 Leave a comment

I do wonder how different the world would be today if Bernie Sanders had become President instead of Donald Trump. It would certainly be a lot better for millions of poor American voters who, instead of voting for higher taxes on the wealthy and more wealth distribution, voted for the complete opposite. Strangely though, if given the opportunity again today, most of them would vote the same way as they did in 2016.

Stuff like this gives economists a headache. It’s much easier to base economic models on the idea that people behave in ways that make them better off, as opposed to looking for ways to shoot themselves in the foot.

Although tricky, it’s important for us to accept that people do behave like this and it’s also important to think about what we can do about it. So, since I have your ear, I’ll give it a go.

Deep down, Bernie knew he wouldn’t win. Of course he believed his policies would benefit more voters than the policies of Donald or Hillary but still, he knew he wouldn’t win. The USA is very right-wing country and there are a huge number of well-funded, well-organised lobby groups that exist to keep it that way. In the context of American politics, Bernie’s policies were extreme and he would have known that convincing a sufficient number of voters of such a radical change in direction would likely be impossible.

So was it a waste of time? Absolutely not. Bernie ended up doing extremely well in the circumstances and while he failed to win the nomination, he did achieve something else – he made it a little bit easier for the next Bernie. His achievement was to chip away marginally at the status quo. The next Bernie won’t win either but next time around, the same policies will be a little more mainstream. One Bernie alone won’t bring policies of equality to the United States. You need a lot of them. The first few will fail, perhaps the first many will fail. Eventually one will succeed.

The problem, of course, isn’t in finding people who agree with the policies – they weren’t really that extreme. The problem is finding people who have the guts to be the first ones over the cliff, knowing that their chances of being the first successful Bernie are slim at best.

Anyway, the Brexit mess is still rolling down the hill, like a giant snowball of poop, and a lot of people have been asking me if I am in favour of a People’s Vote. It’s essentially a second referendum in which the voters, this time around, would have the added benefit of knowing the actual alternative they could vote for.

To be honest, I struggle to have enthusiasm for it.

What should be abundantly clear to everyone by this point, is that there is no good alternative to EU membership. The possible outcomes if we leave the EU are a shitty deal that leaves everyone worse off, or no deal at all, which leaves everyone even worse off than that.

Given those options or a People’s Vote, then yes, I’d rather have the vote. Let’s roll the dice again – it can’t be any worse. We would, however, get a few months of Boris, Gove, Rees-Mogg, The Daily Mail, The Sun and the rest of them, in full bullshit propaganda mode. Add into that a fallacy of the human brain – people are very bad at admitting when they were wrong – and we will end up having another uninformed vote.

It’s not inconceivable to think that such a campaign could result in people voting for no deal at all and us ending up worse off than if, after the first vote, we’d just called, “Stick”.

What’s my alternative suggestion? Thank you for asking – it’s very simple but we will need some help from our politicians.

Our politicians have to have the guts to stand up and say something like this:

We have taken on board the result of the referendum. We have spent two years working on it, trying to find out how we could make this work for the country.

The result is, that it doesn’t. Deal or no deal, there is no way to enact departure from the EU without causing significant hurt to the economy and citizens of the country.

We looked at it – for two years, we really did look very hard at it. But it’s a bad idea and we’re not doing it.

One MP doing this alone won’t make a difference – we’re going to need a bunch of them. If they take this position in sufficient numbers then we have an opportunity to avoid an utterly unnecessary catastrophe.

The problem, of course, isn’t in finding people who agree with remaining – the majority of MPs were in favour of that to begin with.

The problem is finding politicians who have the guts to be the first ones over the cliff.

RedEaredRabbit

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Filed under Economics, Politics, Uncategorized Tagged with

Royal Fail

01/04/2014 2 Comments

Jonathan Portes, via Twitter, drew my attention to this article in The Telegraph by Tory MP, Douglas Carswell:

20140401-215636.jpg

The article is a fantastic example of how, no matter how bad the situation, politicians are able to rise above the usual constraints of fact, logic and evidence and carve out their own reality.

It is, of course, an article in response to the report that found that the government, when selling off Royal Mail, had substantially undervalued it.

In case you missed it, on the morning of 11th October last year, the government sold off Royal Mail. By the end of that day its value was £750m higher than that for which the government had sold it. It’s a bit like selling your car to your next door neighbour, only to find that, later on the same day, they’d sold it on to your other next door neighbour for much more.

While we won’t get the £750m back from Royal Mail’s new shareholders, at least with this government, we can easily get it back through cutting benefits for poor people. Hoorah.

Anyway, back to that Telegraph article:

Far from undermining the case against Royal Mail privatisation, today’s National Audit Office (NAO) report that suggests Royal Mail’s sell off was bungled actually convinces me that it the right thing to do.

That’s some logic that only a politician could come up with – if the government hadn’t bungled it, he would have remained unconvinced on the whole affair. But because they did bungle it, he is now convinced it was a good idea.

The basis for this “logic” is that because it was sold too cheaply, it proves that that government weren’t competent in knowing what to do with it, so it’s ok to sell it for much less than it is worth. That’s like saying, “I am rubbish at driving my Ferrari, so I should sell it for the price of a Nissan Micra.”

The article moves on, apparently now forgetting that it had previously said the sale was “bungled”:

Predictably, the NAO report is being interpreted as evidence that Royal Mail was sold off “too cheap”

In fairness, it is being “interpreted” this way because that’s exactly what it says.

The article then loses itself in a very muddle-headed analysis of what determines the value of a company. Essentially we are told, as the headline suggests, that the reason for the sudden and substantial increase in valuation was because the company was privatised.

This just makes no sense whatsoever.

A share price is essentially a measure of the market’s view on the future profits of a company. Occasionally a share price will increase substantially within a day but it happens when a piece of information becomes known that dramatically changes the market’s view of the future of the company. For example, if a pharmaceutical company announces that it has developed and patented a new drug that cures a common condition for which there was previously no treatment, then their share price might suddenly go up a lot. That’s understandable because the market expects their future profits to reflect this new piece of information.

On the day that Royal Mail was sold off, their new private status did not cause them to develop, patent and announce a new, substantially more efficient, way of delivering letters. The increase in share price was simply because the government undervalued the company when it sold it off.

So where did the money go? As we found out, a small number of investors in the City bought up a huge amount of shares and sold them on shortly afterwards, making hundreds of millions of pounds of profit. It really does take a politician to come up with the bizarre kind of argument given in this article to justify why it that money should have been profit for a few people in the City rather than money for the public purse.

If the government were now holding their hands up and admitting their mistake, while simultaneously apologising to the poor people, whose benefits are now being cut, we could at least give them credit for being honest.

Predictably (hey I can use that too), it’s smoke and mirrors time and if this is anything to go on, the government’s smoke and mirrors are looking thinner than ever.

