IEA Blog

I have written previously that it was a bad idea for the government to take over banks, but given that they have, they ought to be run in taxpayers’ interest.

A good starting point is UKFI, the UK government’s investment vehicle’s first objective of “maximising sustainable value for the taxpayer, taking account of risk”. So, what would this mean in practice? From the government’s perspective, I must realise that banks play a pivotal role in the economy. So maximising the value and minimising the risk to the taxpayer is very different from if I were I private sector shareholder.

As we have seen, if a bank becomes insolvent in the future, it is likely that government will be unable to resist the temptation to bail the bank out. If you are a private sector actor, you’re loss is limited to the value of the shares. But the taxpayer could have to bail the bank out at any time in the future, bearing the whole loss. So, from this perspective, a government-owned bank should be much more cautious. The reward package should therefore incentivise the senior executives to ensure that the bank is solvent in the future. For example, senior executives could be rewarded through bank loan stock and equity in their pension fund which could not be sold until they retired. That way they have an interest in the long-term prospects of the company, not just short-term shareholder value.

So what incentives have the senior executives of state owned banks, under the watchful eye of UKFI, awarded themselves? The RBS chief executive has been awarded a remuneration package that encourages him to maximise the value of the bank’s shares of the sort that is widely blamed for their collapse in the first place.

There has long been an important problem in the selling of and advising on retail financial products.  Large numbers of individuals and firms call themselves “financial advisors” or even “independent financial advisors” when they are not really advisors at all, but salesmen.  What I mean by this is that they have a direct financial interest in the customer deciding to buy one product rather than another, because they are paid on commission, and hence are in no position to provide unbiased advice.  Their claim to provide independent advice when their incentives are so biased amounts to a form of fraud.

To try to get around this problem, regulation has engaged in all sorts of contortions.  Those selling retail financial products have a duty imposed upon them to provide advice that is in the best interests of customers; those selling products of just one company had to describe themselves differently from those selling products of many companies, and so on.

None of these contortions would have been necessary had a simple expedient been adopted, as I have urged for many years and as the team I directed recommended in the recent large project we did for the European Commission on credit intermediation: those who describe themselves as “advisors” should have no financial interest in the products on which they advise; those with such a financial interest must indicate that they have such and describe themselves as “sales personnel”.

The FSA’s reform announced last week finally identifies this problem correctly, but its solution goes too far - it bans all commission selling.  This is neither necessary nor efficient.  There is nothing bad about selling, provided it is clearly such, and commissions are very useful incentive mechanisms to encourage selling effort and reward good performance.  Unfortunately this means the FSA’s latest reforms of the advice regime are unlikely to last much longer than their many previous repeated false starts.

“Approximately 32 per cent of children in Wales - 192,000 children - live in poverty”, argues a condensed report by the Joseph Rowntree Foundation. The paper (which builds on an earlier study addressing child poverty in the UK as a whole) calls for concerted action by the Welsh Assembly and the national government. It raises a number of important issues, and some of its proposals point in the right direction. This is surely to be welcomed, regardless of whether or not one believes that the Welsh headline poverty rate is the appropriate focus. (I believe that it is not, because if the rate per se was the problem, here’s an easy way out: Secede from the UK. This would make the annual poverty threshold drop by about £1,000 for a two-person household, due to a lower median income in Wales.)

The report identifies long-term economic inactivity of parents as a major risk factor of child poverty, and rightly states the aim of moving people out of worklessness. However, it also calls for a “regular and predictable uprating of benefits [...] for families who are out of work“. This overlooks the fact the benefit system already provides huge disincentives for parents, especially single parents, to enter the labour market. For the ‘median single parent’, leaving the workforce is associated with a loss in disposable income of just over one third, even ignoring job-related costs like transport. Worsening these disincentives hardly serves the JRF’s goal of tackling worklessness.

