Trying to judge today's trade by the old rules

We have to admit that we quite like the mental image this conjures up:

The idea of buccaneer Britain trading freely outside the EU is a fantasy

Avast ye scurvy swabs and buy moi foine products!

Yes, yes, and given that one of us just dubbed a pirate's voice for a computer game, thrice yes. However, there is a slight fault in the argument being put forward here about trade:

The first is distance. Imagine if all of Britain's trade agreements were suddenly erased from history, and we had to restart our negotiations from scratch. Our first priority would be to reduce the cost of trade with big, nearby economies. Trade diminishes quite rapidly with distance: half of Britain’s exports go to the EU, which makes up a fifth of the world economy. Meanwhile, the non-European members of the OECD – although they comprise a third of the global economy – only buy a quarter of Britain’s exports, because on average, they are seven times further away.

This very definitely used to be true: the costs of trade were dominated by the simple transport costs of doing that trade. Given the general path dependency we see in the economy it's not all that surprising that the pattern persists. However, this is no longer true of new trade as a result of an invention made back in the 1950s: the shipping container.Certainly, it has taken a few decades to really work through the global economy but the costs of trade now are almost entirely divorced from simple physical distance. If you're on the container network then it costs something under $5,000 to ship 36 tonnes of anything anywhere. If you're not on that network then it is many multiples of that price.

More, a significant portion of that price is organisation, pick up and delivery, the container itself. The actual distance to be traveled doesn't make all that much difference. In this sense, in this transport sense, Chicago is as close to Coventry in geographic terms as Caligari is, as Cologne is. Not entirely you understand, but pretty much so.

The European Union idea, that we should be encouraging trade between close geographic neighbours even to the point of discouraging more long distance routes is a little like the work of the Reverend Malthus. Entirely true until the very date that someone sat down to write it all out. Traditional geography did matter and the system was designed to account for that. But that first container ship set sail 6 months before the Treaty of Rome was signed. The structures of trade based upon geographic proximity were thus being invalidated by the new technology at the very moment that policy tried to enact policies for that geographic proximity.

It has been true that, and current trading patterns still echo that it was true that, geographic proximity was important in trade. The actual distance traveled now is of near no importance at all. The world has changed since we set the rules, you see?

You've got to pay the market price not just whine about nationalism

To the economist the definition of rent seeking is rather wide. It's really the attempt to secure a privilege in some manner, a way to corner something, free from that awful competition of the market. It being, of course, that awful competition of the market which reduces profits, thus seeking that protection leads to increased profits flowing to those who achieve the protection. Our example today is French vignerons.

As an official sponsor of France's Tour de France, there might seem worse choices than a wine named Bicicleta. But its discreet "Made in Chile" label has struck a sour note with French winemakers, who are threatening to block the three-week bicycle race unless it is replaced with a home-grown beverage.

One amusement to note:

The sponsorship contract has been in place for the last two years, with Bicicleta wine promoted in Britain at the opening stages of the 2014 Tour, and in Holland and Belgium last year during stages in those countries.

But Languedoc-Roussillon winemakers said they had only very recently become aware of the deal.

Light may have a certain speed, news travels rather more variably. And there's good reason why the French regard this region in the same manner we do darkest Dorset or the nether regions of Norfolk. Somewhat rural might be the polite way to put it.

But to the claim:

“It is unacceptable to allow the Tour de France organisers to promote a wine from Chile," the Young Farmers group (JA) said on its website. "They should be supporting only French produce."

The Tour is an entirely commercial operation, the sponsorship an entirely commercial matter. What the wine makers are insisting is that, on those grounds of produce nationalism, foreigners should be banned from such contracts meaning that locals can get them at cheaper prices. That is, this is rent seeking on nationalist grounds.

And, as with all other forms and types of rent seeking, there is only one correct answer: on yer bike sunshine.

Property rights and the wealth of nations

The International Property Rights Index, compiled by the Property Rights Alliance (based in Washington DC) and 92 partner think-tanks around the world, contains some interesting stuff. Finland tops the index, followed by Norway, New Zealand, Luxembourg and Singapore. At the bottom is (you guessed it) Myanmar, Bangladesh, Angola, Haiti and Venezuela. Indeed, the figures suggest a very strong and significant correlation (0.822) between a robust property rights system and GDP per capita. Countries in the top quintile of property rights scores have an average per capita income some 24 times higher than those in the bottom quintile. There is a positive but weaker correlation between property rights and economic growth, and property rights and foreign investment.

Interesting too is the result that the countries with the greatest gender equality, in terms of access to property rights, are again the richest, with Finland, Norway, New Zealand, Luxembourg, Sweden, Japan, Switzerland, Canada and the Netherlands topping the ratings. The countries with least gender equality feature many of the poorest, namely Bangladesh, Myanmar, Yemen, Libya, Angola and Nigeria.

