Are the LDP’s principles useful for policy-making? (No)

The big news in Australian politics has been the new rabble of Senators. David Leyonhjelm of the Liberal Democratic Party (LDP) is one surprise newcomer.

Leyonhjelm is desperately trying to differentiate himself and his party as one based on a set of principles that promote freedom in both economic and personal realms.

But every time I read or hear anything he says alarm bells ring.

I want to show in this post that the LDP principles he so feverishly promotes offer no guidance on making real political decisions that involve trading-off rights and responsibilities between different segments of society.

As a basic example, if I believed in the principle that football players should be free to make individual choices about their kicks, passes, and various strategies, within the rules of football, how does that guide me in the creation of the rules themselves? It merely assumes the existence of appropriate rules, yet the government, in this case football’s governing body, has the task of creating the rules.

Take another example. I believe in the freedom of drivers to choose their routes on the road. Okay fine. But that’s not going to help in deciding the rules of the road that allow people to cooperate to the degree necessary to ensure their freedom to choose. Should we have traffic lights? Stop signs? How will rights of way be decided or enforced? At every stage of these many decisions involved in rule-making there are trade-offs between groups to consider.

Even if you believe there should be no rule governing a particular behaviour on the road, that is itself still a choice that needs to be assessed against alternatives.

Let us now take a quick look at the principles of the LDP.

Economic Principles
• Free markets and freedom of choice
• Low tax, limited public spending and minimal regulation
• Widespread ownership of private property 

Social Principles
• Civil society and volunteerism
• Civil liberties and individual freedom
• Individual liberty and personal responsibility under the rule of law 

Government Principles
• Constitutional liberal democracy
• Ethical and impartial government under the rule of law
• Devolution of power including decentralised government and competitive federalism 

International Principles
• Free trade in goods, services and capital
• Free trade in ideas and culture
• Freedom and human rights

Their first economic principle is “free markets and freedom of choice”. Let’s pick it apart a little. The existence of any market, ‘free’ or otherwise, implies many things, such as private property, extensive contract and tort law, regulations against fraud, theft, bankruptcy, and many regulations governing externalities and so forth.

The government’s role is to decide which trade-offs are acceptable in the legal structures and institutions that allow any market to function. Having a principle that assumes the existence of a market of some sort doesn’t provide any guidance on what sort of legal structure will provide a more, or less, free market.

Minimal regulation is also a principle that doesn’t provide much guidance on how to write regulations. We know from many political exercises (for example in Queensland recently when the Newman government was elected), that legislation page-counts are no guide to the actual tangible impact on productive activity and organisation from a piece of regulation.

So how can this principle offer guidance on which legislation is minimal or not? What metric could be used to assess whether a regulation is minimal or not?

Then there is a principle of ‘widespread ownership of private property’. Really?

Think about it.

All private property is owned by definition. If you mean that just about every individual should own some portfolio of private property, then you have a problem, because that conflicts with the free market principles, which generally concentrate ownership of private property rights. It’s beginning to sounds a lot like ‘we want free markets only if they provide the outcomes we want’.

And if your free markets don’t provide this outcome, then what?

At every turn the LDP want to privatise public assets and abolish government service provision; in health, education, public utilities and transport, and just about everything else. It’s almost like market failures don’t exist, and that somehow granting various monopoly rights to vast parts of what was the public realm, would provide immediate and perfect equality of opportunity and harmony amongst citizens.

It’s the dream of rich old men; a utopia that no one with a sane mind would consider.

Okay, let’s move on to social policies; perhaps this is easier territory.

Again we see freedom professed as a guiding principle, only this time it’s personal. But aren’t all individual freedoms really two-sided? Ronald Coase explained this principle in much detail - that private rights are inherently arbitrary and two-sided.

Does the LDP believe in my freedom to walk the streets naked? Or does it believe in my freedom to walk the streets free of naked people?

Here’s one a little closer to home. The LDP policy on religion states they “Support the freedom of private individuals and organisations to apply religious tests for membership or employment”. But what about our freedom from such treatment?

The LDP have a firearm policy that is straight from the playbook of the NRA. ‘Good’ people should all have guns, so that ‘bad’ people cannot do ‘bad’ things. As if we all know exactly who is who at all times, and what is good and bad. And like all their personal freedoms, they neglect the freedom to live in an unarmed society.

Another principle-free principle to finishes off their social section - personal responsibility under the rule law. But again, by definition, the rule of law is what politics defines, and the law then defines personal responsibility. So how does stating that you want people to obey the law guide you in making laws?

Next, to the LDP’s government principles. Again, not much of substance here. Be ethical and impartial. Whose ethics? The LDP’s or the Labor Party’s?

The last point states something of a goal for the LDP. So I’ll let their competitive federalism stand.

The LDP’s international principles are some of the strangest. Their principle of free trade in ideas and culture, freedom and human rights, seems rather in conflict with Leyonhjelm’s comments about immigration - “some cultures are incompatible with our way of life”.

