Economics

Prices in the EU Emissions Trading Scheme (EU-ETS) have hit new lows in Phase 2 (just over €10/tCO₂). The mechanism became worthless in Phase 1. It looks likely to do the same in Phase 2 (as some of us predicted). It is not providing sufficient incentive for anyone to invest in any carbon-reducing projects. But it is still handing nice rents and market-protection to the beneficiaries of the allocation process. Uncertainty about its value, so vulnerable to political whim and economic fortune, is a significant factor in the reluctance of power companies to invest not only in renewables, but even in new coal, gas and nuclear stations, because their relative competitiveness depends on EU-ETS prices, and any investment can therefore be made uneconomic in the tap of a legislators' pen.

Naturally, Stavros Dimas (EU Environment Commissioner) has taken this confirmation of the irrationality and harmfulness of the scheme as a signal to try to draw others, particularly America, into a global ETS.

Robert Cialdini, in his book Influence, briefly recounts a real incident that was witnessed and analysed by the social scientists Leon Festinger, Henry Riecken and Stanley Schachter, recorded in their book When Prophecy Fails. The details are hilarious and illuminating in equal measure. I highly recommend you to read Cialdini at least, if not Festinger et al. But I will try to precis here the already potted version in Cialdini. A doomsday cult formed around a man with a long interest in mysticism, the occult and flying saucers, and a woman who claimed to channel messages from extra-terrestrial spiritual beings via the device of automatic writing. These messages started to foretell a disastrous flood that would engulf the world. However, they also reassured the members of the cult that they would be rescued by flying saucers that would be sent  a few hours before the flood was due to commence. During the period leading up to the appointed date, the members of the cult retreated into themselves, making little effort to warn others of the impending disaster. Of course, the spaceships failed to materialise, as did the flood. In the immediate aftermath of the non-appearance, there was silence, then introspection and despair, then signs that the group was starting to dissipate. At this point, the woman received a message from the extra-terrestrial spirtual beings, telling the group that "the little group, sitting alone all night long, had spread so much light that God had saved the world from destruction." A second message instructed her to publicize this news. The group set about contacting newspapers and trying to persuade as many people as possible of the truth of their experience.

Festinger et al and Cialdini provide a convincing explanation for this bizarre switch from secrecy to proselytization, at precisely the moment that it had become obvious that their beliefs were unfounded. The members had invested hugely in the cult's belief-system. The psychological cost of admitting it had been for nothing was too great to contemplate. Yet the evidence clearly indicated that it had indeed been a foolish waste. To avoid the spiritual cost of facing reality, they needed another way of maintaining their belief. Their best hope was in persuading others to share their views, for, if enough people agreed with them, it must (psychologically) be true, whatever the evidence seemed to suggest. The proselytizing was not a sign that they were now more confident of the truth of their beliefs, but precisely the opposite - it was the conscious response to the subconscious awareness of their folly.

Of course, people outside the cult could see the flaw in their beliefs, and the desperation that underlay their efforts. Not a single new member was attracted. Let's hope that those in the White House and elsewhere can spot the equally obvious evidence of the failure of the EU-ETS, and the motives for Mr Dimas's promotion of the cult of carbon-trading.

The latest spate of humbug surrounded the "British Jobs for British Workers" strikes.

Even the application of the term "strike" was a piece of humbug. The protesters didn't work there, so how could they go on strike? This was secondary picketing, but no one dared to call it by its real name.

Why has there been no comment on whether there were issues over foreign workers at the sites where sympathy action was taken? If so, were these contracts excluding local workers suddenly awarded in a spate at power stations around the country? Or had no action been taken at these sites previously because (a) there weren't many foreign workers there, and (b) people didn't have a problem with the foreign workers at those sites until they were prompted by the protest at Lindsay? Unless there was a very strange set of coincidences going on, weren't the sympathy actions entirely illegitimate secondary action, against companies unrelated to the Lindsay strike, by people with no previous inclination to protest against those companies, with no obvious achievable objective at those locations?

And what about the original letting of the contract to the foreign firm? Several contractors bid for the work. Labour costs would have been a major component of their bids. Cost and expectations of quality of work would have been major factors in Total's decision. The foreign firm was able to put in a winning bid because, by employing foreign workers, it was able credibly to promise a decent-quality job at lower cost than the British contractors who priced in the costs of using British workers. Should we be surprised about this? Should we criticise Total for taking the obvious business decision? Or should British contractors and British workers be asking themselves if they aren't overpricing themselves? If most of the politicians, commentators and businessmen involved hadn't been so feeble in failing to point about this fundamental reality, this could have been a painful but useful lesson in the realities of the labour market in an economic contraction. Instead, our "leaders" behaved as though they believed the protests to be justified, and allowed it to become a debate about how much and what type of action should be taken to try to buck the market.