The report also argues that “welfare-to-work policies must recognise the specific circumstances in Wales“. It proposes a transfer of competences in this field from Whitehall to the Welsh Assembly Government, which should then develop local solutions. Very well so far. But what is actually meant by local solutions is that benefit sanctions for those who fail to seek work should be used more reluctantly in Wales then elsewhere, because of structural weaknesses of the local economy. This is, in fact, contrary to the concept of local self-government. Giving local governments free reign in the management of expenditure programmes, but having national government footing the bill, would introduce major moral hazard problems.

The whole theory of federalism is based on the principle of ‘institutional congruence’, which is roughly the notion that the beneficiaries, the paymasters and the decision makers of any policy area should be the same people. The devolution of social policy to local governments is a very sensible proposal, but only if it is accompanied by a shift in fiscal responsibility. This would make a region with structural problems like Wales more, and not less likely to experiment with unorthodox ways to tackle worklessness. Given the longer-term detrimental effects of worklessness, the affected parents’ children could stand to gain most.

Lord Carter and the Department for Culture, Media, and Sport released the Digital Britain report nearly two weeks ago. Apart from a few brief lines on the BBC website the media coverage has been largely forgotten. Granted, major celebrities have passed away in the meantime, but a report that proposes a large increase in government power and a so-called “poll tax” on telephone line usage, among other blanket “reforms” should not leave the limelight so quickly.

Digital Britain is culmination of years of research on how the UK can be a more “competitive” digital economy.  It is a tour de force for government researchers and planners. At 245 pages long (or three MB if downloaded online) the document lays out a number of proposals that would “encourage and increase the digital wellbeing of the UK”. Among the key points proposed are the following: universal access by 2012 funded by a tax levy, an increase in Ofcom’s power to thwart illegal internet usage by frequent monitoring of Internet Service Providers (ISPs), financial support for public service content partnerships, the funding of local and regional news programmes and the creation of a new classification system for video games.

Any specific one of these issues is a cause for concern in a public environment of increased government control and higher taxes. And there are other approaches. For example, a market solution to broadband coverage through commercial competition would be a far better solution then an additional tax to fund government intervention. However, what concerns me most about Digital Britain is the overall approach to its development.

In “The Road to Serfdom”, Hayek states that “The movement for planning owes its present strength largely to the fact that, while planning is in the main still at ambition, it unites all the single-minded idealists…The hopes they place in planning, however, are not the result of a comprehensive view of society, but rather of a very limited view.”  Hayek goes on to say that the men most eager to plan society are the most dangerous ones to do so.

The US is the largest digital economy in the world. Originally, the Internet was created by the US Army, though similar plans were around in the private sector. Since its early development, the US digital economy has grown over time due to private entrepreneurship and commercial competition of content creators, ISPs, and infrastructure builders and not through planned government intervention. Digital Britain is a government report promoting a planned digital economy as fostered and controlled by the government. It is a great concern to leave the future of the UK’s digital economy to MPs and ministers and not to the businessmen and entrepreneurs of the digital economy.  How else will the spread of the digital economy occur?  Not by central planning and men who are too wrapped up in the government to see the totality of the digital society outside of Westminster.

Following on from Richard Wellings’ post on the welfare state and saving, perhaps I can comment on the welfare state and babies. Pay-as-you-go pensions systems rely on children to make payments to the elderly. We get such systems in the private sector - operated within families and based on bonds of trust. Throughout much of history - and indeed throughout much of the world today - families have children to provide for them in old age. In countries with poor property rights regimes, this is a sound decision (putting aside for a moment, non-economic reasons for having children). It creates a unit of solidarity within which economic risks can be shared and, crucially, which can facilitate inter-generational transfers.

Intergenerational transfers within families (that is the younger generation working and helping to look after the older generation) cannot be expropriated in the way that the property accumulated in capital accounts can be. No wonder they are a popular means of providing for old age in under-developed countries.  

In countries without a welfare state but with good property rights protection, families can make their own decisions. They can decide whether to have more children, accumulate capital with which a pension can be bought or combine the two.  

In countries with a welfare state, however, children become “public goods”. My children will pay your pension and your children will pay my pension. The usual public good condition of “non-excludability” has been artificially created. Nobody has any direct incentive to either save (because we get retirement provision from the state) or to have children (because in the state pay-as-you-go system, as opposed to the family one, we can all rely on everybody else to have children - so nobody does!).  