In the LDP policy on immigration they seem to want to crack down on ‘unauthorised’ arrivals, but promote ‘authorised’ ones. As if there is no debate about the laws that determine who is authorised and who is not.

So where’s the freedom and human rights? Where’s the free trade in ideas and culture. Or aren’t these really guiding principles at all?

My prediction is that Leyonhjelm will reveal in the coming years that his, and the LDP’s, beliefs in freedom are just as arbitrary as any other. They will pick and choose the freedoms they like based on their personal biases and appeals to their support base. This is nothing new in politics. It is the nature of the game. Just don’t fall for the idea that this party is principled.

A tribal ceremony: Reconciling the economics of debt

The sociology of economics is intriguing. While many observers note the tribalism of the discipline, with the mainstream tribe being the largest and most dominant, within that tribe itself there is surprising confusion about its unifying ideas.

In fact, if I was to be cynical, I would say many economists who attach themselves to the mainstream, in whatever specialist area that may be, are not interested in any consistency of ideas.

Also, many were taught economics in a way that never delved deep enough into the underlying assumptions that core models embody. Perhaps the effort to understand the mathematical representation of a model took away from effort to understand the conceptual ideas within it.

Unfortunately this set of circumstances is hindering efforts at reconciliation and consistency between economic tribes. I consider this post a ceremonial attempt at reconciling theories of debt across economic tribes.

In fact there are many concepts that are easily reconcilable (capital, uncertainty, emergent properties, savings, etc) but there are unfortunate incentives against unifying the discipline.

Debt

Currently there is much concern worldwide about debt. It is widely claimed that the mainstream economic community could not see a crisis coming because it fundamentally ‘looked through’ money and debt to the real economy. And since debt, or in fact the dynamics of debt, seemed an important factors in the crisis, this was a failure of the theory.

It is easy to agree with this critique. But to really understand it we have to disentangle all parts of it, and as we will see, there is an obvious way to reconcile the mainstream with the critique.

Household example

To begin, a theory of resource allocation is right to treat debt as an internal allocation mechanism of real resources in the economy.

In a my household, for example, I can lend my wife money to treat herself a new dress today. If we were accurately keeping internal household accounts that would be a transfer from myself to her. In real terms, my consumption of resources decreases and hers increases.

Next week the debt is ‘repaid’ according to our internal accounts when my wife lends me money to take the kids to the football.

When we look at our household as an aggregate entity, our total resource consumption is unchanged by the debt, which merely represents an internal reallocation.

There were no future resources brought forward for my wife to consume. The debt did not leave a cost to our children. Even if it was never repaid, I already paid for my household’s debt with the resources I didn’t consume when I transferred purchasing power to my wife.

It surprises me that on this crucial point the core mainstream concepts are consistent with the functional finance or modern monetary theory perspective, yet there remains animosity between these groups. I have come to believe that this is mostly a result of inadequate understanding of their own conceptual apparatus by the mainstream (here’s an example of how the noisiest mainstream commentators remain confused about their own theories).

Much of the mainstream has equated 'looking through' debt to the real resources of the economic with  ignoring the money creation aspect of debt altogether. This has lead to further confusion in the analysis of banking and economics generally, with the Bank of England recently having to explain the process to the economics community.

These core economic concepts are easily confused when one fails to properly understand the complete accounting of the system at all points in time. Specifically the use of overlapping generations (OLG) models can confuse more than inform, and many students come away from learning these models believing in the possibility of inter-temporal reallocations of resources.

OLG example

To labour the point, the errors made in understanding the concepts at play in debt are evident in the overlapping generations models (OLG) which is commonly applied in economics in order to understand various internal shifts in resource burdens. It can be easily misunderstood to show that debt enables resources to travel through time.

Abba Lerner made the argument I am about to make back in 1961, when he was President of the American Economic Association. He was pulling into line economists Thomas Bowen, James Buchanan, and others, on their acceptance of the political propaganda that debt can distribute burdens across time. You’ve all heard a politician claim that debts are ‘leaving a burden for our children’.

The mistake of Bowen and Buchanan arises because of their incoherent conceptual application of the OLG model. In the model they merely redefine the current generation to mean those who lend the money, and the future generation as the one who pays the money (principle and interest) back.

Let me try and represent the model as simply as possible.

There are two generations (which are simplified into two people) alive in each time period, the ‘old’ and ‘young’. Each lives for two time periods, being young in their first time period, and old in their second. In the table below, which I will use to explain this, the coloured (and white) shaded cells are the same people, or cohort.

Starting from a no debt baseline at period zero, the first period has the old borrow $100 from the young. It doesn’t real matter whether this a new money (how we think of bank debts), direct peer-to-peer transfers, or taxes and welfare spending, the net effect is that those who borrow are able to capture a share of resources in that period.

In resource terms the young transfer $100 of resources to the old. In period two the previous old generation has died, and the previous young generation is now the old generation (yellow table cells), and there is a newly born young generation (white table cells).

The new young cohort then repays the debts, giving up $100 of resources to do so, which are transferred to the now old generation who lent the money in the previous period.