All the same, I have sympathy with the protesters and the vast majority of British people struggling to make ends meet: not because there is an iota of sense in the claims that we should somehow try to ring-fence jobs and rates for British workers at a time when the economy is collapsing (the fastest way to repeat the 1930s experience in America, which seems to be the direction of policy in most countries anyway); but because they have been slowly trapped, by 15 years or more of lousy policy and hopeless management of the economy, into a situation where the average British worker can barely afford to live on the average British wage. Many of them were, of course, complicit in this development, not only because they voted for the idiots who mismanaged our affairs, but also because they happily racked up the debts, luxuriated in the bloated public services, and developed a sense of entitlement from the vast amount of over-protection provided to the under-deserving by the state. But whether or not they were complicit (and those who were not are in no better a position than their profligate compatriots), their situation is almost untenable now, and that is not anything you would wish on anybody, let alone a whole nation.

Just consider one component of the economic choice of the contractors. Look at the barge that the foreign workers are living on, and compare it with the typical cost of rent or mortgage to live in a British house. Of course the foreign workers can afford to bid a lower price for their labour. We have created a situation where we can't afford to work at wages that would be competitive even against other developed nations, let alone developing nations. We can't afford to take lower wages, but we can't compete at the wages that we need for even the most menial quality of life.

No wonder the pound has collapsed, and thank goodness it has and that we have a currency that allows that adjustment. Without realising it, every Briton has in the past year effectively taken a 40% pay cut, in international terms. And the value of all our assets, including our homes, have been similarly cut, even before we take into account the falls in prices. Yet, even now, we are not competitive. Does that give some idea how fat, complacent and lazy we had got? And of the pain we are in for if (as looks likely) the pound now strenthens again, and with it the costs of our labour and assets increase?

I won't go in to the stupidity of Gordon's use of the term "British Jobs for British Workers", and the disingenuity of his claim that the phrase was intended to be interpreted as referring solely to the question of training. Nor will I discuss the absurdity of the internal debate within the Labour party and parts of the media about whether European law is to blame, is right or wrong, and ought to be changed, knowing full well that there is not a hope of changing it, and that plenty of Britons have been on the other side of this fence and taken advantage of these freedoms. These true but somewhat facile points have been well-dissected by our commentariat.

But I am tempted briefly to point out that this yet again demonstrates that the supposed "far-right nationalists", to whom our struggling working classes are supposedly attracted by this sort of problem, are actually far-left nationalists. Lefties are always amazed that it is their voters who most easily cross over to the BNP. Like Billy Bragg on tonight's This Week, they claim that these people have leapt across the political spectrum, from Labour on the left to the BNP on the right, for some reason not pausing en route to consider the LibDems and Conservatives who supposedly lie in between.

Of course, to those of an Austrian persuasion, who define the left-right political spectrum as being from more (on the left) to less (on the right) bureaucracy, authoritarianism, and expectation that the state is all-seeing, all-knowing and will make everything right, the step from Labour to BNP is an easily explicable, small progression for people to make. By voting Labour, they expressed the hope that government could solve all their problems. When government fails to do so, they look for other parties who claim that still more draconian government action is needed. They take for granted that their travails are other people's fault and other people's job to put right. If other people (i.e. the government) try but fail to put things right, it must be because some evil forces are preventing the government's interventions from working. It has nothing to do with the unsuitability of the government's measures, the impossibility of achieving these ends by these means, or the individual's failure to help himself. It is all down to powerful, mysterious, external forces. And who are more mysterious, external, and easy to blame than people who are different to us?

The far-right extreme is not fascism, it is anarchism. Fascism and communism sit side-by-side on the authoritarian, socialistic extreme left (remember, the Nazis were National Socialists). They are distinguished mainly by their emphasis on a nationalist or internationalist scope to their ambitions, not by any fundamental differences of philosophy. But our intellectuals (in the Hayekian sense) persist in placing them at opposite ends of the spectrum, and then create all sorts of convoluted arguments and analogies (perhaps the spectrum isn't a straight line, it's a circle or a cross) to try to explain away the repeated anomalies thrown up by their failed paradigm. Some do it from simple intellectual laziness, others do it to justify their socialistic bias (after all, anything that is opposite to fascism must be right, mustn't it?). But whatever their motivations, it is pure humbug.

Between the points that the media have picked up on, and those that they never would, the analysis of this dispute was a real pick-and-mix of glistening, tooth-rotting, bloating, nutritionless confectionery.

On Radio 5 this afternoon (5 Jan), Seb Coe said something like "It is often forgotten that, between now and 2012, the Olympic preparations will make up around 5% of economic activity in the capital".

It is one example of a common refrain in support of any public expenditure: "this project is contributing X (pounds or percent) to the economy, so it must be good/adding something to the economy." In fact, it seems all public works have to be justified in that way nowadays, along with the linked claim that they are creating Y jobs, and will be displacing Z tonnes of carbon.

It is a staple of classical-liberal criticism to point out that the money for this activity had to come from somewhere, and that this is therefore not adding to the economy, but simply moving expenditure from one place to another. The money taken from taxpayers to pay for the Olympics might otherwise have been spent on all sorts of consumer goods, or saved. The producers of those consumer goods, and the producers of the second-order goods that contribute to the production of the consumer goods, etc. will lose as much as the recipients of public funding to build the Olympics will gain. Additional savings would have helped to reduce the structural imbalances that our consumer society developed over the past decade and more.