I can see some of my Christian friends flying into a rage and accusing me of regarding children as purely economic units. But, my point is more subtle. In a free society, with a minimal welfare state, families will take decisions regarding having children for a  range of reasons. Ensuring economic security can form part of our reasoning. Sometimes people will not be able to disentangle the reasons they have children themselves - we do not necessarily sit down and make rational calculations. However, a pay-as-you-go state pension scheme provides strong financial incentives to take one particular course of action. Do people respond to incentives in this way? Yes they do. One of the authors of our monograph, Pension Provision: Government Failure Around the World, provides convincing evidence.

●  John Triggs celebrates the 150th anniversary of Samuel Smiles’ Self-Help 

●  Eustace Davie reviews They Meant Well: Government Project Disasters

●  Peter J. Boettke and William J. Luther explain the ordinary economics of an extraordinary crisis (pdf)

●  James Bartholomew asks whether welfare ruins ambition (video)

●  Patrick Basham and John Luik on why tobacco displays do not cause young people to smoke

This week, researcher Bernard Casey of Warwick University created media interest with a presentation pointing out that days lost at work as a result of stress now exceed the days lost because of strikes at the height of industrial unrest in the 1970s.

Casey is not the first to notice this phenomenon. Longitudinal data from the British Household Panel Survey, using the General Health Questionnaire, show a sharp increase of self-reported stress over time.

Stress is an issue which creates a good deal of controversy. It is not easy to define: one author claims to have uncovered 650 different definitions. It is a mental state, but can have physical correlates and in extreme cases is associated with heart disease and other physical illnesses.

Media stories, blog comments and think-tank discussions have tended to blame increased stress on the faster pace of work and on poorly trained or ruthless management. The Anglo-Saxon long-hours work culture is excoriated while xenophiles have emphasised how much better things are ordered in our continental neighbours. However my own reading of international data suggests that stress levels are higher in France and Germany than in the UK - while US workers report much lower stress levels than Europeans.

It’s difficult to see just why people report much higher levels of stress than they did in the past. Working conditions are greatly improved - shorter hours, longer holidays, fewer accidents at work, fewer physical ailments amongst the workforce, employment legislation protecting workers from unscrupulous or insensitive employers. 

Certainly when you consider the largely office-based occupations in central government, which report some of highest levels of stress, it is difficult to see why such jobs are intrinsically more stressful than, say, coal-mining, which occupied a substantial proportion of the workforce until a generation ago. It’s worth noting here that non-manual workers consistently report more stress than manual workers despite the latter having more dangerous, noisier and less well-paid work.

High levels of reported stress in a working environment have been seen in academic literature to be associated with job content, the pace of work, interpersonal work relations, working hours, lack of control over workload, organisational culture, communications, and limited personal development opportunities. Much has been made of the need for managers to adjust work practices to try to minimise stress.

But in practice those with responsibilities for large numbers of staff recognise that work-related stress is often difficult to disentangle at an individual level from stress related to personal relationships and circumstances. While most workers thrive in a particular environment, some will see it as threatening or too demanding.

One way of looking at stress at work is to see it as a conflict between emotions and the rationality of the work process. Changes in the work process lead to greater perceived stress, just as changes in personal relationships in private life are seen as stressful.

The big increase in reported stress in the public sector has been argued to be the result of a new managerial rationalism being applied to the work process, although I would say that changes in large parts of the public sector have been more superficial than has sometimes been claimed, and that some part of the apparent stress epidemic is down to the personal characteristics of those entering the expanded public sector in recent decades.  

University staff report very high levels of stress, though anyone looking at this from outside the rarefied world of Academe might be forgiven for some scepticism. Certainly university life has changed in ways which many older staff don’t like, but it’s not clear to me just why this makes the job more stressful than driving a bus or working on a production line with insistent deadlines.