As Lerner explains, if you label the newly born young generation in period two as the ‘future generation’, which lives from period two to three (shaded white) and the cohort who originally borrowed the money in period one, who lived from period zero to one (also shaded white), the ‘present generation’, you can see how a transfer through time seems to occur.

The ‘present generation’ sees a lifetime consumption from debt of +$100, while the ‘future generation’ sees a total lifetime consumption of -$100 from this debt repayment.

Labelled in this way it seems perfectly obvious that debt burdens are being passed along. But only if we artificially conflate the creditor and debtors with 'generations', which can't be done in general.

But of course, the reality is that the resource transfers occur at each point in time, not between times. As the final row shows, in each period there is an accounting balance in resource terms between borrows and lenders. It is only because of the artificial way lenders and borrows are identified by generations, and the necessity to eliminate the debt balance in the next period that provides the result.

Let’s have a look at an alternative, where the same debt is incurred, but repaid (if at all) only after all generations alive upon its creation have died (and the real interest rate is zero for simplicity).

As you can see, this time it is clear that the generation born in the zero period is simply using debt to reallocate from the generation born in period one to themselves. Given the institutional power, they could of course have taxed that generation instead in order to redistribute resources. It is the same net effect.

The generational structure of the repayment of debt at some future point, however, is indeterminant. I have made this clear by labelling the period four repayment of debt with question marks, since who pays who in resource terms in that period for debt repayment is by its nature a result of all institutional resource allocations, including most importantly tax and transfer system. This is the general case.

A final illustration shows that when we consider continual debt-financed redistribution, that the redistribution problem goes away entirely, since all people receive the same redistributions at the same stages of their life. The table below show a continually debt funded reallocation from young to old, with ever increasing debt levels, but no identifiable winning or losing generation.

If you are concerned about general welfare of all people living at any point in time, then you must consider debts as internal transfers at a point in time.

Before I conclude this section, I need to again be clear that identifying winners and losers from these internal debt transfers is not at as easy as bundling all debtors and creditors together and labelling them. The complex interactions of the complete system of internal transfers means we simply cannot isolate these two groups. In fact, it may be very possible if an individual to be a borrower and lender at any point in time.

If I have just borrowed money to buy a house I am a borrower of purchasing power, which is paid for by the community at large via inflation and taxation. But of course I too am part of the community and give up resources via inflation and taxation. Understanding the balance even at an individual level is nigh impossible.

For a policy maker the whole system of transfers in a given period is all that matters, whether this occurs via taxation, transfers, debts or inflation. This is exactly what the core of macro economics says - debts are transfers in resource terms, and therefore balance out in aggregate. But somehow this is easily forgotten when it comes time to talk about policy.

Levels vs rates of change

The level of debt within an aggregate is not systematically important in terms of investment and macro economics. It is, however, important in terms of internal distribution, of which it forms a small component.

But the way in which debt levels change over time is vitally important to understanding the investment and business cycle. The reason being that debts in the private sector are typically incurred in order to finance new capital equipment and construction. By the nature of our banking and financial system, the rate of change in lending is a very good indicator of the aggregate investment occurring in the economy.

Steve Keen has repeatedly made the point is that rate of change in private debt, and its derivative (which he call acceleration of debt, being the second derivative of the debt level with respect to time), are far better indicators of the direction of the macro economics.

So while debt is an internal allocation, because our banking system generally produces debt in order to finance real new capital investment, the rate of change in the debt level can be used to understand the level of economic activity in aggregate.

This point is very subtle, but important. There is no conflict between the view that ones can look through debt in terms of its role in static allocations of resources, while at the same time understand debt dynamics as important mechanisms for financing new investment and therefore determining aggregate demand and growth.

Sadly, some economics tribal leaders have failed to acknowledge these subtleties and merely prefer to fight each other over confusing interpretations of what can be consistent ideas about debt.

Foreign debt

Finally, the mainstream economics tribe usually has divergent opinions about different forms of debt. Foreign debt gets relabelled as foreign investment and miraculously becomes a great thing. But of course this is the only type of debt where a country in aggregate is borrowing externally.

It is the type of debt most loved by economists in general, but the only one in which countries like Australia are generating future obligations to an external party.

The same rationale as before applies to foreign debts - the distribute role of levels versus the investment role of debt dynamics. Foreign debts are a resource transfer at a point in time. We can only accumulate foreign debts by running a deficit in the current account, typically by importing more goods than we export. Hence, in resource terms, we get the transfer from our imported resources.

The investment role here is far more subtle, because unlike domestic lending, there is not necessarily a close relationship between the creation of debts and new capital investment. But I won’t unpick this point any further in this post.

The point I want to make is that unlike internal debts, international debt balances are much more politically interesting. The two (in fact many) parties have different objectives, institutional constraints, and a complex web of non-monetary relationships such as military alliances, and resource interdependencies, such as reliance on either food or minerals imports.

Any questions about external debt are therefore inherently political.

One could construct a hypothetical baseline with which to compare and make judgements about external debts. This baseline would have a hypothetical market generate a relative currency value at a level that maintains a current account (and therefore capital account) balance. We only trade goods for goods in this scenario. In fact, it is a ‘no foreign debt’ scenario.