But this argument, though true, has two weaknesses. It doesn't seem to sum up the full economic inadequacy of the claim. And it is at the same time unpersuasive to those who believe in public expenditure. What additional responses might help to tackle the fallacy?

I've been beating a fairly solitary path on this for a while, and in the process making myself unpopular with the major players in the electricity industry (which provides another clue to the huge rent-seeking potential of cap-and-trade) and their representatives. But, judging by this article in this weekend's Sunday Times, it looks like others may also be coming to share my view.

My policy of paying no attention to the news had been going well, and then the boss decided that we simply had to respond to an article in The Times. So it's temporarily back to banging my head against a brick wall, as you may have guessed from the appearance of this post.

The article in question was a Guest Comment by Sam Laidlaw, Chief Executive of Centrica, whose heading summarises his argument pretty well: "Put a price on carbon, but not a tax". This might seem to be a reasonable, even a liberal argument. Unless you are close to the energy industry, you would probably not realise how this was just another example of the way that energy policy has become a plaything for the energy corporates to try to gain commercial advantage. The Government's policy is practically being dictated by the positions of companies like Centrica, who are very clever in dressing up self-interested positions as plausible, apparently impartial and principled arguments. I will let the letter I sent to The Times explain how so in this case:

Sir,

Sam Laidlaw says that we must "put a price on carbon". He does not differentiate between sources of carbon, and rightly so. Our climate does not, and neither should we.

One of the many failings of cap-and-trade, unlike a carbon tax, is that it is not practical for highly-fragmented markets, such as the very large market for domestic heating. The domestic consumer of 'natural' gas (or heating-oil or LPG in remote areas) is therefore not "forced to pay", which reduces incentives for householders to act sensibly and to consider alternatives like renewables.

Mr Laidlaw opposes the intervention of government(s) in setting the price of carbon, but in fact such interventions pervade the system of cap-and-trade. In the absence of a carbon-tax, the only other levers that the Government can pull in the domestic sector are either partial, bureaucratic and poorly-funded grant-mechanisms (such as the Low-Carbon Buildings Programme, in which Centrica’s subsidiary British Gas has been given a privileged position), or regulations and obligations (such as the Energy-Efficiency Commitment, in which again only the major energy suppliers, such as Centrica, can participate).

Mr Laidlaw presumably prefers these mechanisms to a tax that is the only practical way of pricing carbon equally across all types of consumers, large and small, but he then must accept that most of his customers are insulated from the cost of carbon, an approach that he says is wrong. Policymakers and consumers ought also to be concerned that those measures embed the power of the incumbent energy suppliers, and inhibit innovation and competition from new entrants.

Yours,
etc.

It was not published, of course. I have no complaint - that is their prerogative. But more strangely, I also tried, when it wasn't published, to post this message (in two parts, because of the 1000-character limit) to their website, but it hasn't shown up there either. Another message that I posted afterwards, in response to another poster who suggested we should have a government-subsidised investment fund rather than carbon-pricing, has appeared, which makes me wonder why the earlier posts didn't show. Was this a technical hitch, or was it moderated? It seems unlikely to be a technical issue, as the later post got through fine, and it is strange for both halves of the first message to suffer a technical glitch that other messages did not experience. My guess is that it was moderated, but why?

Apparently “No government should ever be in the business of protecting executives who make the wrong call or bad decisions,” or so said Alastair Darling at the opening of yesterday's conference. But isn't this exactly what he did little over a weeks ago with Northern Rock?

So the Government has promised that it will guarantee Northern Rock savers by underwriting £28bn of deposits? Darling has, in theory, just nationalised the savings industry - yet you get the distinct impression that he is making this up as he goes along.

I had no idea, until today, that I was an investor in Northern Rock and therefore liable for its risk.  Apparently, I am however.  You see, thanks to their stupidity and over "generous" mortgage lending their books have gone a little bit unbalanced.  Now, if my books were unbalanced and I had failed to keep up my re-mortgage payments with Northern Rock they would, rightly, have got a little upset.  As it happens they have been the less than frugal ones and now are facing serious financi

Mark Wadsworth (whose blog is one we recommend in our blogroll) managed to get a long (by their standards) letter published in yesterday's FT, criticizing John Redwood's focus on reducing corporation tax, when in Mark's opinion greater emphasis should be placed on reducing VAT and National Insurance (NI). Well done for getting published, Mark. You are half right.

You are right that some taxes need reducing more urgently than corporation tax, and that NI is one of them. On the other hand, Redwood is nevertheless right that we need to cut corporation tax (if not as a priority above other cuts), and you are wrong about VAT as a priority.

I say this with some confidence, because I happened, the day before, to be browsing the latest version of Taxation trends in the European Union - Data for the EU Member States and Norway, from Eurostat, the EU's statistics office (yes, I am that sad). The figures in there do not support Mark's argument in its entirety.