RedEaredRabbit

 

Filed under Economics, Politics Tagged with , ,

Time for Plan B

08/03/2014 Leave a comment

It’s probably not controversial to say that politicians change their minds a lot. Nick Clegg, for example, found little difficulty in voting to increase tuition fees shortly after he’d happily been photographed doing this:

A pre-election Nick Clegg

It’s easy to pick out Nick Clegg over such inconsistencies (in fact it’s fish, barrel, howitzer time) but this is undoubtedly a common trait amongst politicians. Let’s look at another.

SNP Leader and Baron Greenback doppelgänger, Alex Salmond once described the pound as “a millstone round Scotland’s neck”. These days though he’s desperate to keep it. These days, we are told, that Scotland losing Sterling would cost British businesses hundreds of millions of pounds.

It’s a pretty big change in his position, so it’s worth asking why that change occurred.

Before that though, I feel I obliged to back up claim that he looks like Baron Greenback from Dangermouse:

Alex Salmond

Alex Salmond

Baron Greenback from Dangermouse

Baron Greenback from Dangermouse

Uncanny, no?

Back to the question. Why has his position changed so much? Economically this is hard to answer. While different currency options have different pros and cons, those pros and cons don’t really change a huge amount over the long term*. When Alex was strongly in favour of Scotland scrapping the Pound in favour of the Euro, he didn’t mention those lost hundreds of millions of pounds that are now such a problem.

Unsurprisingly this has nothing to do with economics and everything to do with politics. The past six years have not been kind to the public’s perception of the Euro and while such a policy might once have been a vote winner, today it would be a huge vote loser. The experience of close neighbours, Ireland, (amongst many other Eurozone economies) has been hard for Scottish voters to miss. Here are unemployment rates as one example:

UK & Ireland Unemployement (Source: IMF)

UK & Ireland Unemployement (Source: IMF)

Alex wanted the Euro when he thought it would gain him more popularity for independence and today wants Sterling for the same reasons. Not that that makes him any different to any other politician but it is important to understand that all of this has a lot to do with politics and not a lot to do with economics.

In any case though Alex’s new found love for The Pound is fairly immaterial because, as we’ve seen, there seems to be very little motivation from the rest of the UK to enter into a formal currency union with an independent Scotland. While this has generated much ire from Alex, it’s worth putting this position into perspective.

An independent country cannot demand than another country enter into a formal currency union with it  Unless both countries want to do it, it won’t happen and, to be fair, it shouldn’t happen.

Alex, as an expert on independence, should probably realise he can’t just pick and choose which aspects of independence he wants and which he does not. He might want The Bank of England to continue to act as Scotland’s central bank but, in the case of Scottish independence, that’s simply not a demand he can make.

Given this, it’s surprising is that he doesn’t seem to have any “Plan B” on the matter of what currency an independent Scotland would actually use. With six months to go until the vote, this looks more than a little disorganised. So what are the options for “Plan B”?

Essentially there are three:

Option 1: Dollarisation

Scotland could continue to use the pound as their currency without any formal monetary union. Several countries already do this with the Dollar (hence the term Dollarisation for using a foreign currency), such as Panama and El Salvador. Several also do this with the Euro, such as Monaco, Andorra and the Vatican City. Scotland would be, comparatively, a very big economy to try this out but it is definitely an option. There are some serious disadvantages of it, one of the big ones being that if, as a country, you have no control over your currency, you can go bust.

As an independent country, Scotland would start out with debt of around 80% of their GDP and with no control over their currency, markets would be unlikely to want to give them more very cheaply. Additionally, given recent history, the Scottish financial sector, dominated by RBS and HBOS, is unlikely to want to remain based in a country where they have no lender of last resort. NIESR go into the whole dollarisation thing in more detail here but it’s probably fair to say that:

a) To go down this route there would be an awful lot of details to sort out before September

b) Although workable, there are additional risks in dollarisation over the current system, some of which are material

Option 2: Adopt the Euro

LOL

Option 3: Create a new Scottish Currency

In this scenario, Scotland would set up its own central bank, print its own currency and have full control over both its fiscal and monetary policy. Unlike the other options, it would be economically independent. The down sides would be that the new currency was likely to be more volatile than the pound and there would be costs involved in cross-border transactions between Scotland and the UK when converting from one currency to another. There’s no reason to think that either of those would be an insurmountable problem though – neighbouring countries throughout the globe have used different currencies successfully for a very long time. Additionally markets wouldn’t panic about an independent Scotland using a foreign currency as they’d control their own, so Scotland would be able to borrow at reasonable (albeit higher) rates without being seen as a default risk. I really can’t see any reason why Scotland couldn’t do this successfully and it seems to me by far the cleanest and most workable (not to mention the only “independent”) of the three options.

As I mentioned earlier though – the economics of the debate aren’t taking centre stage (on either side) and, to be honest, it is worth asking whether they should anyway. If Alex Salmond could just communicate a sensible currency policy to the Scottish people we could then just move on to what the debate is really about…

Is it about other economic things?

No it’s not. An independent Scotland would certainly have the ability to operate successfully. Would they be on average better off or worse off? Despite what George or Alex tells you, I doubt there would be a big difference – there’s little evidence to suggest that things would vary much either way.

Is it about political things?

No it’s not. A “Yes” vote would mean Alex Salmond being in charge (and he is clearly a bampot), but a “No” vote would mean David Cameron being in charge and, if anything, he is an even bigger bampot than Alex Salmond. But that is politics for you – no matter how you vote, you’ll probably get a bampot.

So if it isn’t about economics and it isn’t about politics, what is it about?

Let me give you a hypothetical example to explain. Supposing there were clear economic benefits to the UK scrapping sovereignty and becoming the 51st state of the United States, would we all want to do it? I suspect that we would vote “No” and I doubt it would be a close run thing.

Alex Salmond, if he has any sense, should move straight past the currency discussion with a credible alternative to formal currency-union and focus on what is actually important in this debate. I suspect it is the reason he has spent his life campaigning on the subject and it isn’t about economics:

As a Scottish person, would you feel happier if Scotland were part of the United Kingdom or happier if it were not?

We can argue the economic and political details as much as we want. A question such as this goes way past economics and politics and it is essentially the question that will determine the way the Scottish people vote.

I can’t help but add that I hope you decide to stay.

RedEaredRabbit

* I say long term because in the short term pros and cons will change. Perhaps today being in the Euro would make people better off. Perhaps in six month’s time dollarisation would be slightly ahead. A currency choice is a long term option though and not something you can just keep switching every few months. Therefore the long term is where you should focus.

Filed under Economics, Politics

Greed Is Not Good

04/01/2014 3 Comments

As we enter another year under Conservative-LibDem coalition, there are many stories I could highlight as my story of 2013. I could talk about the UK’s credit-rating downgrade and how it underlines the government’s (willing or unwilling) misunderstanding of what determines their borrowing rate. I could talk about how the government should take no credit whatsoever for the signs of economic recovery we have started to see. I could talk about how the government’s policy on immigration is, at best, completely ignorant of the widely available evidence on the subject. I could even forget politics and economics and talk about taking photographs of herons if you want to give me a moment.