What we then need to determine is what benefits a country gains by deviating from this baseline over an extended period. We know that depressing a currency increases foreign demand for tradable goods, and therefore enables more rapid large scale investments in these sectors if there is sufficient internal organisation.

This has been a recipe for development in East Asia for the past many decades, and the subject of much political discussion and intervention (eg. the Plaza and Louvre Accords).

On the other side of the baseline we have countries like Australia that have run trade deficits and current account deficits in general for half a century. The benefits to such countries are short term gifts of relatively cheap tradable goods, at the cost of long term investment in those sectors.

Over time foreign debts have the surprising effects of generating greater reliance on each party for continued stability. In Europe we can see that ignorance of this fact is bringing down the area as a whole.

It should be obvious to any economist who understands their theoretical apparatus that the very existence of foreign debt is a sign of a political will on both sides to sustain an imbalance for their own national objectives. There is no need to continue looking at residual measures of productivity or technology or other magical explanations to understand what is ultimately a political construct.

Conclusions

Debt is a fundamental accounting feature of the monetary system. Economists used to know that they ‘looked through’ these accounts at real resources, and hence were able to see debts as merely the consequence of an internal reallocation. This lead most to believe that debt balances and their dynamics were of no interest at all.

Unfortunately, the discipline has seen a decline in the understanding of core concepts and theories, which I put down to a greater emphasis on a narrow set of mathematical techniques instead of their economic application and interpretation.

Yet there is a clear consistency between looking through debt levels as merely an account of past distributive choices, and paying very close attention to the dynamics of debt in relation to investment decisions, aggregate demand, asset prices and economic growth. Because private debts (and a portion of public debts) are, by the nature of lending processes, used for investment, their dynamics are both a signal of demand, and a driver of demand via feedbacks in the economy.

The inability to see this obvious consistency I believe is brought about by the perverse incentives in the discipline and its sociology that rewards loyalty to a tribe, and punishes attempts at reconciliation between tribes.

Is Chang's economic development really complexity?

I am reading Ha-Joon Chang’s new book Economics: The User’s Guide. About half way through he makes a big effort to explain that GDP is quite an arbitrary construct and should not be interpreted as a measure of welfare or economic development.

In making the point that economic development is much broader than GDP he uses the example of Equatorial Guinea as a country that saw rapidly increasing GDP after discovering oil in the mid 1990s, yet it is usual to overlook the extremely high measured GDP growth in judging the level of development.

Chang defines economic development as

… a process of economic growth that is based on the increase in an economy’s productive capabilities: its capabilities to organise - and, more importantly, transform - its production activities. 

This broad definition reminds of the complexity economics approach some researchers have adopted to understand economic development outside of traditional measures such as GDP.

MIT and Harvard researchers have developed complexity indexes for countries based on the diversity of their productive activities, and more importantly, the uniqueness of those products that are produced. The logic behind this measure is that a country able to produce goods that cannot be widely produced elsewhere has some inherently greater level of internal specialisation and productive knowledge.

Japan leads the way on the complexity index, followed by closely by the usual suspects of Germany, the US, Switzerland, UK, Austria, Sweden, and China a little further down, but no doubt gaining in the rankings.

Australia ranks 73rd, behind Cuba, Oman and Qatar.

Which does make me wonder whether interpreting our own level of development by GDP should be moderated by the heavy influence of our narrow export base, which today is over 50% coal and iron ore.

In any case, I wanted to take a moment to compare the diversity of exports, a key input into complexity measures, for a few countries (data from 2010).

Here are Germany's exports



What about Australia? Note that in the past four years the share to coal and iron ore has grown considerably.



Or maybe Austria



Or perhaps resource rich Canada



For resource rich countries maintaining diverse productive capacity is not a natural market outcome. Both Canada and Australia have seen their complexity rankings fall during the naughties resource boom.

Chang’s point that economic development is a much broader concept than GDP alone is important. As I’ve said before (as has Steve Keen) diversity is an important measure of both the robustness and overall level of development of a national economy. Australia’s narrowing production base opens the question of whether we should, and how we could, direct policies towards encouraging diversity of domestic productive capacities.

Age of entitlement - my SBS Insight notes

With my upcoming debate on entitlement in Australia I though I'd better watch Insight on SBS to see what punters think.

If you missed it, here are my notes.
_________________________________________

Major moral decision - should we support people till they can get a job they might like.

Carrying a job while trying to get one in a different industry?

Says the guy that had no problem getting a job in his industry that he would get a job cleaning toilets full time after his degree.

What should they be prepared to do?

Amanda Vanstone (on the Commission of Audit) -

“In my day I walked up hill both ways to school…barefoot”
“We’ll never have a health or welfare system like the US” mmm… she might regret that
“We are richer than others, so we shouldn’t focus on equality or social issues”

Ignores politician's retirement entitlement that she lives on.

Guy who has no idea what is happening elsewhere in the world compares us with elsewhere in the world.

My family is rich and support me so should yours.

