Five reasons Germany isn’t innocent in the Euro crisis

I actually agree with European Commissioner Olli Rehn when he says there’s no point apportioning blame for the Euro crisis – a lot of people have messed up. It can also be counterproductive. But since you can’t move for tripping over caricatures of lazy Greeks, for the sake of balance here are some reasons why Germany isn’t quite the prudent and innocent victim of dastardly southern European profligacy it is frequently painted as.

Eurozone monetary policy is tailored to suit Germany at the expense of the Greece

The Eurozone countries all share a single monetary policy, set by the European Central Bank in Frankfurt. Any policy set will necessarily be an aggregation of the interests of the member states in Europe.

But for most of the 2000s, the ECB followed a very loose monetary policy of low interest rates, which benefited the north European countries like Germany and France at the expense of Greece, Spain, and Portugal. To policymakers at the time it would have been clear these countries were at risk of overheating from the massive supply of cheap credit this was supposed to create (Any half competent national central bank would have likely set different rates.) But they still did it. Had this not been the case, it’s very likely that the private half of the debt crisis would not have been possible, or as severe.

The monetary policy problem hasn’t gone away either. If Greece had its own currency, it would at this point likely devalue it to make its exports cheaper, shrinking its trade deficit and kick-starting GDP growth. This is what Iceland has successfully done, and its what Argentina did successfully after its severe 2002 crisis. But there’s not a chance in hell of the ECB devaluing to save Greece, because it would have negative consequences for consumers in northern Europe, making their imports and foreign holidays more expensive.

The ECB refuses to use the two policy tools that could ameliorate Greece’s crisis, on the basis that they would harm Germany. This has prolonged and deepened the crisis.

Germany ‘defected’ in the prisoners’ dilemma that is the European common market

The EU is a project of regionalisation. Though multi-faceted, part of its purpose is to shield capital in European countries from competition from abroad with high external tariff barriers, while at the same time providing a large enough free trade bloc to give access to a strong pseudo-domestic market. The idea was that French farmers and German manufacturers wouldn’t have to directly compete with people willing to work for a dollar a day, only people with a similar lifestyle; and so a race to the bottom could be avoided.

But German industrial policy has been to hold down wages and undercut labour remuneration and costs compared to other European countries to make its capital more competitive:

This is a perfectly legitimate thing to do, but in one important sense it is defecting in a prisoners’ dilemma: were all the countries to collectively agree to raise workers’ living standards at the same rate, everyone would be better off. This is arguably the point of regionalising rather than globalising. German capital wouldn’t have gained that competitive edge, but it was partly that edge that led to huge trade imbalances.

You might not have a problem with this: in a market, actors compete. But if you’re okay with countries competing in a market, you have to accept the logical conclusion of markets, which is that some actors will eventually go bust.

There are two consenting parties in any financial transaction

The story of imbalances in the EU is by now well established – at its most simple, prudent German savers and lenders lent to southern European spenders, both state and private. But what was the nature of these transactions? They weren’t charity, or gift loans to an unreliable friend. They were loans by people hoping to make a profit by charging a rate of interest; they were investments. They also turned out to be bad investments.

If there was no risk of Greece defaulting then investors could have just lent Greece the money for free, but seeking to make a profit, they charged a rate of interest (now a 34% return). Charging interest is supposed to ‘price in’ the risk of default – on aggregate, if you set your interest at the right rate you’re not supposed to make a loss. Investors clearly priced the risk wrong.

For anyone genuinely committed to the principles of capitalism, the response ought to be the same as to anyone who bought some stocks or shares that then plunged in value: ‘Tough, you made a bad investment. Better luck efficiently allocating your capital next time.’ Some of the blame for the negative externalities caused by these bad investments must surely lie with the people who made the investments.