Corporation tax needs cutting because, although our biggest competitors have higher rates, we are not only in competition with them, but with the 20 other European countries that have lower rates than us. Not to mention the BRICS countries, and other developing nations. Your principal competitors change according to who is competing most aggressively. The best way to lose your competitive position is to focus complacently only on your old competitors.

(Having said, that, one does need to be careful about what one means by "competitiveness", as Samuel Brittan, pointed out in yesterday's FT. But the conditions that influence where businesses choose to invest and to book more or less of their profits does seem a legitimate area for international tax competition.)

It also needs cutting because high rates of corporation tax distort investment decisions, as companies structure deals and decide their levels of borrowing and saving in order to minimize their tax bills rather than because of the fundamentals. And because experience in countries (particularly in Eastern Europe) in recent years suggests that high rates are at an inefficient point on the Laffer Curve, and that cutting rates to below our current level can increase (or at least, not significantly reduce) revenues.

Although the comparisons for consumption taxes indicate that the UK's rates are already pretty competitive, it would be misleading for me to suggest that we are in competition over rates of VAT in the same way that we are in competition on corporate tax. Most of us do not have much option to go to another country to consume our goods. The costs of doing so are likely to be very much greater than the tax benefit. Nevertheless, it does raise doubts as to whether further reductions in VAT should be an urgent priority.

VAT does not have much impact on costs of production, thanks to the offsetting of VAT on purchases against VAT on sales. It is effectively a tax on final consumption. Apart from the case of one-to-one transactions involving personal services (e.g. paying in cash for your gardener or cleaner), it is relatively unavoidable. Nor is it so high (at 17.5% nominal, 11% implicit, i.e. taking into account lower rates and exemptions) that it will be deterring significant levels of economic activity, relative to other taxes whose rates are significantly higher. Consequently, a reduction in VAT is likely to have a near-proportionate impact on tax revenues - there is unlikely to be a significant Laffer-Curve benefit.

Mark argues that "VAT does not just increase the price paid by the consumer; it also reduces the net price received by the producer. Thus low-margin producers are forced out of business and output is reduced quite significantly." Well, yes, it will be a bit of both, though the combined effect will remain 17.5% (or whatever rate of VAT applies to the good). The balance between one and the other will depend on commercial decisions, which will be heavily influenced by price-elasticity of demand. If demand is inelastic, producers should be able to pass on most of the cost to consumers without dramatically affecting volume, and therefore profits. If demand is elastic, producers will have to choose between passing on the costs to consumers and accepting a lower level of demand, or absorbing the cost to maintain volume, but reducing margins/profits. Their balance of fixed vs variable costs will play a significant part in that decision.

The net effect, as Mark says, is that some marginal products are not brought to market, the volumes of some other products are reduced, and the prices of goods that are essential or at least strongly desired, are higher than would otherwise be the case. But this is not different in effect to other taxes. Corporation tax also affects either the level of profits or the price at which the company's goods must be sold in order to deliver the return on investment necessary to persuade people to invest (or retain their investment). At the margins, it will also cause businesses not to be setup or to divert their funds into more profitable activities, which reduces the range of products available and the volume of transactions, and increases the price of goods for which demand is inelastic. And income tax and NI increase the cost of producing goods with a significant labour input, causing fewer of those sorts of goods to be produced and increasing the cost to consumers of essential, high-labour goods. All taxes have this sort of effect - it is a question of striking a balance between their impact on the economy and the need to raise revenue. In that regard, 17.5% (or 11% on average) on consumption could be expected to have a less significant impact than 28% on profits or 40-50+% on employment.

It is that latter figure that seems a particularly strong disincentive to something particularly desirable. NI, of course, is part of the tax on employment, and the most regressive part at that. I am in agreement with Mark on this, and yet the European figures once again do not appear to support us. The only countries in Europe with lower implicit (i.e. weighted average) tax rates on labour, including income tax and employer/employee social security contributions (SSCs, i.e. NI in the UK) are the tiddlers of Greek Cyprus and Malta. It seems that the UK government is taxing labour relatively lightly. Moreover, our SSCs are a relatively low proportion of the whole (less than half the average) compared to most of our neighbours, whereas our income-tax rates are higher than average, which might suggest that NI isn't even the place to start if one were reforming UK taxes on labour.

And yet, it is still true that our employment taxes are too high. Eurostat knows it too:

"Despite the presence of a number of low taxing countries, taxation on labour is, on average, much higher in the EU than in the main other industrialised economies. The effective tax rate on labour in the United States was estimated at just 23.9 % in 1999, compared with an EU-25 ITR of 36.3 % for that same year. Carey and Rabesona (2002) estimated a 24.9 % average effective tax rate on labour for the United States in 1999, i.e. 12 percentage points less than the estimate for the EU-15; the difference with Korea (13.9 %) was even more than 20 percentage points. Values for Japan (23.0 %), New Zealand (23.0 %), Australia (25.3 %), Canada (30.3 %), and Switzerland (31.1 %) were far below the EU-15 average, too. Martinez-Mongay (2000) found broadly similar differences between the EU and the United States and Japan. Indirectly this is confirmed by OECD data on the tax wedge."