However, in my current state of reflecting on 2013 whilst simultaneously looking to our future, there is one story that I feel needs to take precedence and that story is the story of inequality.

In November, Boris Johnson gave the annual Margaret Thatcher Lecture. You can read the full transcript if you can bear it but here’s a snippet:

Like it or not, the free market economy is the only show in town. Britain is competing in an increasingly impatient and globalised economy, in which the competition is getting ever stiffer.

No one can ignore the harshness of that competition, or the inequality that it inevitably accentuates; and I am afraid that violent economic centrifuge is operating on human beings who are already very far from equal in raw ability, if not spiritual worth.

Whatever you may think of the value of IQ tests, it is surely relevant to a conversation about equality that as many as 16 per cent of our species have an IQ below 85, while about 2 per cent have an IQ above 130. The harder you shake the pack, the easier it will be for some cornflakes to get to the top.

…the income gap between the top cornflakes and the bottom cornflakes is getting wider than ever. I stress: I don’t believe that economic equality is possible; indeed, some measure of inequality is essential for the spirit of envy and keeping up with the Joneses that is, like greed, a valuable spur to economic activity….

When Margaret Thatcher came to power in 1979 they faced a top marginal tax rate of 98 per cent, and the top one per cent of earners contributed 11 per cent of the government’s total revenues from income tax. Today, when taxes have been cut substantially, the top one per cent contributes almost 30 per cent of income tax; and indeed the top 0.1 per cent – just 29,000 people – contribute fully 14 per cent of all taxation….

I proposed that we should fete them and decorate them and inaugurate a new class of tax hero, with automatic knighthoods for the top ten per cent. Well, my friends, I am proud to say I have often been accused of being out of touch, but hardly ever have I produced so frenzied and hate-filled a response. People aren’t remotely interested in how much tax these characters pay. That does nothing to palliate their primary offence, which is to be so stonkingly and in their view emetically rich.

When George Osborne gave his speech about welfare cuts in April, I labelled it the worst speech ever made. I didn’t expect it to hold that record for such a short period of time. Let me take Boris’s points one by one.

The high and ever-increasing level of inequality is inevitable in a competitive economy

In a free and competitive economy, the laws of economics say that workers’ wages are set by supply and demand. That is we would expect workers with skills for which demand is high compared with supply, to receive higher wages than their counterparts. If there is a demand for apples and I am better at growing apples than the average apple grower such that I grow on average 10% more apples each year, then I would expect my wages to reflect this. In fact, if my wages didn’t reflect this, I probably wouldn’t bother growing the extra 10% and instead work fewer hours. Therefore it is fair to say some level of inequality of inevitable in a competitive economy.

However, that level of inequality is very far removed from the wage disparity that we see today. The wages received and the wealth held by the richest 1% dwarf that of the average worker by such a degree that it cannot be explained simply by the supply and demand of their skills. In 1998 the average remuneration of FTSE100 CEOs was 40 times that of their average employee. Just 13 years later it had ballooned to 140 times that of their average employee. This is the scale of inequality we are talking about and it is simply not explainable by supply and demand for skills – it’s not as if the number of people with the skills to be a CEO massively declined between 1998 and 2011. Something else is going on here.

The high and ever-increasing level of inequality is a natural result of varying intelligence

Firstly, it’s worth noting that the intelligence explanation of inequality is completely at odds with the explanation of our current government. David Cameron and George Osborne have for the past couple of years been pushing the explanation that people who do well, “go out and work hard” and being poor or unemployed is a lifestyle choice.

That’s clearly nonsense but Boris’s explanation doesn’t work either. The gap between the super rich and everyone else has increased at such a pace that it simply cannot be linked to intelligence in any significant way. How can the dramatic rise of CEO wages in such a short period of time be explained by “different people have different IQs”? It can’t.

Additionally it is worth asking why, if you accept that there is naturally a variation in ability, you should use that as a reason not to tackle inequality. Surely if you understand that some people are born with a natural advantage it is all the more reason to form policy to support those less lucky.

Let’s look at a couple of other examples of inequality from the US and see if these seem to be linked to a variation in IQs among workers.

In the US, the Walton family (I’m referring to the 6 heirs to the Wal-Mart empire not John Boy etc.) command a wealth of $67.9bn – equivalent to the combined wealth of the entire bottom 30% of US society. That must be one smart family!

In case you think by using the example of one family I am cherry-picking, let’s go macro. This recent paper from UC Berkely showed that between 2009 and 2012, the earnings of the top 1% of Americans grew by 31.4% compared with just 0.4% for the other 99%. Or to put it another way, 95% of the increase in US earnings between 2009 and 2012 went to the top 1%.

Can that possibly be explained by intelligence? No. Something else is going on.

Inequality is necessary to motivate people to work harder

To a point. Going back to my original example, it’s a fair possibility that my apple growing neighbour will see my apple haul is larger than her’s and work hard to increase her output next year.

As I have already stated though, this is just not the scale of inequality we are talking about and the idea that such a motivational effect exists when inequality is high is purely wrong. A small level of inequality might make me see an opportunity for increased wages by working harder but a high level of inequality will have the opposite effect. When a worker in a FTSE100 company sees the pay of their CEO increasing astronomically year on year, while their own pay stagnates, are they more and more motivated? Of course not, it is throughly demotivating.

Worse still, those at the very bottom living in poverty see the gulf they must cross to get out of poverty becoming greater and greater and the chance of crossing it becoming less and less. In South Africa the rich live in luxurious, gated communities surrounded by razor-wire and armed security guards. The poor live around them in shanty towns. If extreme inequality is an extreme motivator then we should expect to see high numbers of South Africans that were born in extreme poverty moving out of it. But we don’t.

The higher inequality becomes, the harder it is to solve.

Margaret Thatcher looked out for the rich and in doing so made things fairer

This one is half right in that Maggie did look out for the rich but the idea that she made things more fair or more equal is (in Boris terms) balderdash and piffle.

The Gini Coefficient is a standard measure of inequality in a country. A Gini Coefficient of 0 means everyone is equally well off. A Gini Coefficient of 1 means one person holds all of the wealth and the rest of the population have nothing. The lower the Gini Coefficient the more equal the society.

This graph shows (in blue) how the Gini Coefficient changed during the period of government over which Maggie was in charge. I’ve included the years back to 1961 (in green) to show that this wasn’t just an existing trend.