So do countries have better property rights because they are rich, or do they get rich because their have better property rights? The remarkable decline of countries that have tried various brands of communism might give us a clue.

The problem with Thomas Piketty

Perhaps more accurately, we should say one of the problems with the work of Thomas Piketty. As Brad Delong points out, the central contention is as follows: Hotshot French economist Thomas Piketty, of the Paris School of Economics, looked at the major democracies with North Atlantic coastlines over the past couple of centuries. He saw five striking facts:

First, ownership of private wealth—with its power to command resources, dictate where and how people would work, and shape politics—was always highly concentrated. Second, 150 years—six generations—ago, the ratio of a country’s total private wealth to its total annual income was about six. Third, 50 years—two generations—ago, that capital-income ratio was about three. Fourth, over the past two generations that capital-income ratio has been rising rapidly.

At first sight this is indeed a problem. The capital of our economy is what we produce our income from. If the capital to income ratio falls then that means we are using the capital more efficiently. If it rises, obviously and equally so, the economy as a whole is becoming less efficient at turning assets into income. However, we need to break this out into more than just "capital".

Using the work of Saez and Zucman we can see that at least on this side of the Atlantic the great capital concentration of the late 19th century was in the value of agricultural land. As the Americas, then the Ukraine, opened up this value fell precipitately. Thus the destruction of the great aristocratic landed fortunes.

The privately held value of financial instruments hasn't really changed all that much over the time period: and that's the bit we usually concern ourselves with when we talk about wealth concentration.

In more recent decades the two components of wealth that have risen again are private land holdings, and that is principally domestic housing and private pensions savings. Again, that privately held value of financial assets, outside those pensions, hasn't really risen nor has it become more concentrated.

So, yes, we've had a rise in the capital to GDP ratio. That part that is house price rises, well, we've had our say about that a number of times. It's the restriction on planning permissions which has driven up the value of land you may build upon. This is inefficient and we have suggested, again a number of times, that we should do something about it. Like destroy the system which artificially restricts, and thus drives up, the price of those permissions.

As to the private pensions this is actually something of a success story. Immediately post WWII someone retiring at 65 could and did expect perhaps 3 to 5 years in retirement before death. Nowadays the equivalent number is 15-20 and it's still rising. Fortunately we did also have a system of pension savings provision which has largely paid for this. That's an inefficiency in the capital to income ratio we can live with: because if we didn't have it then there would be many old people with no income to live upon.

Given that Piketty's observed facts are so easy to explain we don't really need to take much notice of his further worries. None of the above justifies a wealth tax, worries over the creation of a permanent haute bourgeoisie or any of those other fashionable concerns. Fix the planning system and celebrate pensions and we're done.

The terrors of the ISDS provisions in TTIP

We're really all rather mystified by the furore over the investor state dispute settlement system within the Trans-Atlantic Trade and Investment Pact. Unite has been running a campaign insisting it will put the NHS at risk: foreign companies would be able to sue, outside our court system, if their profits from killing us all in our beds were interrupted. Others have been complaining that no future government could renationalise the railways if it came into force. The ISDS has absolutely nothing at all to do with either of those two cases. Nor, if truth be known, with most of what people are claiming about it. Here actually is the current text of what the EU is suggesting to the Americans.

Neither Party shall nationalize or expropriate a covered investment either directly or indirectly through measures having an effect equivalent to nationalisation or expropriation (hereinafter referred to as 'expropriation') except: (a) for a public purpose; (b) under due process of law; (c) in a non-discriminatory manner; and (d) against payment of prompt, adequate and effective compensation.

That is, any government can nationalise anything it wants. As long as all the usual rules about compulsory purchase and so on are followed: it's done legally, for some reason, it's not being done just to shaft someone and it is paid for. All things that we'd expect to be part of normal domestic law anyway, which are in fact part of normal domestic law anyway.

Thus we find it very hard to understand the demonstrations, the protests. There's nothing else in that draft that causes us the slightest concern either. That same clause even insists that it will not cover the compulsory licence of IP (say, a drug or a vaccine that a country cannot afford, under the usual WHO and WTO influenced rules).

We're left scratching our heads and the best we can come up with is as follows. And we will admit that we're not normally this cynical. It is obviously fun to go on a demo and if you choose the fashionable cause of the day that's where all the good looking people are going to be anyway. But in the absence of anything to have a good demo about there's still the need to all get together. And of course something like Unite needs to keep demonstrating (sorry) that it really is doing something for the workers in return for all those union dues. So, in said absence, why not create something to demo about? Doesn't matter how true or not anything is, whatever gets the juices flowing and shows continued the relevance of the organisers works just beautifully.

Sorry, we just can't think of any other reason why there's been this uproar. And read the full document for yourself to see if you can find it.