And that's just the industrialised countries. The comparison with the developing nations will be even less favourable.

In this case, like corporation tax and unlike VAT, there is an element of international competition, as labour can move, if not as easily as capital. We see the effect in the inflow of Eastern Europeans to the UK at the moment (they could equally have gone to Sweden rather than Britain or Ireland, but the numbers were proportionately lower to the high-tax country that opened its doors) or the numbers of French already here, and the outflow of Brits to countries like Australia and the USA. The only country with higher taxes (and then not much, and not in terms of the proportion paid by the employee) to which there are major flows of Brits is Spain, and most of those are going there to retire.

The universal impact of taxes - of preventing some goods being produced, of reducing the volumes of other goods, and of pushing up the price of goods for which demand is least elastic - applies to taxes on employment as much as any other. But it manifests itself in specific and particularly harmful ways. The goods that are not being produced or are produced in lower numbers or are being made more expensive (without the producer benefitting) are jobs. The only way that high employment can be balanced with high taxes on employment is if people are prepared to accept a lower level of take-home pay. But as take-home pay has a significant impact on the sustainable level of demand in the economy, even that would not prevent high employment taxes from having a deleterious impact on the economy and people's wellbeing. And in practice in Europe, there is strong resistance to rebalancing levels of pay to take account of the cheaper labour and lower taxes that can be found elsewhere. The result is predictable and borne out by experience - high unemployment and low growth.

We may look smugly at the relative, official levels of unemployment and growth in Germany, France and the UK and believe that we are doing better than them. But while we undoubtedly have been doing better on average than those of our neighbours who have been slowly strangling themselves for the past decade or more, we are not so much better as the official figures might suggest. Our (un)employment figures are massaged by moving an incredible number on to disability benefit, and our employment figures are entirely dependent on the vast number of additional public-sector jobs (for which demand is unaffected by employment taxes because their "customers" - taxpayers - have no option until election-time but to pay the extra) that have been created since 1999. Worse still are our effective, marginal rates of tax (taking account of means-tested withdrawal of benefits), which provide a strong disincentive for those on benefits to seek work, unless they can jump straight into a high-paying job. We may only be mutilating rather than strangling our economy, and hiding our self-inflicted wounds better than our competitors, but it does not diminish the long-term impact, which is that competitors from outside Europe are catching us up or leaving us behind.

The first priority is clear, and I don't think would be in dispute between Mark, John Redwood and myself (though it would appear that Redwood's party, like the others, would dispute this). We must reduce the size and cost of government as much as possible, so that we are able to reduce the burden of taxation in general. But it will not be possible to reduce taxation to a level which has little impact. Priorities have to be chosen with regard to where the burden of the state should fall. As that burden is effectively a disincentive, it is, in significant part, a question of what one is least reluctant to disincentivize: jobs, profits or consumption (to limit ourselves to the three options considered by Mark). Though it is not ideal to discourage any of these, it seems to me that the least harmful of the three to deter is consumption, then profits, with employment being the least desirable thing to penalize. As things stand, the priorities are in exactly the reverse order. Redwood would rebalance it in favour of profits. Mark would rebalance it in favour of employment and consumption. I would rebalance it in favour of employment and, to a lesser extent, profits.

It seems that Mark and I agree on one other thing, though - perhaps more important than the levels of taxation, to complement the emphasis on reducing the level of tax on employment. Nominal rates are all very well and a worthy target for reduction, but what really matters are effective and marginal rates. This brings into play other factors, such as personal allowances and benefits. In comments on Mark's post, Vindico (a fellow individualist whose blog is now added to our blogroll) suggested that a flat tax be combined with a Basic Income (BI) to achieve a more efficient balance of effective and marginal rates of taxation. Mark agreed enthusiastically, and so do I.

I have been trying to promote BI as an efficient, liberal, compassionate alternative to welfare, and not necessarily a left-wing policy as many seem to assume, for some time. All reforms of the tax system, fiddling with the calculations for means-testing benefits, and sounding tough about forcing people back to work, will have little effect on the draconian levels of effective, marginal rates of taxation on low-earners that keep many of them out of work. Only a Basic Income can solve this. It is a sine qua non of genuine tax and benefit reform. If UKIP were to make it part of their programme, as Mark says they are considering, they would gain at least one more supporter.

The Institute for Paternalism, Protectionism and Regulation today published a report on Energy Security. It is, in the most part, a rehashing of received wisdom, without understanding or insight, but one phrase in the Executive Summary stood out for being more than just vacuous. It is symbolic of the way that this sort of organization, and their friends on the centre-left and centre-right, view the role of government:

"Clearly there is no one-size-fits-all solution to these challenges and undoubtedly a mix of policy measures will be required."

