Exactly why we shouldn't believe Wilbur Ross on trade and tariffs

Don Boudreaux has a correspondent insisting that because Wilbur Ross is a successful businessman, the Good Professor is only a pointy head in an ivory tower, therefore we should believe Ross against Boudreaux on the subject of trade tariffs. This is the wrong way around.

Precisely because of the successful businessman and pointy head bit we should believe the view from the ivory tower.

 Of all the countless fallacious arguments for protectionism, none is more illogical than the one that you offer in your e-mail today – namely, that because “Secretary Wilbur Ross is a successful businessman his understanding of trade [is] rich and reliable” while my and other “ivory tower professors’” understanding of trade “is shallow, not very trustworthy.”

A useful real world test - even if edging up to the lip of a logical fallacy - is to ask cui bono? As one of us put it elsewhere recently:

A protectionist is someone who argues that you should be poorer so they can be richer.

The people who become richer through protectionism are the people who own the businesses being protected. We're going to take the opinion of a man made rich in the steel industry about the desirability of steel import tariffs? 

Professor Boudreaux is of course far too polite to get to the lip of that ad hominem logical fallacy but we're not.

KFC's DHL Debacle shows why markets work

We've all had a good chortle about Kentucky Fried Chicken's problems over their new distribution contract with DHL. Stores closing because of a lack of fresh chicken, musings over who knew they used that ingredient, those sorts of things.

What is going to get missed here is how this shows the superiority of a market economy:

KFC has gone back to its original recipe for chicken deliveries by rehiring Bidvest Logistics in the wake of last month’s supply fiasco.

The American fast food chain was forced to temporarily close hundreds of storesafter it ran out of chicken following the botched handover of its logistics contract to DHL and QSL. “To put it simply,” KFC tweeted at the time, “we’ve got the chicken, we’ve got the restaurants, but we’ve just had issues getting them together.”

We can just hear the Teenage Trots giggling in their bedrooms, can't we? The State, planning, that would have done something as simple as getting chicken to the restaurants, wouldn't it? This will be used as an example of the inefficiencies of private economic action, undirected by said state.

In response we might point out that several of us have lived and worked in places with state distribution of food and believe us, it isn't better than this at all.

However, the real point here is not that a mistake was made. We're humans, any economic system is going to contain humans and therefore we're going to have errors. Given, you know, that erring and humanity bit. What matters is how we clean up errors.

That contract changed on Feb 14, here we are on 10 March, the contract was reassigned on 8 March. That is, 3 weeks after the error started it has been solved.

Now think of any government error which has even been admitted in such a time period let alone solved.

Sure, any system of economic organisation will contain errors. The difference between government planning and market chaos is who cleans up the mistakes, solves the problems, faster? That would be the markets, precisely why they are so desirable - over and on top of all that freedom and liberty stuff.

Measuring quality by outcomes

I think when I do a third edition of my"How to Win Every Argument" I will add a new fallacy to the 94 fallacies I identified and described there. This could be called "Measuring quality by inputs."

I wrote here earlier about "Regulation by result" making the case that if we state what result is to be achieved and leave it to creative brains to find ways of achieving it, we do better than if we stipulate the processes which people are required to follow.

This is different, but related. It seems extraordinary that people should measure quality by the effort put in rather than by the result achieved, but many people do precisely that. Gordon Brown's government measured the quality of education by the amount spent on it, by the pay of teachers, by the size of classes, and so on. Most thinking people would measure the quality of education by the ability of the children to read, write and do arithmetic, and to pass exams. It may be that the inputs listed contribute to an improved output, but that is not intuitively obvious. Measurement of the inputs is not a substitute for measurement of achievement.

It is very common for measurement of the quality of the NHS to be discussed in terms of how much is spent on it, or how many people work in its different departments, whereas many might suppose its quality would be better measured by the death rates for various diseases, or the brevity of recovery times.

We live in the real world, and want to know if it is improving in various respects. To do that we have to look at what happens in practice, rather than congratulating or criticizing the effort or the expenditure applied. Quality is what a thing is like – an outcome not an input.

The white-elephant airport with real elephants

Yesterday I wrote about Sri Lanka’s Norochcholai power plant—the coal-fired power plant that you can’t actually get coal to for half the year—as a classic example of state-led infrastructure projects. But many other such projects in Sri Lanka were far worse.