Beggers can’t be choosers

Are people entitled to a job they might actually like? Yeah, we covered that. No one knows.

Some people not very good at finding work. Really? Such an informative program.

Frank Stilwell -
Points out that poor people are not the only ones who think they are entitled.
Says job-snobs is actually rare.

Tourism Association wants people to wash dishes on the cheap, according to their well-paid consultant, who has been lobbying to open up immigration.
Says there are 30,000 jobs in tourism. seek.com.au says there are 7,000 currently advertised nationally.

Old lady worked since she was 15 - in the post-office, then bus conductor. Public servant for life. Worked hard, thinks she’s entitled to her pension.

Some dude wants to say privilege instead of entitlement.

Guy states the obvious -
“you contribute when you can, and when you can’t others will contribute to look after you”

People shrug it off and start bitching again.

As expected woman with 5 kids shows up with about $20,000 in various benefits. Oh god, now ageing population comes in. Woman does her bit for society. Says hypocritical of government encouraging children but decreasing family support. Really thinks that ageing is solved by more people.

I have no problem giving her a bigger chunk of the pie. Who really cares!

Again, let’s all not talk about the moral judgements we are making.

Single Mum, good earner, gets $160 a fortnight in various benefits. Has a whinge about her life being tough and ‘deserving’ hand out. She has a mortgage. Really?

Why does everyone just justify their position by some appeal to deserts?

Taiwan guy - in Taiwan, in the 1980s, you were expected to look after yourself. Actually scrap that, your family. Why don’t we use the family unit as the social welfare system?

Oh I wish someone had thought of that. Is welfare really stopping that? What if your family can’t support themselves, who supports them… mmm…

Another single Mum says she’s being pragmatic and helping her parents and children.

The guy without a job reminds everyone that we are a rich country. Says it’s very inefficient to have highly educated people pouring coffee and doing dishes.

ANU guy (Andrew Whiteford) -
“Lowest ratio of welfare payments to wages in the developed world”

Audience gasps. Facts are hurting brains and their beliefs.

“We spend less than everyone except Chile and Mexico. South Korea is catching up”.
“We can just spend more by raising more taxes, easy”

Guy who once advised Tony Abbott -
“We need to get in early before we send ourselves broke - a crisis”

Amanda Vanstone -
"If we do nothing now, where will we be in ten years”

Ummm… probably perfectly fine. Anyone want to challenge them to define a crisis? Which metric would cross which threshold?

Old lady (ex-pubic servant again), wants the simple retirement - asks Vanstone what should she do to adjust to reduced pensions?

Amanda Vanstone ignores that. Has a bitch about paid parental leave scheme.

New guy -
Works in a restaurant. Ask Vanstone whether welfare is about raising people to upper classes.

Sure mate. We’ll just all be upper class. See how that works? Get used to things being relative, not absolute.

People clap because Vanstone hired someone who had a job.

Farmer (National party member) can only get backpackers to pick fruit. Locals are difficult, with all the paperwork and stuff. Backpackers need the money to get on with their travels. Better to employ the more desperate people.

Oh oh. Coming up - old lady says her home is not an asset. Ask her kids about that when she dies.

Zara, age 92, full pension, $800/fn. She’s frugal. Has bills. Gardens a lot. Lived in her house in some expensive suburb - Mosman. Neighbours house sold for $2million. But doesn’t know what to do with $1million. Needs her garden apparently.

Here we go.

Vanstone -
“should someone with $2million in asset get same benefits as someone with $0 in assets”

Young guy perks up, wants to stick up for the old ladies.

What about a reverse mortgage to fund retirement.

Other dude - my grandparents sold their farm to fund their retirement and move to the city. It is possible to use assets to support yourself.

Smart guy says - “hey why don’t we have inheritance taxes (or similar) which would fund pensions for those with assets?”

Oldies really like death duties, but think the rich will not let it happen. Woman with no assets doesn’t want an inheritance tax - doesn’t seem to understand how percentages work.

Woman with 5 kids likes GP co-payment, for some reason.

Other woman says people will delay visits and may miss out on early treatment.

Dude who advised Abbott - who recommended GP co-payment while working in a think tank (golly gosh, what a surprise) - says system needs to be sustainable. Doesn’t seem to want to explain what his view of sustainable means. Doesn’t want to consider the health system as a whole.

Guy without a job makes a statement that proves he won’t get one in a hurry.

NSW hands builders and developers rents, again

NSW is preparing to streamline laws to enable redevelopment of strata-title lots. These new laws give more power to developers attempting to amalgamate lots, which will enable them to force sales from owners if 90% of owners agree. Developers are pushing for that threshold to be brought down to 75%, since this would further increase their bargaining power and ability to extract economic rent.

As I said earlier

While I would need more facts to judge the appropriateness of the law, it is worth noting that this is a complete shift in bargaining power towards developers and away from the existing strata unit owners as a collective. 

For example, a developer only needs to buy 50% of lots to get the process started, and then only get agreement from 50% of remaining lot owners. They are effectively able to squeeze the final hold-out owners – transferring rent from those owners to themselves in the process.