Dragging the crisis out to makes sure north European lenders don’t get hit has been expensive

Each time Greece gets another infusion of bailout cash tied to counterproductive austerity measures, the can just gets kicked down the road. The crisis isn’t permanently solved, the bailout money goes to service the mountain of debt until it runs out and another round is needed, and the forced fiscal contraction shrinks Greece’s economy further, reducing its income and ability to pay back its debt.

This has been quite obvious to many observers for a while now, so why would you do it? Because the longer it drags out, the less the impact on lenders there is. The market can price in losses, more bonds can mature, political wrangling can resolve itself, building ‘firewalls’ (bailout mechanisms) for banks. This is explicitly the Mekozy policy.

But ensuring the financial sector doesn’t get hit too hard has hurt everybody else. Every day the Euro crisis hangs over the economy is another day of rock bottom business confidence for capital in real sectors of the economy, tipping countries into recession. The bailouts themselves are very expensive and essentially massive transfers of European taxpayers’ money to non-Greek banks. And Greece itself is being pillaged beyond the point of comprehension.

These are policy decisions made disproportionately in the interests of German (and to be fair, French) lenders, but they have had significant downsides for everybody else.

Germany was actually the first country to break the Eurozone fiscal rules

This isn’t so much a cause of the crisis, though it is relevant. One of the accusations often levelled at the southern countries is they ignored fiscal rules set by the Eurozone. But Germany was just as guilty of this as anyone – in fact, Germany was actually the very first Eurozone country to break the rules of the Stability and Growth Pact: the agreed limit on yearly borrowing of no more than 3% of GDP.

Interestingly, Spain was the only country to keep the Eurozone’s deficit rule all the way up to the 2008 crisis, and even managed to keep within regulations on public debt (keep it lower than 60% of GDP) until 2010 (!) – a rule which Germany actually broke at the same time as Greece, in 2003.

The Government can’t have its cake and eat it with quantitative easing

MPs were on the radio today defending the Bank of England’s decision to launch another round of quantitative easing. The main accusation being made against the move was that it would cause inflation.

Responding to former Monetary Policy Committee member Andrew Sentance, Tory MP Matthew Hancock said that in the past QE hadn’t produced inflation, and that there was no reason to think that it would this time.

“Inflation is falling, it fell very sharply over the last month, the bank predicts that it will continue to do so over the coming months, there are some very good reasons for that,” he told Radio 4.

He’s probably right, as well.

 Velocity 

The inflation that newly created money causes is determined by the so-called ‘velocity’ of that money. This is effectively the rate at which money repeatedly gets used in transactions once it has entered use.

The reason for this is quite simple if you think about it – if the Governor of the Bank of England secretly created a trillion pounds of money but held it in a locked (virtual) room in the Bank and never alerted a soul to its existence, it would not cause inflation. It may as well not exist, it has no contact with the wider economy.

But if a trillion pounds were created and used to pay workers to build a (bloody big) high speed rail network, those workers would probably have spent most of the money they had received in wages by the end of the month.

The businesses that they had spent that money in would be exposed to a massive increase in cash coming into their coffers. They would in turn use that money to expand, pay their staff, spend it on capital goods, and it would filter through to the wider economy.

To everyone there would be more money around, the amount of money actually being used in the economy would increase in comparison to the real goods and services, and each pound would represent less real wealth. Inflation would occur.

Not quite a locked room 

Back in the real world, what the Bank is doing is not quite locking the money in a secret room never to be used, but it doesn’t filter through to the wider economy at anywhere near the same rate as paying it to workers.

The effects of purchasing Government debt are broadly limited to lowering yields on government debt – because buying up the debt raises effective demand for it, hence record low interest rates on Government bonds. This may have a knock on effect in terms of investors who deal in government bonds (pension funds, etc) but for the most part, the transaction stops after the bank has bought the debt and does little else.

The banks don’t necessarily go on to spend the money again like a worker would because banks spend (lend out) their money when they see a profitable opportunity – and at the moment they don’t see profitable opportunities

 Flipside

So inflation is unlikely to happen after another round of QE. But there’s a flipside to this – because money that enters the economy isn’t actually being spent, the money supply to businesses hasn’t actually increased as it did in the contrived High Speed Rail example. Because no one but the state is really exposed to the new money, and the state doesn’t really care, there isn’t really a stimulatory effect.