Pensions don't come for free

Toby Nangle has written a very good post on pensions, pointing out that Pay As You Go (PAYG) pensions and fully-funded pensions are similar in that they both represent the old having financial claims on the young. We can fund their pensions through taxing the young or by having them own financial assets. In his words:

Pensioners will collectively consume output produced by the young. Money, as always, mediates – and so in place of ‘consume output produced by’, read ‘receive income from’. Pensioners will receive an income that can come only from non-pensioners. This income could be in the form of rent, dividends, and interest only from the young, or the proceeds of asset sales made only to the young. This income could be in the form of tax transfers only from the young. Or some mixture. It was ever thus and it will ever be thus.

This is true, and a good point. But he goes too far in implying that this makes PAYG pensions and funded pensions similar overall, or that deciding between these two socially only involves practical questions. There are two huge differences.

1. Inside a recession, when interest rates hit the 'Zero Lower Bound', extra consumption can increase aggregate demand. However, most of the time the economy is neither in a recession nor at the ZLB, and extra consumption comes at the expensive of extra saving (and saving is what goes into investment). Unless you are above the 'golden rule' level of saving—and this is very, very unlikely when there are so many taxes on saving and subsidies to non-saving (like providing retirement incomes) in our society—then extra saving (and investment) raises your productivity and living standards.Basically: if we force pensioners to save and invest to fund their retirements then when they actually do retire we have more capital, which means higher productivity and higher income. Thus, for any given level of retirement benefits, bearing it is an easier burden.
2. Governmental claims can only be on your country's own citizens. Financial go all around the world. If you save a lot in your youth, invest those savings in foreign capital, and that capital earns a return, then your pensioners' claims could be on the young working citizens of another country—possibly one with a growing population! (NB having claims on the youths of another country doesn't necessarily make them worse off; if foreign investment raised a factory or funded training that made those citizens more productive then everyone can benefit.) Of course, this second point doesn't question Toby's story as a model for the world as a whole, just when we're considering individual countries separately—and since this is how pensions tend to be considered this is probably the way we should look at the question.

Yes, PAYG and funded pensions both involve bundles of financial claims. Yes, they might both be the same size, and one main difference is simply how the system is run and intermediated. But it does not follow that other differences are small or trivial; PAYG is likely to lead to a lower level of saving, investment, capital and income. Under PAYG, the burden of the elderly is heavier, because we have narrower shoulders.

GDP really only is a proxy, not actually how well we're doing

There are those who criticise the concentration on GDP as a measure of how well we're doing. And they're right: although not quite for the reason that they think they are. To say that it doesn't matter that we're all getting richer, that we should just be content, is nonsense of the most arrant sort. Any casual glance around the world will show that there are still outrages such as absolute poverty which greater wealth could solve: thus we do indeed want to get richer. However, the argument that GDP isn't a very good measurement of how much richer we're getting is entirely true. As this little story tells us:

While global economic problems have taken much of the blame for tightened tech spending lately, another culprit may be afoot: computing on demand delivered over the Internet.

The idea is that instead of capital spending on equipment people now rent it by the month. This plays merry hell with our GDP statistics. For people do indeed look at something like business investment in computing as a measure of how much, well, how much is being invested and thus likely how rich the future will be. But investment is defined as what gets written off over longer than one year. And renting the cloud kit is current expenditure. That's not investment: and thus those reading the runes on business computing investment are going to be fooled by this. For we've still the same amount of computing, still, at least possibly, the same amount spent upon it too. We've just changed the classification of that spending.

But that's not all:

Take Ted Ross, CIO of the city of Los Angeles. He needed to upgrade the technology that powers the city’s Business Assistance Virtual Network, the site where vendors bid for projects from various city agencies. Mr. Ross considered buying new blade servers to host the site. Instead, he decided to run the site on Microsoft’s Azure technology. He’ll halve his costs, and the migration should take four to six weeks, he said.

Actually spending less while still getting the same amount of computing done? That's something that makes us all richer. And yet one of the things we also know about GDP accounting is that it doesn't deal well with these "hedonic" improvements. Either the improvement in performance at the same price, or the availability of that same performance for a lower price.

We do want the world to be becoming generally richer, yes we do. And that means we do want GDP to rise: it's a measure of the resources we have available to solve problems and while the world still contains problems we'd like our ability to solve them to rise too. However, we must always remember that GDP is a proxy for that increasing wealth and that we shouldn't set it up upon a pedestal as being the only goal.

Of course being good at business doesn't make you good at economics

Don Boudreaux makes an important and underappreciated point here:

Here’s a refrain that I’m being bombarded with by e-mail and on Facebook; this particular version is a Facebook comment by someone named Thomas Marise (whom I don’t know):

Trump has proven time and again he knows his stuff when it comes to economics. He has a personal wealth of $10Billion proving his understanding. Hard to argue with results.