Sounds innocent enough, but consider if you applied the logic in other fields. What about the field from which the phrase is drawn? There is no one-size-fits-all solution for clothing, so the Government needs a mix of policy measures to ensure that the correct balance of sizes is supplied. There tends to be less demand for the smallest and largest sizes, so to reduce the risk that the market may not provide equal choice to these consumers, we will have a policy to encourage or require production of extra-small and extra-large sizes. The larger sizes use more fabric and therefore cost more to produce, so we will have a policy to subsidize outsize clothing, to avoid people being "discriminated" against for their size. There are a range of collar, bust/chest, waste, hip, inside leg and thigh sizes, so we will have policies to ensure that sufficient quantities of each size is produced. And these different measurements occur in a range of combinations. Shall we have policies to try to calculate the incidence of the various combinations, and mandate that production match these calculations? Or shall we mandate the mean or median combinations, as government is fond of doing in other fields (people's deviation from the mean being a "second-order" issue)? How shall we allocate responsibility for production of different sizes and shapes to the various design houses? Should every range have to comply with all these policies, so that no one is deprived of a choice that someone else has, in accordance with the principles of equity? How will small lines survive when they have to satisfy rules that compel them to service the whole market? How much variety will be on offer? And how will new styles, designs, and innovations occur when designers are bound tightly by rules that determine the sizes and shapes that they must offer?

It's ridiculous, of course, but it is no less ridiculous to apply this approach to the many fields, such as energy, where the Government and bodies like the IPPR believe that it is essential to intervene with a wide range of targeted measures. The truth is exactly the opposite. It is precisely because there is no one-size-fits-all solution that it is important for the Government to intervene as little as possible. We need to allow the market to function without skewing it, so we can discover the optimal balance of options.

Tim Worstall picked up yesterday on George Monbiot's rant against "neo-liberalism" and its promoters in the Mont Pèlerin Society and elsewhere. George names a large number of participants in the global conspiracy to promote the view "that we are best served by maximum market freedom and minimum intervention by the state", but

"the most powerful promoter of this programme was the media. Most of it is owned by multimillionaires who use it to project the ideas that support their interests. Those ideas which threaten their interests are either ignored or ridiculed. It is through the newspapers and TV channels that the socially destructive notions of a small group of extremists have come to look like common sense."

Which publication could be more representative of this global capitalist conspiracy in the media than the Financial Times? So it was interesting to see the stories they covered that same day, and the angles they took on those stories:

• "One-third of biggest businesses pays no tax". The fact that many of our largest companies pay no tax suggests that there is something inequitable in our corporation-tax regime. Interesting way to promote the virtues of capitalism.
• "'Hundreds of millions' in failed debt for Barclays". One of our leading capitalist institutions has been incompetent in its management of our money, and is implicated in the larger losses suffered by Sachsen LB, an East-German state bank.
• "Sarkozy pushes to widen EU's global role as a policy 'priority'". Promoting the virtues of the super-state.
• "Cutting red tape 'could weaken HSE'". The unions tell us how important it is for the Government to wrap everyone in cotton-wool and rules.
• "Shoppers to pay as demand rises for milk powder". Oh look, we've found another area where the capitalist system doesn't seem to be delivering benefits to the people.
• "Earnings gap adds to welfare state's hard task". Yet another piece of effectively socialist research from the LSE given plenty of attention by our capitalist cheerleaders.
• "EU referendum calls are misguided" (Leader). The Contitutional Reform Treaty is a "tidying-up exercise" necessary to ensure that we do not have a "do-nothing Union", and the "motley band" calling for the Government to honour its pledge to hold a referendum are "misguided" and acting against "the national interest". That'll be more big government on the capitalists' wishlist, then.
• "The Republicans' jockeying on terrorism is terrifying". Coupled with an earlier story on "Democrat victory as another Bush ally steps down", this wasn't exactly shoring up the morale and credibility of one of the supposedly leading forces for unfettered capitalism.
• "Exeunt private equity's prima donnas". Schadenfreude at the comeuppance being experienced by some of our most excessive and irresponsible capitalists.
• "'How I did it' books give me a sinking feeling". We have nothing to learn from some of the world's leading entrepreneurs, who turn out to be semi-literate fools, judged by their writings.
• "The cost of hidden bias at work". Even managers of our capitalist institutions can be victims of its rampant aggression and inequity.

I'd say George has nothing to worry about. When the media's supposed high representative of free markets is loaded down with this much material critical of markets or supportive of big government, it's those of us who believe in freedom that need to worry, not twats like Monbiot who think they know what's best for us. Which leftward slant amongst even our supposed market advocates is not very different to the intellectual climate after the war, which led Hayek, Friedman and co to judge that they needed to found a society to preserve the idea of freedom and to discuss how to promote it. Plus ça change.

Cap-and-trade mechanisms scored early successes when deployed within national boundaries against pollutants like SO2 and NOx. That success led politicians and economists to think that the approach could be extended to all emissions, and to international arrangements. In particular, they hoped it would provide a relatively pain-free way of tackling carbon emissions. They should have consulted sports scientists: no pain, no gain.

We have seen recently the failure of the most high-profile of the carbon cap-and-trade mechanisms - Phase 1 of the EU Emissions Trading Scheme (EU-ETS). This was, apparently, unpredictable, and anyway Phase 1 was just a trial period. Phase 2 will be much better, we are told.