So the Bank of England isn’t quite secretly printing money and keeping it in a locked room on Threadneedle Street – it’s printing money and carting it down the road to the other banks in the City, where banks will keep it in a locked room there for a bit.

The people crying about inflation are wrong; but this also means that any suggestion that QE is likely to stimulate the economy beyond raising the confidence of the misinformed is wrong as well. Likewise, calls to spend the money on real projects would probably stimulate the economy as the money entered the wider economy, but would probably be inflationary as well as the money would be of a higher velocity. If, though, as the Bank predicts, we’re entering a period of deflation, that might not be such a bad thing in moderation.

The Liberal Democrats and Lansley’s NHS privatisation

 Remember how the Lib Dems couldn’t vote against raising tuition fees because they had agreed to abstain in any vote on the subject in the coalition agreement?

Here’s something else from the coalition agreement:

“The Liberal Democrats have achieved one of their manifesto pledges by getting a commitment to elected members of PCT boards.

The coalition policy document this morning said ‘directly elected individuals’ would take some places on boards with the rest appointed by ‘the relevant local authority or authorities’.

There are no details on the relative proportions yet but at his speech to the Royal College of Nursing Congress last month Nick Clegg suggesed two-thirds of a board could be elected with one-third appointed councillors.”

May 2010, Health Service Journal

Of course, Government policy is now to completely abolish PCTs and replace them with the much-criticised Clinical Commissioning Groups – a way to get NHS commissioning into the hands of private companies.

The Liberal Democrats have never given any reason why they’ve abandoned support for PCTs.

On Wednesday Shirley Williams reaffirmed support for them on Radio 4’s Today Programme, saying “I myself am dubious about whether it was wise to break up the Primary Care Trusts, which I think were just becoming really effective.”

And yet none of the nearly two hundred amendments to the Health Bill that have been proposed look to retain PCTs.

Presumably the Conservatives will be whipped to vote against the Health Bill since it breaches the Coalition agreement? Ha.

 

UPDATE: It has been pointed out to me by Mark Pack that Paul Burstow, the Liberal Democrat Health Minister with responsibility for social care has called for PCTs to be abolished.

 He first did this two months after the coalition agreement was signed, going against both Liberal Democrat policy and coalition policy.

His argument was that social care and health should be commissioned together, which isn’t actually happening under Lansley’s proposals for CCGs, so this is fairly irrelevant other than to highlight the selective enforcement of Government policy by the Lib Dems.

‘In the Black Labour’ and budget deficits

Hopi Sen insists that In the Black Labour (ITBL) is a Keynsian project. He explains that “fiscal conservatism does not entail short-term fiscal stupidity” and compares ITBL’s publication now to writing a paper in the winter telling people to prepare for spring.

The message is that once the need for fiscal stimulus has passed, the principles of ITBL – not running a budget deficit – can be enshrined through the proposed measures; though not before. For as long as a stimulus is needed, it should be applied.

This seems like a reasonable position. But there is a problem: when will the need for fiscal stimulus pass?

Mainstream predictions now suggest that the economy will be facing a Japan-style lost decade.

If you have an hour, Richard Koo, Chief Economist at the Nomura Research Institute, explains the causes of the eastern economy’s prolonged period of stagnation very well.

In very basic terms, what happened in Japan was that a huge build up of private sector debt has had to be paid down by firms who had borrowed to invest, but not seen adequate initial returns on their investment.

This has meant that now even for firms turning a profit, any surplus generated does not get reinvested into expansion, but rather goes into paying down that existing debt.

Here is a graph of Japan’s debts: private in blue, public in black.

You can see firms paying down their debt. But you can also see public debt increasing.