Now NSW is going a step further in their quest to transfer rents to the development industry. The recently passed Home Building Amendment Bill 2014 will not only reduce the liability of builders and developers for building defects, but will be enacted retrospectively to apply to building contracts entered from 1 February 2012.

If you bought a new apartment build since February 2012, you have now lost many of your previous rights of recourse to the builder or developer in the case of defective construction. 

One of Sydney’s leading strata lawyers, David Bannerman, sent me a short summary of the changes under the heading NSW Government Hands Developers a Windfall

Now that the Home Building Amendment Bill 2014 has passed the Upper House (28 May 2014), the NSW Government will be able to introduce changes that will massively reduce the liability of builders and developers for building defects so that in many cases owners will have to bear the burden of repairs themselves. 

Amongst many changes designed to have that effect, most defects will now only have a two year warranty period from the date of completion. This change will apply retrospectively to contracts entered into after 1 February 2012, unless a claim has already been made either with the court or the home warranty insurer by the time of assent.

This change merely hands over liability from builders and developers to owners who had paid for services over the past two years. Mere transfer of obligations away from builders and developers.

There’s two wins for the development and construction industry, and two losses for owners of strata title lots. Incremental legal changes such as this reveal a lot about government priorities.

Retirement confusion: Savings are not investment

I’m constantly surprised at how fundamental concepts in economics are so easily confused as soon as they are applied to real-life policy.

Take the issue of fully-funded versus pay-go pension systems. In a pay-go system, pensions are paid to qualifying individuals each year by the government out of general revenues. In the fully-funded system, individuals are forced to save in their working years to fund their retirement in later years.

Australia and many other countries have transitioned towards fully funded systems in the past couple of decades. This change can partly be attributed to a fear that pay-go systems are unsustainable, and partly because economic theory suggests that fully funded systems can increase the growth path of the economy through their effect on increasing savings, and therefore increased investment.

But the fear of unsustainable pay-go pensions, and the growth effects of fully funded systems, are both unfounded.

This is a very confusing area for many people, which is why it was so important to clarify the difference between saving and investment in my earlier post. When an individual or group within society spends less of their income, this does not automatically imply increased investment in new capital goods in proportion to that saving.

When my fully-funded pension account buys BHP shares, it buys them from existing owners, who may very well be retirees selling down their assets to fund their retirement.

Using this basic example we can see that a fully funded pension system involves the young buying assets from the old, which is a transfer to the old in exchange for an asset.

But this is exactly what a pay-go system is as well. It is a transfer from the young to the old via the tax system rather than via other financial vehicles. Or we could think of it as an exchange of the asset of a guaranteed retirement income instead of a BHP share. The diagram below summarises this point.

Regarding the investment effects, some have argued that when pension accounts buy shares they force prices up, thereby generating more investment. But to believe this you then need to explain some mechanism by which the share price was a binding constraint on new investment.

Does the BHP share price determine investment decisions in new mining ventures? Or is it the expected price path of the minerals, the ability to secure contracts for future output, and the costs of the facility?

Sure, there may be some small cases where equity value is binding, but that doesn’t mean that an investment opportunity will not instead be undertaken by a separate entity that doesn’t have that constraint.

Others have suggested that the share of savings that does go to direct investment funding, such as the example here, is sufficient to make the point. To me, this is the rare exception that proves the general rule and moreover makes the point that under normal circumstances debt, in the form of bank lending, is the almost universal investment funding tool.

To wrap up this point, here is the breakdown of assets in Australian superannuation (retirement savings) accounts from APRA. Only a very small share of these assets could be interpreted as being new investment. Most shares would be purchases of existing assets, with a rare exception of capital raising for new ventures. Cash and property are obviously not related to new investment, leaving fixed interest assets that may also involve a component of new investment.

The other important point here is that anything that makes a pay-go system unsustainable also makes a fully-funded system unsustainable, though I think neither system is. Each is merely a transfer from one group to another in society, with the same level of output to be shared at each point in time. 

Let’s be clear about this. In the pay-go system, wealth is transferred between taxpayers and the retirees each year. The retirees share of the economic pie is whatever is determined by demographics and government policy on retirement pensions.

In the fully-funded system, we have the bizarre situation of working age people buying assets from retired people who had accumulated them in the past, so that they can then sell them when they retire. There is a lot of asset churn in this system to generate what is a transfer from working age to the retired at all points in time. In essence, it is a pay-go system with the added cost of private funds management.

I have made this point in more detail in the past. 

My point here is that this is yet another example of economists inappropriately equating savings, which are transfers, with investment, which is the production of new capital equipment.

Quick links: Crony politics, utility, Becker, exports

The Greens proposed in parliament to implement a Federal Independent Commission Against Corruption with similar powers to the NSW Commission. Labor and Liberal refused to vote, in the process revealing their entrenched reliance on cronyism for their existence.

Former Queensland Electoral Commissioner Bob Longland on 7.30 discussing his idea for federal authority in charge of publishing political donations to all parties at all levels of government (and I guess enforcing disclosure requirements as well).