Except EU-ETS wasn't the first, and it isn't the last. In July 2006, two economists (David A. Evans and Joseph A. Kruger) published a paper titled "Taking up the Slack Cap: Lessons from a Cap-and-Trade Program in Chicago", looking at Chicago's Emissions Reduction Market System (ERMS), and its lessons for larger mechanisms like the EU-ETS. They summarize its performance thus:

"ERMS is particularly relevant to the questions outlined above because the first years of its operation reveal a curious outcome. Despite expectations to the contrary, emissions have been significantly below the annual allocation of emission allowances, and allowance prices have been much lower than predicted. Trading has been limited and many allowances have expired unused. Essentially, it appears that a fundamental prerequisite for a tradable allowance program is missing - there is no scarcity of allowances."

Sound familiar? Now we hear that the Regional Greenhouse Gas Initiative (RGGI), "the United States' first foray into cap-and-trade programs for greenhouse gases", is "over-allocated by 24 million short tons or 13 per cent of the cap in 2009".

Three cap-and-trade mechanisms that were all over-allocated, leading to a collapse of prices in the market. And all of these were a surprise? Or did we need three trials, because no one could work out beforehand that if the cap was set higher than the level of emissions that industry could easily achieve, the market would collapse?

Conservative Home today reports an interview that David Cameron gave to the Yorkshire Post.  The interview is based on where Cameron will position his party at the next election.  He tells the Yorkshire Post that the next election will be fought on social issues as opposed to economic ones.  It seems the Tories have all but given up on the idea that genuine tax cuts

Tim Worstall has challenged, in a recent post, the logic of the DfT's suggestion that Air Passenger Duty (APD) needs to be increased further to take full account of the contribution of aviation to carbon-emissions. By Tim's calculations, taking Stern's figure of $85 as the social cost of a tonne of carbon-dioxide emissions, the cost of carbon emitted by air travel is "around and about the amount currently charged" under the APD.

One could raise a number of reservations about this estimation, but let's say (for the sake of argument) that he is right. It raises interesting questions, either about Stern's calculations, or about this approach to welfare economics.

Tim cites approvingly the DfT's explanation of the principles underlying Pigovian taxation. The DfT does indeed reduce the idea to its most basic essentials, but it seems to me that the essence has been corrupted or lost to some extent in the act of reduction. Let me see if I can set out the idea clearly, so we can judge mechanisms like the APD for how well they embody the economic theory that underlies them.

Economics, if it treats only of monetary values, is subject to the Wildean criticism that it knows the cost of everything and the value of nothing. Economists have therefore felt it important to consider the impact of actions on utility (or, simplistically, happiness). Welfare is the notional sum of utility or happiness amongst a group (ignoring for the moment that it is ridiculous to aggregate something incommensurable like happiness). Welfare economics is the study of economics from the perspective of maximizing welfare.

In theory, if all participants in a transaction agree voluntarily to its terms, then they must all feel themselves at least to be no worse off from the transaction, and some of them presumably feel themselves to be better off, or why would they have agreed to it voluntarily? This satisfies the condition needed to demonstrate that an action has increased general welfare. By definition therefore, free markets increase welfare. This (and the inability to make the same case for coerced actions, such as those obliged by the state) is the basis of the libertarian philosophy.

In practice, however, it is often the case that people not party to a transaction may be affected by it. The classic example is a factory whose effluent is discharged into a river. No matter whether all parties engaged in commercial transactions with the factory-owner do so voluntarily, the contribution of the factory to the general welfare may be negative, if the benefit to the direct participants is outweighed by the impact on those who use the river downstream from the factory. The pollution of the river is, in the language of economists, an externality - a value (negative in this case, but they can be positive too) that is attributable to someone's activities, which they are not able to capture (if positive) or obliged to incur (if negative).

Externalities skew decisions, such that the options that provide the greatest benefit to society (maximize welfare) may not be the ones that offer the greatest benefits to the participants in transactions. The way to ensure that markets provide the optimal outcome for society is to internalize the externalities. In effect, this means ensuring that the party responsible for the externality is attributed the cost or value of that externality.

A Pigovian tax (named after Arthur Pigou, the Cambridge economist who first set out a detailed exposition of welfare economics) is a mechanism whereby the cost of a negative externality can be internalized to the producer of that externality. If the impact of the effluent from the factory results in losses to those downstream at a rate of £100/litre, a government may impose a Pigovian tax of £100/litre on the factory, so that the factory-owners' decisions take into account the full costs of any choice, and not just those incurred directly. The Pigovian tax provides an incentive for the factory-owner to minimize the discharge of effluent or even to locate elsewhere where the external costs of disposing of the effluent are lower.

However, the application of the Pigovian tax is not sufficient in its own right to ensure that welfare is maximized. It may be that the factory-owner has few feasible alternatives, and decides to continue to discharge and pay the tax. In that case, the damage (or disutility) to those downstream is no less than before, and the utility of the factory-owner has also been reduced by application of the tax. The utility of the government (or taxpayers generally) may have been increased by the revenue from the Pigovian tax, but it is not the government or taxpayers generally who were being harmed by the externality. The Pigovian tax can only be said to have achieved its objective if it represents an accurate valuation of the harm and if it is distributed as compensation to those on whom the harm is inflicted, proportionately to their share of the harm. In other words, a tax (or charge) cannot be said to be an effective mechanism to internalize externalities unless it either deters the externality or fully compensates those who experience the effect of the externality (or a bit of both).