Why this happens is simple if we remember that:

GDP = C + I + G + (X-M)

Because firms are paying down their debt, investment (I) is low. Consumer spending (C) is unlikely to be making up this gap when everyone is trying to pay down their credit cards with stagnant wages. And the balance of trade (X-M) is less likely to be moving in a positive direction if domestic investment is low.

So state spending (G) makes up the output gap in order to keep GDP positive, avoiding a recession. It’s worth noting that between the years 1995-2002 Japan’s annualised growth rate was as low as 1.2% which means it would have have been routinely negative without the extra public spending, which increased by more than that amount each year. And so the black line on the graph above soars – in fact, Japan’s public debt to GDP ratio outstripped that of all other nations before the crisis hit in 2008:

 Deutsche Bank has even forecast Japanese public debt reaching 300% of GDP by 2020.

And the thing is, when economists say that the UK is in for a lost decade, they don’t just mean in terms of symptoms. The same things are happening here.

The UK now has more private sector debt as a % of its GDP than Japan:

 

And as a result of that, UK investment – here measured in gross fixed capital formation – has declined as a proportion of GDP since the recession and stubbornly refused to come back up.

How does this relate to ITBL?

In short, it may sound alright in principle to be talking about “preparing for spring”. But spring might be a much longer way off than the authors of ITBL seem to think.

The lessons learned from Japan suggest that consistently high budget deficits might be the only policy tool we have to prevent a decade of stagnation turning into a decade of recession  – a tool to fill the output gap while our private sector pays down its debt.

This suggests that deficits might need to be a fairly permanent feature of the UK’s economy for some time to come.

Of course, Hopi and Anthony could merely respond that if that’s when spring comes, that’s when spring comes, and that ITBL will still be valuable then.

But if spring is at best two elections away, is it really sensible to be talking about building the Labour Party around it now?

The Labour Right and welfare reform: living in the past

This morning on LabourList Owen Jones tore Liam Byrne MP to shreds over welfare reform. Byrne had argued that the “evil of idleness”, reinforced by the welfare state, was to blame for high unemployment.

He suggested that the way to correct this would be to punish those who rejected work, and have the government take steps to place them with training or employment.

Owen’s deconstruction was compelling. But I’ll add something else: this is not a new idea. Labour already pursued such a policy in 1998. Then, it was referred to as the “New Deal”.

The New Deal’s architects successfully identified a new problem for the welfare state as it existed – that full employment, which Britain had enjoyed since 1945, was dead. The neoliberal reforms of the 80s had ended the period of low unemployment in favour of a ‘flexible labour market’.

(source: House of Commons Library)

Like Byrne today, the Labour ministers at the time hypothesised that the welfare system was now getting the way of people finding employment.

Labour’s new policy introduced two core changes. The first was the ability to withdraw benefits from those who “refused reasonable employment.” And the second was introduction of training schemes and placements to try and help the unemployed become more suitable for employment.

In both cases the onus of reforms was on the unemployed individual – either the lazy individual or the unprepared-for-the-new-economy individual. Depending on what their problem was the policy would either stop rewarding them for their laziness, or give them the tools they needed to compete in the new economy.

And as the Labour manifestos of 1997, 2001 and 2005 pledged, Labour would restore full employment – not by providing jobs, but by fixing the problems of the lazy, or unprepared individual.

But the policy failed dramatically. Labour’s reforms never returned unemployment figures anywhere near their social democratic low. The closest they got was to bring the figure down to what it was in the late 1970s, when this poster brought Margaret Thatcher to power:

Here are the unemployment figures for 1980 to 2011:

The withdrawal of benefits from the unemployed succeeded in decoupling the claimant count from the actual unemployed figure – leaving many people unemployed but unable to receive subsistence benefits because they no longer qualified for them.

But as the above graph shows, despite the extension of the policy to all adults from 2002 unemployment was roughly flat from the turn of the century until the 2008 recession – when it rocketed.

The New Deal was a well-conceived and well-intentioned policy – in 1998. But it misunderstood the causes of the problem it sought to address, assuming that the unemployment was caused by individual failings of workers rather than the simple fact that there were not enough jobs to go around.