The contenders for the crown of 'worst possible waste' range from the Weerawila cricket stadium, an engineering marvel in the middle of nowhere, to a television and radio broadcast tower that when completed is expected to be the tallest structure in South Asia—one might ask why.

But surely the prize should go to the international airport outside the former President’s home town. Boasting a runway longer than Changi Airport in Singapore, it faces the wrong direction; instead of aircraft landing into a headwind, they approach in a crosswind—a dangerous condition for landing.

The white-elephant airport (which serves no airlines) has, however, succeeded in attracting real elephants (which are large and potentially dangerous and destructive animals), since it sits by a wildlife sanctuary. Herds of buffaloes and deer also invade the premises. So firecrackers, soldiers, policemen and wildlife wardens have been employed to drive them out. Desperate officials have reportedly even turned to the local cattle rustlers to deal with them.

In addition, the airport lies right in the path of migrating birds—another hazard to aircraft. The authorities proposed a mass shooting of peacocks, but the plan was hurriedly shelved-because of religious sentiments (the birds are regarded as sacred). 

SriLankan Airlines, the country’s national carrier, was about the only airline to fly there—mostly carrying Sri Lankans who flew to the airport to take advantage of the generous duty-free allowances designed to attract tourists. After cutbacks in its operations even SriLankan stopped flights and the authorities turned some of the air cargo terminals into rice storage to accommodate the bumper harvest in the region. A rather expensive way of storing grain!

Ravi Ratnasabapathy is a Fellow of the Advocata Institute, a free-market think tank in Colombo.

So we didn't need the EU regulation at all then?

A slightly puzzling Guardian column talking about car insurance. The EU insisted that prices could not vary solely on the basis of gender, ending the manner in which women were generally charged less than men. The result of which has been:

My conclusion is that the EU ruling has done women a favour. Before, insurers bluntly charged you a bit more if you were male, a bit less if you were female. Now they have to price it according to rather more concise data reflecting your individual driving behaviour.

My guess is that women were actually paying too much before the ruling and are now paying premiums that more accurately reflect their risk.

Car insurance may have become less equal. But it is more fair.

The argument here is that the insurers have delved more deeply into the data and now discriminate upon things like miles driven, occupation, size and expense of car and so on. The justification being that the EU rules forced this.

Hmm, yes, we've seen no other sector of the economy start to use Big Data at all have we? No one, not subject to EU regulation, has started to slice and dice their customer base. Nope, nada.

There's a very strong temptation to insist that the change would have happened among profit hungry companies anyway as the technology emerged to enable this. But how to decide? Regulation caused it, regulation is irrelevant to it?

As an aid to decision making, consider roaming. The EU is very proud of the fact that is has reduced the costs of using a mobile phone from one country to make calls inside another. We've even Remoaners insisting that the loss of this will be a significant cost of Brexit. We ourselves would note that such freedom from roaming charges is available on any number of plans out there in the marketplace. Including to and from and within many countries which aren't in the EU and thus not subject to the regulations.

This is more about the EU claiming credit for something that would and did happen without them than anything else. Being able to point to the regulations is that credit claiming. 

A howler from the IPPR

The IPPR have a report out today calling for corporation tax to be hiked and employers’ national insurance contributions to be cut. You don’t have to read far in the report to spot an absolute howler.

From the report’s Executive Summary (emphasis my own):

“The corporation tax rate should be increased, and the proceeds used to fund a reduction in employers’ national insurance contributions (ENICs). We model a rise in corporation tax from 19 to 24 per cent, which would allow a reduction in ENICS from 13.8 to 11.8 per cent. This change will ensure that shareholders bear a greater portion of the burden of corporate taxation, allowing the proceeds to be passed on to workers through wage increases or additional employment. A higher rate of corporation tax would also raise the value of investment allowances, creating a larger incentive for investment. The changes would shift the burden of taxation away from less profitable businesses with high input costs onto more profitable ones”

Let’s put it to one side whether shifting taxation from businesses with high input costs to businesses with low input costs is a good idea. The idea that a higher rate of corporation tax increases the incentive to invest is categorically wrong.

Guys. It’s time for some optimal tax theory.

In the 1960s Dale Jorgenson and Robert Hall put together a framework for evaluating the effect taxes have on investment. It’s pretty straightforward. It sums up all the associated costs of capital such as taxes, depreciation and borrowing costs. If an investment can generate a return net of those costs then it’ll take place, if it doesn’t then it won’t be made.