Greenhouse-gas (GHG, or, in the vernacular, carbon) emissions are an externality. They are a particularly difficult example, because the impact of the harm is uncertain and because most of those who may experience the harm are remote, both geographically (e.g. inhabitants of vulnerable countries) and temporally (i.e. future generations). It is important that mechanisms to internalize the carbon externality reflect the remoteness and uncertainty.

If we applied that tax of £100/litre to the factory-owner in the above example, but recycled the revenues to him by some subsidy or tax-break, there would have been no point applying the Pigovian tax in the first place. Similar could be said if we recycled the tax-revenues to his customers - the amount that he had to increase his prices would be balanced by the extra amount that his customers were able to pay for them. The tax would be neither an effective deterrent, nor an effective means of compensating those who experience the harm. It would simply be an inefficiency in the market, perhaps effective at salving consciences, but of no real value. Indeed, if it is effective at salving consciences, it may exacerbate the harm, because customers may consume more of the good, freed (superficially) from the responsibility of considering the impact of their choices on those affected by the externality.

In the case of carbon emissions, most of us, metaphorically, own shares in the factory, and most of us live downstream. But some own more shares in the factory and suffer less of the impact of the pollution than others (e.g. rich world vs poor world, this generation vs future generations). If we impose a Pigovian tax on the factory, but recycle the revenues to those who own most of the shares, we have not effectively internalized the externality. We may have exacerbated the harm by letting the factory's customers think that they now need not worry about the impact of the factory's externalities. This is exactly what most of the rich-world mechanisms to internalize carbon externalities, including the APD, are doing.

So John Redwood has spelt out the future of the economy with a raft of tax cuts.

So John Redwood has spelt out the future of the economy by promising that a Tory government will ensure the stability of the economy before committing to any tax cuts.

It is being reported that in the first few weeks of government, Gordon Brown has announced a total of 40 government initiatives at a cost just shy of £40bn!  A pretty hefty sum in just a few weeks - confirming that his grip on government spending was tight even when Blair was in power given that he has so much to "spare" now.  It also goes to show what a meddling and micro managing PM he is going to be - just as he was as a chancellor. 

Cc: Iain Dale, Andrew Mitchell, George Osborne and anyone else interested in really helping the world's poorest, rather than token gestures and photo-ops

Changes to EU rules may put many British winemakers out of business, The Observer reported yesterday. Britain being an inhospitable country in which to ripen grapes to their full sugary concentration, British winemakers often add sucrose or grape must to their fermenting grape-juice, to ensure a sufficient alcohol content. The EU intends to ban the use of sucrose, and stop subsidies on grape must. The EU will also continue its ban on planting more vines, thus preventing the recently British wine production from being expanded. Should we feel sorry for the British producers?

I am much obliged to Paul Nollen, with whom I have been having a discussion about the Basic Income concept, for pointing me at Bernard Lietaer. Here is how Professor Lietaer's Wikipedia entry begins:

Bernard Lietaer is an economist and author who was one of the designers of the Euro. He studies monetary systems and promotes the idea that communities can benefit from creating their own local or Complementary currency, which circulate parallel with national currencies.

Here is what Professor Lietaer has to say about himself on the website of one of his organizations:

Bernard Lietaer is the author of the forthcoming "Of Human Wealth" and "The Future of Money" (London: Random House, 2001), has been active in the domain of money systems for a period of 25 years in an unusual variety of functions. While at the Central Bank in Belgium he co-designed and implemented the convergence mechanism (ECU) to the single European currency system. During that period, he also served as President of Belgium's Electronic Payment System. His consultant experience in monetary aspects on four continents ranges from multinational corporations to developing countries. He co-founded one of the largest and most successful currency funds becoming its General Manager and Currency Trader. He was Professor of International Finance at the University of Louvain; and is currently Visiting Professor at Naropa University in Boulder, CO. He is the co-founder of ACCESS Foundation, (www.accessfoundation.org), an educational non-profit whose objective is to communicate best practices in the domain of complementary currencies. He is currently a Fellow at the Center for Sustainable Resource Development at UC Berkeley.

So this is the man who co-designed the ECU and the Euro, implemented the ECU, ran the Belgian EPS, and founded and ran one of the largest offshore currency trading funds (Gaia). He is also (according to his CV) a member of the Club of Rome, a Fellow at the World Academy of Arts and Sciences, a Fellow of the World Business Academy, and a Founding Member of the Global Futures Forum. He must be a pretty serious financial expert. Let's have a look at his intellectual efforts.

Interesting post over at Bearwatch, on the recent purchase by the UK government of a huge quantity of US securities, and the risks to both the American currency, and to British reserves as a knock-on effect.