Three successive Labour majority governments enthusiastically pursued what Byrne is suggesting as a priority, to no avail. We have nothing but evidence that there are fundamental problems with their hypothesis about what causes unemployment.

And yet we get this old, out of date idea from the man in charge of Labour’s policy review – well over a decade behind the evidence.

Letter to the chair of the Lib Dem backbench health policy committee

The government’s latest move towards privatising the NHS is a proposal to let hospitals raise half of their income from performing private operations.

There’s a lot wrong with this.

I have written a letter to the chair of the Liberal Democrat backbench health policy committee – John Pugh MP. I’m publishing it here in full because it explains why this is a terrible idea.

Dear Mr Pugh

I am writing to you with respect to your role as the chair of the Liberal Democrats’ backbench health policy committee.

It was recently reported in the news that the coalition government is planning to lift the cap the on private income earnable by hospitals to 49% of their total income.

If this change goes ahead it is likely that hospitals, strapped for cash, will take this offer up with some vigor in order to increase their income in the face of cuts from state funding.

I would urge you to please reject these proposals outright, and to ensure that they do not see the light of day. They would be a complete disaster for the NHS.

I say this not only because I feel uneasy about the increasing role for the private sector in the NHS, but because there are sound economic arguments that suggest that such a move will undermine the quality of care for the rest of patients.

If hospitals gain a significant proportion of their income from private patients, they will be incentivised to invest in healthcare capital goods – equipment, training, specialists, etc – that is demanded by private patients.

As you will be well aware, the sort of operations demanded by private patients are generally of a completely different sort from those demanded by the majority of the health service.

This change will absolutely produce a complete misallocation of healthcare resources within the NHS, to the detriment of the sorts of operations, care and procedures that the majority have, and in favour of the profit making operations that tend to performed privately.

The Conservatives will be well aware of this – but they do not care because they instinctively believe that the market is the best way to allocate capital resources. Whether or not we believe that is true in the case of healthcare, the vast majority of people do not have a presence in the private market for healthcare. (and nor do they wish to) Their needs would not be represented by allocating capital through market mechanisms.

If we were ever to try give everyone such a stake, the only logical conclusion of these reforms is complete privatisation and marketisation of the National Health Service.

The proposals are absolutely strikingly similar to what has been inflicted on Britain’s universities, where institutions have been allowed to raise revenue from international students and private business research ventures. This has led to universities spending significant amounts of money on catering to the needs to international students and private business, to the detriment of the ordinary students. If these proposals become law, NHS will undergo the same treatment, as hospitals increasingly become geared around the needs of private patients.

I would appreciate a response on this issue, and urge you to reject the entire health bill. It is becoming evident at every turn that whatever tinkering goes on at the edges, it is still fundamentally a project for the Conservatives to privatise the NHS. As soon as one aspect is defeated by the Liberal Democrats, a new one quickly appears in its place.

Please reject the bill in its entirety.

Yours faithfully,

Five arguments for economic democracy

Peter Tatchell argues over at Compass that the Left, and Labour, should make economic democracy its new focus. I agree. In this post I’m going to flesh out some reasons why this is a good idea, and in my next post I’ll look at some concrete ideas as to what economic democracy, industrial democracy, workplace democracy, or workers’ control and ownership could look like in practice.

The failure of regulation

The regulatory system takes the idea that firms will want to do bad things that harm society, and tries to solve it by developing a set of external rules to govern their actions.

During the economic crisis, this system failed. There is strong evidence both ways to suggest that it failed because of regulatory capture, or simply because of the shortcomings of regulators themselves when pitted against the most highly remunerated and motivated workers on the planet.

But instead of trying to limit firms’ behaviour, an alternative approach might be to get them to want to do different things.

If a firm is currently a genius psychopath with no regard for anything but shareholder value, instead of trying to force it to obey laws it doesn’t want to obey, we might try to give it a new personality instead.