Such a claim is illogical, even if we assume – falsely – that Trump earned every cent of his monetary fortune honestly rather that at least some of it through government-orchestrated theft.

Knowing how to run a business is not the same thing as knowing economics.

It's worse than just that they're not things being measured along the same axis of human endeavour. It's actually that rather a large amount of knowing how to run a business is in managing to avoid the things that economics, and economic policy, would like to do to that business.

Think it through for a moment: every business would love to make excess profits, profits above the average cost of capital. And much of business itself is trying to work out how to do so. but at the level of the economy we don't want anyone to be making excess profits: we don't want anyone to be making more than the average return to capital. And that's rather the difference between markets and capitalism as well as between business success and economics.

Sure, business is capitalism, let's make the profits where and when we can for private benefit. But it's markets that curb this tendency, markets which force only those pushing the technological boundaries capable of making those super-profits. It's also markets which compete away those excess profits as other producers catch up with that boundary pushing. Finally, it's economics which explains both why the markets are desirable and why they work.

Much of business is trying to avoid market forces, much of economics is discussing how much we've got to insist that market forces be allowed to work. They really are two very different subjects and success at one, knowledge of one, by no means even implies success at the other.

Yes, obviously industrial production is down

We cannot quite share this shock and horror at the news that industrial output is down:

Britain's industrial plight was laid bare today after official figures showed output at the end of 2015 fell faster than at any time over the past three years. Industrial production contracted by 1.1pc in December from the previous month, the biggest monthly drop since September 2012 and much worse than the 0.1pc decrease expected by economists.

And for manufacturing:

The ONS also revealed that manufacturing production fell 0.2pc in December, the third consecutive monthly decline. The last time the UK's manufacturing sector contracted for three months in a row was during the depths of the Great Recession in 2009. Compared with a year earlier, manufacturing output fell 1.7pc, against expectations for a 1.4pc decline.

One reason we're not all that worried is that manufacturing output is some 10% of GDP, meaning that a 2% fall in the sector is 0.2% of the economy as a whole. Industrial output is essentially energy and mining plus manufacturing and that's not much larger as a portion of the economy. And we have all noted that the prices of fuels have dropped recently, meaning that an index of the value of what is produced is going to fall whatever happens to the volume of what has been produced. Essentially, these are minor changes in a minor part of the economy.

A second reason we're not all that bovverd is that there isn't anything special about manufacturing or industrial output. Sure, they're nice things to have but they are no more valid or valuable than any other form of economic activity. The standard trope that making things you can drop on your foot is the only important form of production is simply wrong.

And the third reason we're not worried is this:

David Cameron has hailed Britain's technology sector as "extraordinary", after a report revealed companies are generating £161bn for the economy. According to the Tech Nation report, now in its second year, the digital economy grew 32pc faster than the rest of the economy between 2011 and 2014, and is creating new jobs at an unprecedented rate. The sector accounts for 1.56m jobs across the UK, with this workforce growing by more than 10pc over the three-year period - three times faster than the wider UK job market.

Yes, obviously, that's being bigged up by that quango but this is exactly what we would like to be happening. The current industrial revolution is in those digital thingies, those 1s and 0s being placed in precise rows. We Brits pioneered the first industrial revolution, rather lagged in the second and third, but seem to be doing well at the fourth. And just like doing well at the first made us relatively richer than everyone else, lagging at the next two led to a bit of relative poverty, getting this one right will lead to relative riches again.

And this is what an economy is supposed to do: over time move from doing that doesn't add very much value old stuff to the adding lots of value new stuff. Something we seem to be doing rather well. We wouldn't say that all is lovely in the rose garden but it's most certainly not doom and gloom.

New Report: Migration and Development

The best international development policy would be to let in more workers from the third world in to work in Britain, according to a new paper from the Adam Smith Institute. Politicians should stop trying to save entire countries with foreign aid programmes and instead help their inhabitants by letting them move to developed countries, it says. The report Migration and Development argues that doling out billions in foreign aid risks propping up corrupt kleptocratic governments and having little impact on development; letting people move to where they can be most productive is a reform that really works.

The paper, authored by Swedish policy analyst Fredrik Segerfeldt, suggests an immigration target, modelled on the 0.7% of GDP foreign aid target, in order to boost the welfare of the global poor.

Not only would this help the migrants themselves, but it would even help their source countries to develop, Segerfeldt says. Migrants send around three times as much home in remittances as governments send in foreign aid, and this private development aid is far better targeted, going directly to those in need and not through flawed institutions. The money is often used by developing country citizens to educate themselves and raise their human capital, helping to create a virtuous development cycle.

To assuage worries that migrants will empty the state’s coffers as a fiscal burden on the state, Segerfeldt advocates both that migrant work permits be temporary, and that the full suite of benefits would only be available to natives.

To access the full press release, click here.

To download the report for free, click here.