UK Gini Coefficient (1961 - 1990) Source: IFS

UK Gini Coefficient (1961 – 1990) Source: IFS

And this graph shows how real income changed during her time in charge for each fifth percentile:

Real Weekly Incomes 1979 & 1990 Source: IFS

Real Weekly Incomes 1979 & 1990 Source: IFS

As you can see the income of the poorest went down, while the richer you were, the more your income went up!

As Boris says, it is in large part due to Maggie that today the richest are paying a higher proportion of the total income tax than ever before. While that’s true he has failed to mention RedEaredRabbit’s Law of Income Inequality:

If you give the rich all of the income, the rich pay all of the income tax.

That doesn’t make it fair.

The rich should be lauded for the amount of income tax they pay

This one might be the worst of the lot.

A rich person who pays income tax (without trying any dodgy tricks to avoid it) is obeying the laws of the land. They are obeying them every bit as much as a poor person is who is paying their taxes. No one is paying income tax to be philanthropic – they are simply obeying the laws of the land as set by the politicians.

More than that though, are we seriously trying to say that someone in severe poverty would rather be where they are now, watching every penny just to put food in front of their children but paying a small amount of tax, rather than being a millionaire who pays much more? I leave you to choose your own heroes here.

Income tax is a government policy. It is they who decide who pays how much income tax. To say that heroism and knighthoods should come with the 45% bracket is worse than ridiculous.

The 99% hate the 1% for being rich

This is the always the last refuge of the right in this discussion. If you are concerned about rising inequality you’re just a nasty jealous person. This is not the case. The 99% do hate something but it isn’t the 1%.

The 99% hate the system that sees the wealth of the 1% accelerating away from everyone else. They hate the fact that the same system that caused the 1% to go from rich to super rich simultaneously caused their own pay to stagnate. And they hate the fact that this system caused a global economic crisis for which they are paying the price.

People don’t hate the individuals, they hate the system that causes the inequality. Why is it hugely convenient for right-wing politicians to push the case for the former? Because the responsibility of the latter lies solely with politicians and it is a system that those on the right seem to rather like the way it is.

Summary

It’s easy to say that inequality is inevitable in free market economics but that is simply not the case. Inequality did not suddenly balloon under Margaret Thatcher because the laws of economics were different in the 1980s – inequality ballooned directly because of the policies of her government.

Boris would like us to believe that the laws of economics exist in a vacuum but they don’t. They exist in a world dominated by politics. While the laws of economics help us to understand what the outcomes of different government policies might be they do not decide the policy that a government chooses to go with. Economics doesn’t define economic policy any more than economics decides the laws of the land. These are determined by politicians and those politicians absolutely have the power to reduce inequality if they choose to implement measures to do so.

CEOs of FTSE100 companies are allowed to give themselves large increases in remuneration not because of economics but because the politicians have set laws on corporate governance that allow them to do so. Companies operate monopolies not because of economics but because the laws of the land set by politicians allow them to do so. Banks were allowed to lend irresponsibly in the run up to the financial crisis, not because of economics but because politicians relaxed banking regulations to allow them to do so.

The problem with allowing inequality to increase forever might seem fine to Boris, (who we should remember, described his second salary of £250,000 for his Daily Telegraph column as “Chicken Feed”) but it has really serious implications.

Today we live in a country in which a child born into a rich family has a significantly greater chance of receiving a high income later in life than a child of equal intelligence born into a poor or average family. That is not the sign of a well functioning society.

We live in a country in which a child born into a family at one end of the income spectrum has a significantly higher life expectancy than a child born into a family at the other end. That is not the sign of a well functioning society.

As I have said, the laws of economics do not exist in a vacuum. Our politicians have every opportunity to reverse this trend, not just by implementing controls at the top but also by investing seriously in state education in the poorest areas and reducing poverty, especially child poverty.

We do not employ our politicians simply to tell us that it is “inevitable” that the profits from everything we produce should go the richest few. We employ them to look after every one of us, rich or poor, and don’t ever let them tell you that doing so is not feasible because of economics or free markets.

Boris has his sights set on being Prime Minister. You have seen the rise in inequality that occurred under the leader he idolises and you have heard his abdication of political responsibility for inequality.

One day he will run for PM.

When he does, you know what to do.

RedEaredRabbit

Filed under Economics, Politics

Killing the Confidence Fairy

20/11/2013 1 Comment

Long-term readers might recall a blog post I wrote a while ago that explained why the UK government could borrow money at such low rates while the economy was weak. The government’s explanation was that their austerity policies had given markets “confidence” in the UK economy. So high was the confidence their policies had created, we were told, that we were now able to borrow money at the lowest rates in history, despite an ongoing economic depression.

If that smells a little fishy, it’s because it was. As I explained in that post, our low borrowing costs were a result of the market expecting short-term interest rates to remain low because they expected the economy to remain weak. Only when the economy started to recover would we see UK borrowing costs going up.

The government’s confidence argument was tested earlier this year when the UK lost its AAA credit rating, (the maintaining of which was one of the government’s key economic pledges.) If the government was right and confidence in the economy meant lower interest rates then this would, as they had repeatedly warned us, lead to a big increase in our cost of borrowing. I predicted the opposite would occur.

And what actually happened? Yes, the cost of borrowing went down after we were downgraded.

You might think that, after that, the government would have admitted that their faith in the Confidence Fairy had been misplaced. Well you might, if you were unfamiliar with our government.

Moving on, over the past two quarters we have seen the start of an economic recovery. Yes, it has been the longest wait we have had to recover after any recession in our history but a recovery it is nonetheless. So what would the government’s explanation of borrowing costs driven by confidence predict? It would predict that as the economy recovers, confidence would increase even further and borrowing costs would go down.

And what would my explanation of borrowing costs driven by expectation of future short-term interest rates predict? As the economy recovers the expectation of higher future short-term interest rates would cause the government’s borrowing costs to go up.

Let’s see if we can spot any movement in the rates during the past six months that might help us work out who’s right. This from Bloomberg:

Yield on 10Y UK Gilts

Yield on 10Y UK Gilts

If you favour the argument that low rates are all about confidence then explain to me why the cost of borrowing increased significantly during the period that the economy started to recover.

The confidence argument was, of course, nothing more than a means to an end – a manufactured tool to scare us into thinking that austerity during the bad times was a necessity. In a country like the UK, with control over its own currency, the confidence argument had no economic basis whatsoever and now we have the evidence to prove it.

The confidence argument was a lie. It really is that simple.

RedEaredRabbit

Filed under Economics, Politics Tagged with , ,

It’s the Recovery, Stupid.

01/11/2013 2 Comments

Ok, I had a bit of fun in my last post but the (hopefully) obvious point I was making was really anything but fun.

The bloodletting analogy works very well and not only because that ancient practice lengthened the patient’s recovery but also because of the reason that it gained such popularity. And what was that reason? Well most of the time, patients undergoing a course of bloodletting got better. It had nothing to do with the bloodletting of course, it was due to the fact that when people are sick they usually get better. It’s easy to laugh at how dumb our previous generations were but when I look around today, I’m not sure we have learned any more than our ancestors about the difference between causation and correlation.