Particular forms of economic democracy might be able to work towards this end, by introducing considerations into a firm’s deliberating process other than just shareholder value. In economic terms this means reducing a firm’s propensity to want to generate negative externalities, rather than restricting its freedom of action.

It makes sense politically

The Conservatives have spent the last few years talking up co-operatives, gushing all over John Lewis, and have just given all public sector workers the option of turning their schools, clinics or other public service organisation into an employee owned co-operative.

This is an ugly parody of Labour’s 1983 pledge to “give new rights to workers to convert their firms into co-operatives” that hides what is effectively an attempt at mass privatisation behind the language of egalitarianism. The effect of this policy will probably be similar to the effect of Right to Buy – state assets sold off at knock-down prices would quickly be bought up and consolidated into the hands of a few monopolists.

But were Labour to make their 1983 pledge today, it would be very difficult to see how the Conservatives could criticise it without appearing hugely hypocritical. If anything it would emphasise their disdain for public services by refusing to consider them on an equal footing with private businesses; at the very least it would rob them of some of their “progressive” spiel about co-operatives and the Big Society.

If Labour wanted the opportunity to do something radical without actually sticking their neck out, economic democracy would be a great place to start.

No longer a choice between democracy and decentralisation

One of the main arguments for public ownership is one of democratic accountability. Private-sector firms are currently only accountable at an executive level to their shareholders, and sometimes in an indirect way their consumers, whereas nationalised industries are accountable to the state, which is in theory broadly democratic.

But if firms could be made accountable to society through a system of economic democracy, then nationalisation would no longer be necessary for all people to have some stake in the direction of industry.

This isn’t to denigrate public ownership – many things may simply still work better under state control– the railways, utilities, banks, etc. But the choice between public and private could be based solely on utility rather than with the added complication public ownership being practically required for democracy.

Most of the big decisions are already made outside the state

This is more true than at any time since the Second World War – we have multinational corporations bigger in GDP terms than entire countries. We have the simultaneously absurd yet run-of-the-mill state of affairs of “Belgian” bank Dexia having an asset worth 150% of the GDP of that country.

Though the response to the economic crisis may have bought about a recent increase in state intervention, this is supposed to be an aberration in our economic system rather than “business as usual”.

If you accept the principle of a democratic society, this is worrying, because currently the only part of our society that is really democratic is the state. This may have been fine under social democracy, when states controlled significant parts of society, but now the global field of power is more complicated.

One alternative to bringing things back under the control of the state – which has it’s own problems – would be to make those corporate institutions which now make the decisions themselves more democratic.

It might improve productivity

The overwhelming proportion of productivity improvements in UK industry come from firms entering and exiting the market place rather than incumbents improving productivity. This is an indication of organisational stupidity – firms being unable to learn – which is a problem.

Chris Dillow outlines some of the reasons behind this, but chief amongst them is that within firms, there’s no mechanism for feeding back or translating individuals’ learning into the organisation as a whole.

This is because hierarchies are notoriously bad at picking up on tacit, dispersed knowledge. On the other hand, one of the strengths of democracy is as a keen aggregator of fragmentary information. Curing or ameliorating organisational stupidity would have a positive effect on the production process.

Another good reason to think that democracy might help solve this problem is from our experience with a broadly democratic state. Thinking of the state like a large firm, it’s interesting to see what a huge effect a wholesale, sweeping change of management can have on the effect of services it provides. Just ask anyone who used public services under Thatcher and then again 20 years later.

–

Next: What could economic democracy actually mean in practice?

The media and #occupylsx

Paul Sagar points out that one of the reasons why people might find it difficult to identify with the cause of #occupylsx camp is because of its prolonged nature:

Of my friend’s text, however, what really stands out is his closing line: “It’s been two weeks though, who has that much time?”