Great idea. But it seems the Queensland government is taking the opposite approach and reducing disclosure requirements.

Some brilliant detailed criticism of the leap of faith hidden between utility and welfare maximisation at Interfluidity

And a follow up post here

Forget the SMD theorem. In 1986 Gary Becker showed that market demand curves will slope downwards even under irrational choices where a budget constraint exists.

Given my previous post mentioning export-led growth via high levels of investment, here’s a chart of the export share and investment share of GDP (all countries and all time periods from the World Bank database)

Bogus economic excuse for inequality debunked

As I explained yesterday, saving by an individual is usually achieved by buying monopoly assets from others, forgoing consumption in order to capture a future flow of income for oneself.

This usual way to save is merely a transfer of assets whose value equals the difference between income and spending. Someone gets richer, others poorer. But importantly, the rate of saving of an individual, when understood in this manner, bears no relation to investment in the quantity of new capital goods in the economy generally and can’t be related to the rate of growth of the economy.

This point is quite obvious.

Yet it is very common to hear that rich individuals, because less of their spending goes towards consumption items, are able to save more, leading to greater levels of investment in new capital goods and higher future productive capacity.

While many economists profess a degree of caution in such analysis when challenged, the very notion that saving at an individual level equates to a proportional level of investment in new capital at a national (or global) level is embedded in the economic way of thinking.

Here’s Tyler Cowen making the point implicitly

Stocks of wealth stimulated invention by liberating creators from the immediate demands of the marketplace and allowing them to explore their fancies, enriching generations to come.

And here’s Karen Dynan et al.

…active saving corresponds to the supply of loanable funds for new investment and therefore may be helpful in gauging the effect of a redistribution of income on economic growth. 

But since saving at an individual level is almost solely about buying monopoly assets from others, this claim simply cannot be made. Saving at an individual level is nothing more than a transfer of ownership of existing wealth.

When I buy some Apple shares in order to save, I merely buy from the current owner, changing absolutely nothing in terms of Apple’s intentions to invest in new production machinery and equipment.

If saving is as I described, the fact that the wealthy have a lower propensity to consume, and therefore a higher marginal propensity to save, merely implies increasing wealth inequality, as assets accumulate in the hands of the already wealthy; a trickle-up effect if you will.

This is particularly relevant to current debates about how to address inequality. Would a wealth tax on the rich decrease overall investment? Not at all. The tax would be a transfer of ownership of resources, just like the saving of the rich is a transfer of assets and unrelated to investment in new capital equipment.

It is possible under very specific circumstances for an individual's savings to exactly match investment. For example, if I buy a specific financial instrument that pools my funds with others to finance construction (but not land purchase) of a new building. But that is a rare case that proves the general point that there is no proportional matching of saving and investment at an individual level.

While I have said nothing that contradicts economic theory, I do find it frightening that experts in the field have such contrasting views on the matter.

Can a nation save?

I want to offer here a brief analysis of how I think about saving and investment, and why it is important to be very clear about these concepts in policy discussions.

Usually economists equate saving and investment when they shouldn’t. I find it easier to think of savings as not consuming today in order to consume in the future, whereas investment is the production of some new capital good today, say a building, machine, vehicle, that will facilitate greater production in the future.

Let’s start by looking at saving.

I’ve argued before that you can’t borrow from the future. Debts are merely a trade of goods or services in the present for an obligation of different trades in future periods.

A similar conceptual logic is at play when we think of saving. We don’t produce warehouses full of food, clothes, machines and equipment and store them for the future. My superannuation account[1], for example, doesn’t own a share in such a warehouse in order to provide me with the goods I will need when I retire.

Instead my superannuation account owns monopoly assets. These assets are products of the institutional and legal framework of society. I might own a share of a patent monopoly; a sort of institutional power device that guarantees its owner the ability to capture a share of the income generated by the use tools and techniques covered by the patent.

Individuals save by buying assets that comprise a set of monopoly rights. The catch, however, is that all monopoly assets are owned by someone, so any individual who ‘saves’ by buying monopoly assets is merely distributing future incomes to themselves and away from others.

You may now be questioning my claim that all monopoly assets are already owned by someone. What about if I invent a new technology that I then patent. Didn’t I create new monopoly right that was taken from no one?

Actually no.

When you register a patent you are taking away the right to future incomes arising from that technology that would have been available to everyone else using it, and directing that income to yourself.

Saving at an individual level is merely a transfer, so in aggregate there is no ability to save in the way we think of individual savings.

So why is this relevant to a discussion on how nations can save?

Because a nation is one part of the global aggregate, and can save by accumulating monopoly assets currently owned by entities from other nations.

A country that is saving will run a capital account deficit and a current account surplus. They sell goods to other nations in exchange for monopoly rights to future income streams owned by foreign entities.

Usually this situation is sustained by active management of the domestic currency. To keep the domestic currency value low the central bank prints new money to buy foreign assets. This process decreases the relative value of the domestic currency, increasing demand for exports, and represents automatic saving for the country from buying those assets in the first place.