As I have mentioned several times over the last few years, the basic model of macroeconomics that is taught to first year students has performed very well during the financial crisis. It explained why our economy was weak and it explained why the economy, after an initial period of recovery in 2009, then went into a state of economic depression in 2010 from which it is only now, three years later, starting to recover. Basic macro did other useful things, like explain why a country whose debt was in a currency that they controlled (e.g. the UK) didn’t turn into Greece, (whose debt was in Euro, over which they had no control.)

You could summarise it by saying that the financial crisis gave a very strenuous test to the basic model of macroeconomics and that model came through with flying colours. That model, when applied to the circumstances in which our government came to power, (an economy suffering from a lack of demand, with interest rates at zero), said that cutting government spending would just make things worse. Output in the short term would be determined by demand and cutting government spending would further reduce demand. Cutting spending at such a time would cause the economy to remain unnecessarily weak for an unnecessarily long period.

Lo and behold that was what happened. The government had predicted, with their austerity measures in place, the UK would see significant growth in 2010, 2011 and 2012 but all we got, as the basic model predicted, was depression.

I think on that part of the argument we’re pretty clear – the basic model predicted bad things, the government predicted good things and we got bad things. There is though, apparently, some confusion regarding the fact that we are seeing the economy starting to recover, (and I do believe it is a recovery). The government is now saying this recovery advocates their policy of austerity in a depressed economy. That seems reasonable enough, doesn’t it?

Er, no. In making this argument, the government is intentionally misrepresenting the basic model and what it’s supporters said.

The basic model told us that output would be driven by demand in the short-run and supply in the long-run. In other words, assuming that the downturn didn’t cause the UK to lose its ability to make things, the economy would eventually adapt and growth would one day begin again.

The argument was never that growth would never return with government policy, it was simply, that when we have all of the knowledge and all of the tools to implement a recovery in the short-run, why should we wait for the long-run? The British economist John Maynard Keynes faced the same arguments in the 1930s when he proposed government spending to solve The Great Depression. He acknowledged that, irrespective of government policy, the economy would recover in the long-run but as he famously pointed out, in the long-run we’re all dead. If you have the knowledge and the tools to solve a depression now, you should probably do it. The alternative of waiting for the long-run would be pretty dumb.

But, remarkably that’s what we did and in doing so, created by far the longest recovery from a recession in our country’s history. This graph from NIESR, showing the current recession vs previous recessions, demonstrates just how dismal our ability to recover has been. No previous recoveries even come close to being as slow as our current one:

UK Recessions Compared (NIESR)

UK Recessions Compared (NIESR)

I wouldn’t care too much about saying, “I told you so”, if our politicians could just be honest about exactly how badly their austerity policy has performed. If they were now saying, “Our policies have directly caused the weakest recovery ever. Soz!”, I might leave things at saying, “Thanks for being honest and let’s not do anything this dumb next time around.”

Saying that a recovery now is advocation of their policy is entirely ridiculous though and there is a real danger, as the recovery continues, that people will accept that austerity in a demand-led recession causes a recovery and the same mistakes will be made next time.

Of course, the reality is that the government’s policy was never about engineering a recovery. The reality is that they used the recession as camouflage for the policy they wanted to implement anyway – shrinking the public sector and reducing taxes for the rich.

I often refer to the bad policies as “mistakes” but that is giving the government far too much credit because all along, they knew exactly what they were doing and why they were doing it. Economics is far from perfect but it will have proved an extremely useful discipline if only we learn the lessons of the past six years.

If an eventual and inevitable recovery in the long-run is taken to be a justification of what our politicians did then we might as well throw economics in the bin and just let our future selves be governed on nothing more than the political ideals of the right.

RedRearedRabbit

Filed under Economics, Politics Tagged with , , , , ,

Economic Bloodletting II: Revenge of the Quacks

25/10/2013 2 Comments

Britain, 1642. A patient, Mister Edmund Conomy of London, sits up in bed, sipping broth from a bowl. People stand around his bed amazed at his miraculous recovery.

Four long years earlier, Edmund had been struck down with a severe case of anaemia. The new local physician, Doctor Gideon had fortunately arrived early on and prescribed a course of bloodletting to treat his condition. Doctor Gideon had pumped out a few glugs on his first visit, then returned each month and never noting a change in his patient’s condition, continued, each time, to pump out a few glugs more.

Mister E. Conomy’s housekeeper was a lady by the name of Miss Carmen Sents. Miss Sents, had taken issue with Dr Gideon’s prescribed treatment:

“He’s weak enough already.” She told the doctor. “Removing his blood will just weaken him further.”

“Rubbish,” snapped Dr. Gideon, “The cause of this man’s illness is clearly that his previous physician allowed him to produce too many blood cells.”

“Look, if anything he needs more blood cells, not fewer. If you can’t see that, then at least leave him as he is and wait for his body to eventually recover on its own.”

Miss Sents’s protests were ignored and over the next three years, Dr. Gideon continued his policy of letting blood from Mr E. Conomy. Mr. E. Conomy didn’t recover though. In fact he looked worse than ever.

By the fourth year, Dr. Gideon, noticing the pale and shrivelled look of his patient, decided to drastically reduce the amount of blood he was letting at each visit but he didn’t want to tell anyone he was doing that. He did just a tiny bit each time to show he was sticking to his “tough policy” because he was afraid of what people would say if he changed course.

Then the miracle happened. Mr. E. Conomy started to recover and once he started to recover, the recovery was quick. With every month that passed, his strength grew and within a year he was almost as strong as he was when the illness struck.

Dr. Gideon was made a hero. Stories of the success of his bloodletting on Mr. E. Conomy spread far and wide. Perhaps it would not be unfair to say that Dr. Gideon was a major factor in spreading them.

And what became of Miss Carmen Sents? When Mr. E. Conomy learned exactly what had cured him, and of the erstwhile protests of Miss Carmen Sents, he fired her and sent her out of his house to live on the streets. After all, the success of his treatment was obvious and where would he have been if people had listened to her?

Sadly, in all of the bravado, no one seemed to notice that in every previously recorded case of anaemia, the patient had, without bloodletting, recovered much faster than had Mr. E. Conomy.

Sadder still, they now thought that bloodletting was the best way to solve anaemia.

RedEaredRabbit

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Facts? Where We’re Going We Don’t Need Facts!

14/10/2013 4 Comments

So the European Commission have, for three years, been asking the Cameron government to provide evidence to substantiate his claim that the UK is suffering from a problem of “benefit tourism”. Having received nothing back in response, today they called “Shenanigans“.

As I have discussed on here before, the effects of immigration are overwhelmingly positive to the UK economy. Immigration increases economic growth. Immigration doesn’t increase unemployment. Immigrants contribute 30% more through taxes than they take through public services. In short, we would be doing significantly worse without immigrants.