When I used to box at a gym in Southport, a post-training discussion once turned to the TV series Big Brother. The general conclusion was that not only were all the contestants freaks, but they were Not Like Ordinary People. Why? Precisely because they could swan off for 10 weeks without worrying about work. For most in the discussion, that was enough to discredit each and every contestant. The BB housemates weren’t from the real world. The world where kids and mortgages ruled out such summer sojourns. And that bred both a fairly obvious contempt, but also an underlying if mild resentment.

Leftist activists might endorse OLX with passion. Many of them are out there right now, proudly taking part, braced against the cold by the sincerity of their views. But activists should remember that goldfish bowls create visual distortions, in both directions. And like it or not, dissimilarity quickly breeds contempt.

This sounds fairly convincing.** Most people would find it exceedingly difficult to leave their families and jobs and live in a tent in Central London for weeks at a time. And coverage from the gutter press has made its angle to discredit the camp a peppering of references to “anti-capitalist thugs” and imagery of creepy looking masked men. They’re a “pot smoking rabble“, not People Like Us(™). As Lacan would say, they are The Other.

But Paul’s comments also reminded me of the press’s coverage last week of empty tents. On Tuesday the Telegraph and a Tory councillor snorted that:

It would appear most of the protesters are heading home to sleep in their own beds at night rather than staying onsite.

On Monday the revelation was described as a “charade” and pressure was growing on the church and other authorities to evict the camp.

“It is like a phantom camp – a big charade,” said Matthew Richardson, a Corporation of London councillor, who is calling for action to be taken.

“It just shows that most of the people don’t have the courage of their convictions and are here just to make trouble and leaving your tent here overnight is a good way to do that.”

Or as the Press Association newswire put it:

Protesters camped outside St Paul’s Cathedral in London are going home at night to get ready for work and look after their families

You’re damned if you do, etc…

** Though that said, it seems that it’s completely outweighed by the fact that most people agree with the aims of the protest. ICM’s latest polling shows 53% agree with the statement “the protesters are right to call time on a system that puts people before profit” compared to only 38% who say they are naive.

Market metaphors, unemployment and ideology

Tim Worstall attacks Compass’s Plan B for the economy, particularly the suggestion that the government increase welfare payments to alleviate poverty and increase demand:

“We’re going to cut unemployment by subsidising unemployment more. Ignorance of the basic causality here seems to be an essential doesn’t it? If you subsidise something you get more of it.”

Although Tim seems to miss the point slightly, he raises an interesting question. That is, to what extent is the market metaphor applicable to unemployment?

The implication of what Tim says – that raising benefits is like a subsidy to unemployment – is that unemployment is a sort of “good” that is purchased by people depending on whether it is the most rational thing for them to buy.

There are a few good reasons to think that it really isn’t a good way of thinking about unemployment at all:

Firstly, empirical historical data suggests there’s a lot more going on than people making the rational choice to be unemployed. The graph of unemployment in the 20th Century looks like this:

If Tim is right to treat unemployment like a good receiving a subsidy, the key dates we should see unemployment rise are in 1911, with the introduction of National Insurance by Lloyd-George, in 1942, with the introduction of Beveridge’s Social Insurance and Allied Services, and in 1948, with the creation of the post-war social democratic settlement at the passing of the National Assistance Act. These would all have been massive subsidies to unemployment.

Furthermore, you might expect unemployment to fall sharply for roughly a decade following 1979, as Thatcher refused to increase benefits to keep up with inflation.

But at all the relevant points, the opposite actually seems to be true. Unemployment actually falls sharply when you’d expect it to rise, and rise sharply when you’d expect it to fall. Furthermore, the 1945 to 1979 period, where welfare payments were historically the highest, also has the lowest unemployment rate. No correlation emerges, and any impact seems to be completely negligible.

Another reason to doubt the claim is that unemployment is quite an unpopular pastime. According to research by Ipsos MORI, a majority of those in employment said that they would suffer a loss of confidence from losing their job – this amounts to a psychological and social hit on top of a financial one and is consistent with the idea that people simply do not want to be unemployed – even if this is financially irrational. There are a few reasons for this, the strongest non-financial one being that society exists. Being unemployed is generally seen as a bad thing, and something to be avoided; it can make you a social pariah, and also can also simply be boring.