The amazing thing about Hall and Jorgenson’s User Cost of Capital equation is that it lets you mathematically prove that the IPPR’s claim that higher rates of corporation tax will increase the incentive to invest is wrong.

Alan Cole (formerly of the Tax Foundation) in his paper Fixing the Corporate Income Tax, shows that raising the corporate tax rate increases the cost of capital.

“Hall and Jorgenson derive an expression for the price of capital, as follows:[10]

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“where c is the cost of capital services, q is the price of capital goods, r is the discount rate, delta is the rate of physical depreciation on the asset, k is an investment tax credit, z is the present value of the depreciation deduction on one dollar’s investment, and u is the tax rate. For the purposes of this analysis, we will concern ourselves with the relationship between z and u.

“The value of z under current law is greater than zero, but less than one. A value of zero would correspond to no deductions at all, whereas a value of one would correspond to a system where deductions for capital equipment were taken immediately. (This is also often known as “expensing.”)

“Recent Tax Foundation research found z to be 0.8714 in the U.S. in 2012, meaning that the present value of the depreciation deduction schedule for the average investment made in 2012 was only about 87 percent of the value of the actual investment.

With a value of 0.8714 for z, we find that the cost of capital increases as u increases. That is to say, a higher corporate rate (under current depreciation schedules) increases the cost of capital."

It’s true that as the net present value of capital allowances increases the effect that a higher rate has on the cost of capital falls (capital allowances also become increasingly expensive). If we allowed firms to immediately write-off capital investments (known amongst wonks as full expensing), then the corporate tax rate would have no effect whatsoever on investment, but at no point does a higher corporate tax rate increase the incentive to invest. The IPPR’s claim is simply false.

George Osborne’s 9 percentage point cut in corporation tax was funded in part by making depreciation schedules less generous (and in the case of industrial buildings scrapped them altogether).

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As a result, the UK’s Effective Marginal Tax Rate in 2016 was only 3% lower than in 2007. Osborne’s rate cuts were effective at attracting international capital, but failed to move the needle on domestic investment. Hiking corporation tax without expanding capital allowances (which is what the IPPR propose) would hit investment hard.

The coal-fired power plant you can’t get coal to

For over a decade, my country—Sri Lanka—followed a state-directed, debt-fueled model of infrastructure development. The results were mixed: just how mixed is illustrated by is the 900Mw coal-fired power plant in Norochcholai. It is regarded as a success: but read on.

The largest power plant in the country, Norochcholai was expected to transform the energy supply, producing reliable cheap power and freeing the country from the vagaries of the weather. Up to that point, the bulk of the country’s power was being provided by hydropower. 

The plant was designed and built by the China National Machinery and Equipment Import and Export Corporation (CMEC) and partly financed by a loan from the EXIM bank. Controversy dogged the project from inception: the idea was first floated in the 1980s but environmental and other concerns stopped it from being built. In 2005 a positive environmental impact assessment from 1998 was dusted off and the agreement with CMEC signed.

However, Sri Lanka does not produce coal. So the plant was sited by the seashore to facilitate the unloading of coal. Naturally, a pier should have been built for ships to dock and unload. But this was never done. Under pressure from environmentalists, the site was shifted from the eastern deep water port of Trincomalee, to Hambantota in the south, before finally settling on the West coast—where the water is too shallow to accommodate a pier.  

This means that the ships that bring coal for the plant must now discharge their cargo mid-sea onto small barges that transport it to shore. Inefficient enough: but unfortunately, Sri Lanka is also a tropical country, subject to the monsoon. So for six months of the year, the waters are too choppy for the barges to operate. So the plant has to stockpile half a year’s supply of coal in the open, where of course it gets wet.

Since a change of Government in 2015 the two sides have traded allegations of corruption, poor design and the use of substandard materials in the project. CMEC have retorted by blaming breakdowns on the transmission lines and a lack of technical skills in Sri Lanka. The fact that all the instruction manuals for the power plant were written in Chinese may have contributed to some of the confusion evident among local engineers.

Remarkably, despite all these mistakes, plus teething troubles that led to many unexpected shutdowns, and more recent problems of pollution from coal dust and fly ash, the coal power plant remains one of the best Chinese projects. It does at least generate power at relatively low cost: when it was completed in September 2014, the President announced a 25% cut in the electricity tariff (with cuts in kerosene, petrol and diesel prices thrown in for good measure). As an example of a state-led infrastructure project, however—it is a classic.