You will notice that there is a marked difference between the messages I just gave you and the messages that the government sends out when discussing this subject. The biggest difference though, is that my messages are based on evidence and facts as opposed to the creation and fuelling of prejudices. (Read my earlier post, “The Immigration Fallacy” for more detail and links to comprehensive studies on the subject.)

The Daily Mail gave us a fact though, “600,000 Unemployed EU Citizens Living in Britain!” Except that it wasn’t a fact. Their definition of unemployed being different to everyone else’s by including people who weren’t seeking work such as students, retired people and spouses of employed people. The number of EU immigrants claiming job-seekers allowance, it was pointed out, was actually not 600,000 but 38,000. Now we can of course, quibble about the definition of unemployed, but if we were to use The Daily Mail’s one then overall UK unemployment, as Jonathan Portes noted, would be in excess of 15 million people, or around six times higher than our current way of measuring it.

Looking for supportive evidence was obviously a failing strategy when attempting to justify their policy of demonising immigrants, so Number 10 instead told us to forget the facts and appreciate that we needed to act due to “widespread and understandable concern” over people coming to the UK to access benefits. Well of course there is widespread concern now! The government have spent the last three and a half years trying to convince people that immigrants and benefit claimants are the root of all evil.

I’m not sure the tactic of:

  • Scare people into believing there is an immigration crisis
  • Get tough on immigration because people are now scared about an immigration crisis

…..is necessarily better than:

  • Look at the overwhelming evidence
  • Create a sensible policy based on it

The whole “benefit tourism” thing is an example of a Phantom Problem – a key tool in the government’s spin arsenal. I wrote about them in detail here, but essentially Phantom problems work like this:

  • You decide on a policy you want to implement based on your political ideals
  • Because it is based on your political ideals rather than evidence you can’t sell the policy to the public based on facts
  • You put a huge amount of effort into convincing the public that there is a crisis that can only be dealt with by implementing your tough policy
  • You implement your policy off the back of the huge public panic you have created
  • The public thank you for being tough and sorting out that crisis that was about to happen

Obviously I can understand why this disingenuous approach to policy-making is so attractive to the Conservative Party. On this, any many other issues, the evidence is simply at odds with their political ideals. I understand it but seriously, don’t we deserve a bit more than that? Ok, they have shown that using a basic framework of ignoring the facts but marketing their idealisms can be effective in molding the country as they’d like it to be, but it’s not hard to see why that is not an optimal strategy for delivering benefit to the majority.

Given that the evidence shows that immigrants contribute significantly more on average, I do see a certain irony when I see the Tories standing up behind a lectern on which is emblazoned the phrase, “For Hardworking People”.

For Hardworking People

For Hardworking People

Perhaps all they need is a wider lectern so it can say, “For Hardworking People…. As Long As You’re Not a Foreigner.”

RedEaredRabbit

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Bubblenomics

23/09/2013 4 Comments

If someone asked you to name the country you most associated with tulips, you’d immediately say, “The Netherlands!” Interestingly enough though tulips aren’t in fact an indigenous Dutch flower, having been introduced from Turkey in 1593. The Dutch quickly fell in love with them though and over the following decades they became highly prized as status symbols among the Dutch social elite.

One of the things that helped them achieve such status was the fact that the supply of tulip bulbs was quite limited, (a flowering bulb takes seven years to grow from seed) and so, as demand increased, prices did too. As prices began to take off, flower sellers bought up as many bulbs as they could in order to get them before their prices increased further. This led to a further drop in supply and a further hike in prices. It wasn’t just the flower sellers though – traders had noticed the seemingly ever-increasing price of tulip bulbs and saw a new way to make money. They started buying them, not to plant in their gardens – they were buying them in order to sell them on later at a profit.

Flower sellers and traders alike were buying bulbs now because they expected them to be more expensive later on. That is, they had an expectation that prices would keep rising and that made them want to buy them now.

If you think by talking about tulip bulbs in the 1600s, I have completely lost the plot, then let me tell you what happened next. In the winter of 1636 – 1637, the already inflated price of tulip bulbs increased by one thousand percent in just three months. Bulbs of rare varieties sold for the same price as an average house and many people mortgaged or sold their properties in order to get in on a seemingly guaranteed profit.

But then something happened. There are different theories to what the event was, or if there even was a particular event that triggered it but one day, prices stopped going up. Panicked investors saw that the peak of the market had been reached and started selling. As supply increased and demand decreased the price started to drop. Soon everyone was trying to offload their tulip bulbs before it was too late but… it was already too late. The price of tulip bulbs plummeted spectacularly until soon they were back at the price that someone might want to pay to have a nice flower in their garden. Such was the shock that the entire Dutch economy collapsed and entered a depression.

While it is easy to look back at this event and conclude that the Dutch simply went mental, almost 400 years later we still experience economic “bubbles” and the effects are every bit as severe today as they were to the Dutch people of the 17th century. So what are bubbles? How to do they form? How do they grow? Why do they burst?

We’ll answer all of this and more in my five rules of Bubblenomics.

The 1st Rule of Bubblenomics

In order for a bubble to have a chance of starting you need lots of people to really want to buy something – in fact you need more than that. What you really need is for lots of people to really want to buy something more than they did last month. Bubbles are not formed off the back of high demand, they are formed off the back of increasing demand. As we saw in 17th century Amsterdam, the tulip bubble was built on the demand for tulip bulbs increasing… and increasing… and increasing. If the demand had doubled and then stopped there would have been no bubble (just more expensive tulips) and so the first rule of Bubblenomics is simply:

In order to create a bubble, the asset must experience a sustained increase in demand.

Easy enough. I’ll make it clear now though, a sustained increase in demand is not the definition of a bubble and it is not, on its own, enough to create a bubble. To understand how a bubble forms we need a few more rules, which I’ll come on to next.

The 2nd Rule of Bubblenomics

There are many different examples of bubbles in many different areas of the economy. Recent examples are the dot com bubble, which inflated during the late 1990s and burst in the year 2000 and the recent housing bubble, which caused the current global financial crisis.

As well as a sustained increase in demand, all of these bubbles have something else in common – a limitation on supply. Let me explain what I mean by that.

Suppose Mars Bars suddenly become really trendy and the demand for Mars Bars goes through the roof. Mars would quickly respond to this by making more Mars Bars. The increased demand would be met with increased supply, the price would quickly stabilise and no bubble would ensue.

Bubbles only form on something of which there is some kind of limitation on supply, such as the number of shares in a dot com company, tulip bulbs in 17th Century Amsterdam or houses.

Therefore the second rule of Bubblenomics is:

In order to experience a price bubble, the supply of an asset must have a limitation such that increases in demand cannot be easily met by an equivalent increase in supply.