This all points to a fairly obvious fact to anyone who has ever been unemployed: that it is rarely a choice. Hence why unemployment rises in recessions, and falls in the good times. For the market/good metaphor to be applicable to something, it has to be a choice – otherwise the metaphor breaks down.

But it’s not just unemployment: there’s good evidence to suggest that the market metaphor breaks down more often than is generally recognised, even with commodities. Take UK bus deregulation:

“Competition had arrived. And it arrived in style. The bus wars began. New operators in an area began targeting established routes, running their services five minutes before the incumbant operator. Buses would end up racing each other down the road, attempting to get to the busiest bus stops first.”

… “In 2006 Manchester suffered another one on the lucrative 192 route when operator UK North decided to wade in by adding new services, thus increasing the already frequent service to 12 buses an hour. Stagecoach responded by increasing its own services and adding in its low cost Magic Bus to the route.

The result was so many buses that the local council waded, concerned about safety. Gridlock occurred after Piccadilly Garden bus station couldn’t cope. Buses ended up queuing down the nearby streets, blocking other bus routes and the city’s Metrolink tram system was repeatedly suspended as it simply couldn’t get down the road. Buses that were too long for the relatively small bus station got stuck whilst trying to negotiate corners. The chaos only really ended when UK North’s operating licence was suspended on safety concerns.”

Just as Tim Worstall mistakes unemployment for something bought and sold, the Thatcher Government misunderstood was that buses weren’t really like fruit and veg on a market stall. If you get loads of competing buses on the road at the same time, you don’t get the free market of neoclassical wet dreams: you just get a traffic jam.

This, again, seems like a fairly obvious fact. When looking at a bus, you wouldn’t think “it’s like a market” unless you had some very odd preconceptions about the world. But it is still a mistake that a lot of well-educated and well-renumerated people made. Presumably because they had some very odd preconceptions about the world. Those preconceptions are what we call “ideology.”

The lunacy of cutting or abolishing the minimum wage

A quick economic sketch:

Dr Eamonn Butler, Director of the right-wing think tank The Adam Smith Institute, makes the argument that we should scrap the minimum wage in order to reduce unemployment. Similar calls have come from right-wing Tory MPs. The IEA also unsurprisingly chimes in. With unemployment up again today, it’s likely we’ll hear more of the same from the usual suspects.

The argument behind this is simple enough. Assuming firms have a fixed amount of money to spend on wages, and they could pay some of their workers a lower equilibrium wage (because the current one is held artificially high by the minimum wage floor) they could then hire more workers – thus reducing unemployment.

But Iain Duncan Smith, the Secretary of State for Work and Pensions helpfully points out that the current benefit system leaves you better off out of work that in work. Presumably if people were able to work for below the minimum wage this would be even more true.

So what would the result of scrapping the minimum wage be? Firstly, if Butler is right, those who were currently working at the minimum wage would have lower wages. Secondly, if Duncan-Smith is also right, those who were previously unemployed and were now in work would have less money to spend than they did when they were unemployed – maybe even more-so than if they got a job today, because the minimum wage would have been scrapped.

What is a fall in wages and disposable incomes going to do? Almost certainly cause a fall in effective demand. Which as Duncan Weldon points out, is exactly the problem with the economy at the moment. And of course, unless demand were to pick up, firms are unlikely to start investing that cash they’re sitting on either.

Let’s hope that Butler and Duncan-Smith aren’t both right! As it happens I think Dr Eamonn Butler is probably the most wrong here. Firms aren’t likely to hire more people simply because labour costs have reduced. Firms are already in surplus and are net savers at the moment – they could hire more people if they wanted to. The reason they’re not doing it is because there is no effective demand for their services. And one of the reasons why there is no demand is because real wages are falling…