Ravi Ratnasabapathy is a Fellow of the Advocata Institute, a free-market think tank in Colombo.

As George Monbiot doesn't understand the environment is a luxury good

Apparently there's some confusion out there in environmentalland about the environmental Kuznets Curve. All it is, really, is an observation that the environment is a luxury good. By this we do not, at all, mean that nothing need be done about it. Quite the contrary, we mean that only richer societies are going to do anything about it. Thus this is simply nonsense:

Pinker suggests that the environmental impact of nations follows the same trajectory, claiming that the “environmental Kuznets Curve” shows they become cleaner as they get richer. To support this point, he compares Nordic countries with Afghanistan and Bangladesh. It is true that they do better on indicators such as air and water quality, as long as you disregard their impacts overseas. But when you look at the whole picture, including carbon emissions, you discover the opposite. The ecological footprints of Afghanistan and Bangladesh (namely the area required to provide the resources they use) are, respectively, 0.9 and 0.7 hectares per person. Norway’s is 5.8, Sweden’s is 6.5 and Finland, that paragon of environmental virtue, comes in at 6.7.

Pinker seems unaware of the controversies surrounding the Kuznets Curve, and the large body of data that appears to undermine it.

Sadly, such is the state of economic knowledge out there that we've even got to step back and explain what a luxury or superior good is. It doesn't mean something which is better, nor has it the colloquial or vernacular implications of luxury, something only for the rich and leisured.

An inferior good is something we spend less of our income upon as our incomes rise - potatoes, say. A normal good is something we spend the same portion upon, a luxury something we spend a higher portion of those rising incomes on. Just about everything is any and all of the three at some income level.

That environmental Kuznets Curve doesn't say, necessarily at least, that a richer society will be a cleaner one. What it does say is that after a certain level of income (wealth, if you prefer) then a society will spend a rising portion of that increasing income on a clean environment. It refers not to what absolutely will happen but to the economic capability of what resources will be devoted. 

Once that is understood then the arguments against it disappear. We still get to have those lovely arguments about what should be done, which is the most important thing we should devote those resources to. We are, just as with GDP itself, just making an observation about the economic resources available. How they're deployed is another matter.

That's also where it all gets interesting of course, we ourselves arguing that a cleaner environment is indeed something worthwhile - because everyone else seems to think so, the true determinant - which is why we must be efficient in our deployment of those resources in cleaning it all up. Rather than killing off the industrial capitalism which provides the resources to do the cleaning....

A no-brainer inheritance tax cut

To most voters inheritance tax is profoundly unfair, even the Fabian Society thinks the tax is too toxic to save. Worst still, rather than cutting the rate or scrapping it altogether, ministers have instead carved out exemptions for family homes distorting investment into property. Beyond being widely perceived as unfair, the tax is also much less progressive than many suppose. Greg Mankiw points out that the incidence doesn’t just fall on fortunate heirs, but also on workers who don’t receive a bequest.

“The estate tax is a tax on capital. As such, one would naturally expect it to discourage capital accumulation. Now, put this together with the fact that a smaller capital stock reduces productivity and labor income throughout the economy and the implication is clear: the repeal of the estate tax would stimulate growth and raise incomes for everyone, even those who never receive a bequest.

“The average worker has little reason to know that his weekly paycheck is smaller because of the existence of the estate tax. He may never realize that he bears part of the burden of the estate tax.”

Of course, the tax does have supporters. They worry about powerful dynasties forming and consider heirs undeserving. But there’s one inheritance tax cut everyone should support.

Under the status quo, each pound bequeathed over £325,000 is taxed at a high 40%. At the same time to avoid double taxation, capital gains are forgiven at death. This is backwards. As the Institute for Fiscal Studies’ Mirrlees Review put it “There is no case for forgiveness of CGT on death.”

This creates a powerful incentive for individuals to hold onto an asset when they would be otherwise better off selling up and putting their money in more profitable opportunities elsewhere. Taxes that reduce the number of times an asset changes hands also tend to reduce liquidity and increase volatility.

The Treasury estimated in 2012-13 that forgiving capital gains at death costs the Exchequer around £490m a year (annoyingly they haven’t calculated it lately). Since then the rate has fallen from 28% to 20% and revenue has nearly doubled.

Politicians are understandably resistant to adding further taxes on families when loved ones pass away, but forgiving capital gains at death is a terribly inefficient way to do that. The solution is a no-brainer. Scrap the exemption and plow the funds into cutting the inheritance tax rate.