Modern cases of this mercantilist approach include Japan, South Korea and China.

Now here’s where the link between saving and investment becomes important, but where most economic discussion becomes confusing.

The country doing the saving is technically labelled as having a negative rate of foreign investment, meaning they are buying more foreign assets than foreigners are buying of their assets. Dissaving countries are labelled as having a positive rate of foreign investment.

Such terminology is deceiving; even more so when we think in terms of the investment dynamics at play.

The saving country will be a more attractive place to locate capital investments in tradable sectors because of relatively lower costs.

Countries with net foreign investment will actually become less attractive places to invest in large scale capital inputs to tradable goods production.

The key relationship to remember is this. Countries can save the way individuals can by buying monopoly assets currently owned by foreign entities. But this is merely a transfer between the two parties and cannot happen at a global level.

What national saving does is make the country a more attractive place to invest, at the expense of the non-saving country. Saving increases a countries future domestic productive capacity at the expense of future domestic productive capacity of non-saving countries.

For developing countries, mercantilist policies and national saving are a good thing. But to have a proper debate about economic policy we need to acknowledge the realities of saving and investment relationships between entities and in the aggregate.

fn.[1] The Australian version of a private retirement savings account

Unique economics of healthcare

I was prompted to write this follow-up on health economics after seeing a recent post by blogger Noah Smith, who weighs in with some reasonable views after some intense criticism of the ‘freakonomic’ Chicago-boy Steven Levitt. In a meeting with UK PM David Cameron, Levitt and his co-author apparently made some rather absurd remarks about health care.

They told him that the U.K.’s National Health Service -- free, unlimited, lifetime heath care -- was laudable but didn’t make practical sense.  

"We tried to make our point with a thought experiment," they write. "We suggested to Mr. Cameron that he consider a similar policy in a different arena. What if, for instance...everyone were allowed to go down to the car dealership whenever they wanted and pick out any new model, free of charge, and drive it home?"  

Rather than seeing the humor and realizing that health care is just like any other part of the economy, Cameron abruptly ended the meeting... 

This nonsense reminds me that what constitutes economic debate in the US is often laughable at best.

Health care is obviously not like most other parts of the economy. As I said last week medical services are credence goods - goods which we don’t know whether we need, and even once we’ve consumed them, still don’t know if they were good value. In economic terms, these goods suffer from the worst possible information failures, particularly with respect to the asymmetry of information between the seller (in this case the doctor) and the consumer.

For these goods the demand curve may slope any which way, and people are often left to use price as the only signal of quality (or quantity for that matter). This means that a socially optimal level of medical service provision cannot be determined using basic marginal economic analysis.

Not only that, there are substantial positive externalities to most health care services. Vaccinations are the obvious example, but the same principle applies more broadly.

Once you’ve accepted that health care and medical services don’t fall neatly into preexisting economic models, you need a better way to think about the potential efficiency of any health care system. Rarely is this step taken in public debate.

One way to assess any health system is in terms of the two main sets of incentives - those of the patients, and those of the medical service providers (doctors and suppliers of medicines, equipment and accessories).

We often hear about the patients, with the archetypal case of the lonely hypochondriac making a few extra trips to the GP or emergency department when the service is provided free of charge. Sure they exist, but as I’ve said before, pricing these visits deters both the time-wasters and those with genuine medical needs. Making prices for patients reflect production costs in health care systems has the benefit of reduced health expenditure, but comes at a cost of poorer health outcomes.

But in general no one wants major medical services even at a zero price. Here’s a comment from Noah’s blog making that point

Most medical treatments are painful, unpleasant, and time consuming, and are only desired when non treatment is worse. While making treatment costly will deprive some of access, it will do little to make treatment more undesirable than it already is.

On the other side of the ledger we have the incentives of doctors and other businesses involved in the supply of medical services - drug companies, suppliers of medical equipment and so on.

Here there are usually financial incentives to over-treat or over-prescribe. To take just one example, new evidence from Australia’s two-tiered system shows that in private hospitals there are more medical interventions for low-risk births than in public hospitals.

Indeed there is clear evidence of these interacting incentives following the announcement of the $7 GP co-payment in the Australian federal budget. Some medical centres have been text-messaging patients to remind them that they are not charging fees, possibly due to lower patient numbers. On display is the doctor’s incentive to earn a living providing medical services by marketing to customers, interacting with the uninformed patient reacting to a price that doesn’t even exist yet in a way they can't possibly know is beneficial for them or not.

As a final point, we rarely hear about the monopsony buying power of having a single medical provider, which can be significant. A single national (or State level) healthcare entity is in quite a position of power in negotiating supply contracts when they are the only game in town. In a world were drug companies are heavy political hitters, having incentives within the government to reduce drug costs to economise on health spending seems an important consideration.

If we are going to have an intelligent debate about efficient health care we need to remember three key points

1. We must consider benefits as well as costs (including externalities) 
2. There are serious moral judgments necessary about the scope and priorities of health care 
3. Medical services are credence goods, hence there are unique incentives at play