You might be asking why, given the second rule, housing is a good candidate for bubble creation. If demand goes up, we should just build more houses, right? Sadly is isn’t that easy.

Demand for houses is volatile and increasing the supply of houses takes time. Suppose that one year the demand for houses in central London is 5% higher than it was in the previous year – you can’t just quickly meet supply by suddenly building 5% more houses in central London. There is the lack of space, the planning regulations and of course, the fact that it takes a long time to build a house. Because of those things, that increased demand just translates into an increased price.

The 3rd Rule of Bubblenomics

A price increase alone isn’t a bubble though and to understand how a bubble forms we need to look at the third rule. Basic microeconomics tells us that when the price of something goes up, we should expect demand for that something to drop and in most situations that is true. In bubble situations however, the opposite happens. Let’s stick with housing to explain this.

When house prices start to increase, potential buyers see that prices are going up and start piling in order to buy something before prices go up even more, thereby further reducing demand. More people are buying, not because the current price is low – it isn’t – but because they expect it to be higher in the future and although now is expensive, now is still cheap compared with what they expect next month might be. That means that more people want to buy now and current prices increase.

This is what the third rule covers:

The expectation of future price increases fuels current demand

Another way of putting it would be, “Aaarrgh! House prices are going up and up! I need to buy now, before they’re even more expensive! Aaargrh!”

I did make that sound a bit panicky but how many times during the decade before the financial crisis did you hear people talk about having to get on the property ladder before it became unaffordable? If you hear logic like that, it is a clear sign of a bubble in progress.

If you take the first three laws together you can begin to see how a cycle might form – demand keeps going up and with supply constrained, prices increase and as the price increases become sustained, demand goes up further because buying now is better than buying later. Together those three explain a lot but in order to really understand bubbles there are two more laws we need to cover.

The 4th Rule of Bubblenomics

As I mentioned, there are different theories of what caused the Dutch tulip bubble to pop but I suspect it had something to do with the availability of funds. That is, people simply ran out of things to sell  in order to buy tulip bulbs – after all, once you’ve sold your house, you’re pretty much done.

The equivalent in a housing bubble is how much someone is willing to lend you in order to buy a house. A bubble can only keep inflating when buyers have the access to funds to sustain that inflation. The housing bubble that caused the recent, global financial crisis is a perfect example. As prices increased, banks just responded by lending more money.  If the banks had said, “We’ll only lend 80% of a home’s value and that lending can be at max, three times your income”, the bubble would never have happened. They didn’t though. As prices increased, bank lending just increased to further inflate the bubble.

This is the fourth rule of Bubblenomics:

Inflation of a bubble requires someone to keep providing the air

The 5th Rule of Bubblenomics

Don’t worry, this is the last one and it is the simplest one of the lot. The first four rules dealt with how bubbles form and grow but they don’t explain how they burst. What I am calling the 5th rule of Bubblenomics is known in economic circles as Stein’s Law, after the late American economist, Herbert Stein. It says simply this:

If something can’t go on forever, it will stop.

Bubbles see prices increase dramatically and as we have seen, the price increases are self-sustaining for a while. The reality though, is that the price of something can’t go on increasing faster than people’s income forever. At some point, people either won’t want to buy it, don’t have enough money to buy it or can’t borrow enough money to buy it. That much is inevitable – if something can’t go on forever, it will stop.

As the Dutch saw in 1637 and the world saw in 2008, when a bubble stops the result can be catastrophic. So, it should be obvious to everyone that we want to prevent bubbles, right? Right. It should but clearly it isn’t. Just look at the UK government’s “Help to Buy” scheme, which even Vince Cable pointed out would do little more than create a new housing bubble.

He was of course quickly silenced by George Osborne but let’s remember that Vince is an extremely well-qualified economist and George has an undergraduate degree in history.

Apparently a degree in history that didn’t cover the Dutch Tulip Bubble of 1637.

RedEaredRabbit

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The Popularity Paradox

16/08/2013 3 Comments

This week I’ve been pondering an apparent paradox: Given the fairly disastrous economic achievements of the current government, how in the world are they able to remain so popular in the polls?

Part of this is surely a lack of confidence in the opposition but even so, I don’t think that is enough of an explanation. The polls are not just saying that a lot of people still prefer the government to the opposition – the polls are saying that a lot of people actually trust the government on economic policy. This is The Popularity Paradox – the fact that the government can be hugely unsuccessful and still retain a surprising level of popularity. This post is my attempt to explain that apparent paradox.

Part I: The First Rule of Politics

The first thing we need to do is break our association between political success and political popularity. Democracy is far from an ideal system – the first rule of politics isn’t “Make things better!” The first rule of politics is “Win the next election!”

Because of this, the popularity of a policy is far more important than its success – the primary goal of government policies is to achieve popularity. You can see this in the way that governments deal with taxes. Sometimes increasing taxes would be sensible but governments know that increasing them is a vote loser, so they don’t get increased or they get increased in strange areas that they hope people won’t notice. Similarly they know that tax cuts are popular so a government might cut income tax before an election, even if it makes no economic sense for it to do so. Popularity is everything.

Do you think the trucks hauling, “Illegal Immigrants Go Home” signs were aimed at illegal immigrants? Was the government really expecting illegal immigrants (who they tell us can’t speak English anyway) would just see these trucks, pack their bags and leave? No. The message on those trucks was not aimed at illegal immigrants at all – it was aimed at voters. It was an attempt to boost popularity for the government by convincing people that illegal immigrants were a huge problem and that the government was implementing a tough solution.

Will this stunt result in fewer illegal immigrants? I can’t see how, but that was never its aim. The aim was popularity and whether or not it actually ends up resulting in fewer illegal immigrants is by the by.

Popularity is not achieved through success. Popularity is achieved by convincing people that there is a problem and then telling them how you’re going to solve it. That brings me nicely on to my next point.

Part II: Partial Problem Solving

Let’s take a look at a generic process for solving a problem. It might look a bit like this:

  • You define the problem you wish to solve
  • You find the underlying causes of the problem
  • You design a solution to address the problem
  • You state clearly how you will measure the solution’s success once it is implemented
  • You implement the solution
  • You measure how well the solution performs against your pre-defined criteria
  • You design and implement improvements to the solution and reassess against your pre-defined criteria (repeat this as necessary)

You might be wondering why I’m boring you with this. Well, one way of looking at a government is as a group of people we put in charge to solve problems in our society. In order for people to have trust in a government, they need to understand both the problems that the government is trying to solve and the solutions they are using to solve them.

Let’s look at an example from the current government:

  • Problem: Immigration is too high and unaffordable in its current state
  • Underlying causes: Immigrants are arriving in huge numbers, taking jobs from British citizens and claiming massive sums in benefits
  • Solution: Clamp down on non-EU immigration. Hold a referendum on EU membership so we might soon be able to clamp down on immigration from within the EU too.

Let’s look at another example:

  • Problem: The UK’s economy is weak because of high government spending
  • Underlying Causes: The previous government went on a spending spree that was unaffordable
  • Solution: We need to immediately reduce government spending.

In both of these cases the government clearly defined the problem and the underlying causes and then clearly set out the solution. Both of these policies were popular with a lot of people. Let’s remember though, the seven steps of problem-solving that I outlined above. The government is only performing four of the seven steps. Let’s look at the list again, this time with the steps the government is doing underlined:

  1. You define the problem you wish to solve
  2. You define the underlying causes of the problem
  3. You design a solution to address the problem
  4. You state clearly how you will measure the solution’s success once it is implemented
  5. You implement the solution
  6. You measure how well the solution performs against your pre-defined criteria
  7. You design and implement improvements to the solution and reassess against your pre-defined criteria (repeat this as necessary)

In the second example I gave, the government has spent three years unwilling to adapt a policy that has not even got close to solving the problem of a weak economy. A much better way of doing things would be to admit that the initial policy wasn’t working and adapt it. After all,  the economy is complicated and it is unreasonable to expect every policy you start off with to be perfect and never require adapting. Willingness to adapt a policy based on how well it performs is essential when trying to solve a complex problem.

Those missing steps might help to explain why the government’s solutions are unsuccessful. To understand why they are popular however, we need to look at something I’m going to call The Ignorance of Crowds*.

Part III: The Ignorance of Crowds

When we vote, we are expected to assess the relative merits of a huge number of different policies across many different areas of government. We need to determine what the best policies are in economics, health, education, foreign policy, crime etc etc etc. An economist might be an expert on monetary and fiscal policy but lack the knowledge to make a good judgment on education policies. A teacher might be an expert in education but lack the knowledge of the relative merits of sanctions vs military intervention in Syria**.

A small number of people are experts in one area. An even smaller number are experts in two. I doubt anyone is an expert in more than three. You can see why this is a problem in a situation where a crowd of people needs to each, individually pass judgment on a wide range of complicated subjects.

But why is this important in understanding why a policy can be simultaneously unsuccessful and popular? Have a look again at the steps of the problem solving process that are highlighted (the ones the government is doing) and those that are not. It is quite easy for a non-expert to understand a clearly defined problem. It is also quite easy for a non-expert to understand a clearly defined solution. However it is much harder for an non-expert to assess whether or not a policy is actually succeeding.

So the government defines a problem that the crowd understands (e.g. debt is too high) and defines a solution that the crowd understands (e.g. spending must be cut) but unless an individual has some level of expertise in that area they are forced to rely on the reports of third parties to know whether or not that policy is working. This would not be such a bad thing if the third parties took time to carefully explain how they had reached their judgments so that they could be understood by non-experts but that’s very rare because the third parties from whom people get this information are of course, the media and the politicians themselves.

The Ignorance of Crowds says that as non-experts we can understand a problem that is presented to us and we can understand a proposed solution but it is very hard for us to know how successful that solution actually turned out to be. That means the definition of the problem and the definition of the solution are far more important factors in determining a policy’s popularity than its success.

This explains why the government only worries about certain steps in the problem solving process. The things that make you popular are clearly stating the problem you wish to solve and clearly stating how you want to solve it. Whether it works or not is almost by the by.

Part IV: Phantom Problems

So we’ve looked at how a problem should be solved and seen how and why the government doesn’t do things like that. We’ve seen that a government can take advantage of The Ignorance of Crowds by giving the appearance of solving problems that they are in fact not solving at all and we have seen that solving problems is not their main concern in any case. There is though, another reason for that gulf between popularity and success and this one is far worse than anything I’ve mentioned so far.

In the set of steps for solving a problem that I outlined, you start by defining the problem, then working out the underlying causes and then defining the solution. The government does not do this. What the government does is nothing less than scary.

The government starts with the solution – that is, the policy that they want to implement. They then work backwards to come up with a “problem” that they can use to justify that solution.

Look at the examples I gave:

  • Problem: Immigration is too high and unaffordable in its current state
  • Underlying causes: Immigrants are arriving in huge numbers, taking jobs from British citizens and claiming massive sums in benefits
  • Solution: Clamp down on non-EU immigration. Hold a referendum on EU membership so we might soon be able to clamp down on immigration from within the EU too.

Now, if you were to start at the problem end you would never even get as far as defining this as a problem. Immigration has a clear net benefit to the UK. Immigrants contribute to economic growth, don’t take jobs away from non-immigrants and take less on average than non-immigrants do in benefits. We are better off with immigration than we would otherwise be. The only way you can arrive at the problem that the government defines is by starting from the solution you want to implement (I don’t like foreigners, let’s get rid of them) and then work backwards to define a problem.

This is an example of what I call, a Phantom Problem – that is, a problem that is scary, doesn’t really exist and has been made up purely to justify the “solution” you want to implement.

Let’s look at the other example:

  • Problem: The UK’s economy is weak because of high government spending
  • Underlying Causes: The previous government went on a spending spree that was unaffordable
  • Solution: We need to immediately reduce government spending.

The government dislikes public spending. Not, because it caused the financial crisis though, (it didn’t) but because government spending is paid for through taxes and they like low taxes. After all, taxes are a key instrument through which wealth is distributed from the rich to the poor. The government doesn’t like taxes.

But, whether or not you support lower taxes is irrelevant. The fact is that the financial crisis wasn’t caused by public spending – it was caused by irresponsible bank lending. “The UK’s economy is weak because of high government spending” is an example of a Phantom Problem.

Summary

Partial Problem Solving explains why government policies are often unsuccessful. The Ignorance of Crowds explains how the government makes unsuccessful policies popular. The phenomenon of Phantom Problems allows a government to arbitrarily create policies around their own ideals that have no real basis for existence. Unsurprisingly, a solution that addresses a Phantom Problem will almost always do more harm than good. We might turn away immigrants that would otherwise have made everyone better off. We might implement spending cuts that further harm an already weak economy rather than strengthening it.

These things together explain how our government can be far more popular than the success of their policies would merit and The First Rule of Politics explains their motivation for doing it. It’s a pretty sad state of affairs but it does at least show that The Popularity Paradox is not really a paradox at all. It’s simply the logical result of a government that is adept at exploiting the weaknesses of the democratic system.

So – benevolent dictatorship, anyone?

RedEaredRabbit

* I Googled “The Ignorance of Crowds” and see that different people have already used this term for different meanings. I am using it purely as the definition I give here and not referring to how anyone else might have used it. As Humpty Dumpty said,  “When I use a word, it means just what I choose it to mean — neither more nor less.”

** I’m not being snooty here –  I count myself among the ignorant. That is the reason I generally avoid education or foreign policy or a whole bunch of other things on this blog. Like anyone else, I am mostly ignorant of most complicated things.

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