In looking at the increase in reported stress, I would focus more on changing cultural attitudes towards work, the medical profession’s unwillingness to challenge self-diagnosed stress in signing people off from work, and the compensation mindset which has seen stress as a justification for payouts under disability discrimination legislation (even though the DDA was not originally intended to cover stress).

Employers will rightly want to see if there are ways in which they can minimise stress consistent with getting the job done efficiently. No sensible boss wants to work people into the ground. But policy-makers and opinion-formers should be very wary of assuming that employers are solely to blame for the increase in reported stress. And certainly there is no justification in what we currently know about the phenomenon for further legislative intervention.

A new study published today by the Institute of Economic Affairs examines the compatibility of the Islamic religion with free-market economic policies. Contrary to the concerns of many in the West, the study finds that the main tenets of Islam are not opposed to the key elements of a free economy such as the primacy of property, respect for family, the importance of nurturing business, enforcement of contracts and allowing individuals to trade freely.

Whilst some aspects of a free economy that was based on Islamic principles would look quite different from the main features of Western economies, there are no obstables in principle to Islamic societies being economically free, open and business-friendly.

 
The most important general principles highlighted by this study, edited by Imad-ad-Dean Ahmad and published in Economic Affairs, the journal of the Institute of Economic Affairs, are as follows: 

• The fulfilment of contracts appears immediately after prayer and charity in the list of what defines righteousness in the Qur’an.
• Well-defined property rights, including procedures for recognition and inheritance, are basic elements of the establishment of a market economy. In Islam, private property is not simply recognised, it is sacred.
• The Qur’an encourages trade, prohibits fraud, and prohibits envy.
• The Western notion of “liberty” shares much with the Muslim understanding of justice, which includes freedom of religion and intellect (thought and expression).
• While parts of the Muslim world have some catching up to do with the West in terms of women’s rights, in the case of women’s property rights it was the West that lagged behind the Muslim world. The Qur’an guaranteed women rights of property and contract, and even a share in an inheritance, fourteen centuries before some states in the USA granted married women the right to property at all. 

These principles have been applied in practice in the Muslim world - even if they are not universially applied today. For example, the parts of the study looking at Dubai, Turkey and Moorish Spain illustrate how the basic features of the market economy can exist side-by-side with a devoutly religious society.

Furthermore, the section of the study on entrepreneurship based on internet platforms shows how Muslims need not wait for domestic policy reforms in order to take advantage of business opportunities - trading online simply allows individuals and enterprises to bypass regulatory impediments. Finally, the substantial issue of interest on loans is addressed by a group of three Muslim scholars. Whilst the way in which Islamic finance bypasses the prohibition on interest is not uncontroversial, even within Islam, Islamic banks are thriving and using impressive self-regulatory vehicles to ensure that good business practice sits alongside the adherence to religious principles.

Writing in an environment in which respect for freedom of contract and property rights is being eroded in the Western world, the editor of the study concludes by arguing that: “harmonious economic development will require both Western civilisation and the Muslim world to recognise the importance of liberty, contracts and private property as universal values.”

Islam and the Free-Market Economy is edited by Imad-ad-Dean Ahmad. Click here to download the editorial (pdf).

The last decade has been marked by a combination of low savings rates and high debt levels in both the USA and Britain. Indeed in 2005, the savings rate in the US reached zero, while 13 million adults in the UK - more than 1 in 4 - have no savings or investments.

The lack of savings, together with the readiness to take on debt, suggests that a high proportion of the population has a high time preference. In other words, the present is valued far more highly than the future.

Arguably the current financial crisis cannot be divorced from the short-term, “hand to mouth” culture that has come to dominate the USA and the UK. The widespread unwillingness to defer material gratification contributed to the debt bubble that precipitated the crash.

But the negative consequences do not end there. People with no savings are also more likely to have to rely on welfare-state safety nets when they lose their job or develop a health problem. They will also tend to be more reliant on state handouts in old age and may therefore vote for socialist political parties that promise to increase such benefits. There is also a strong association between high time preferences and criminality.

While it may be tempting to blame “cultural decline” for the phenomenon, the absence of saving in countries such as the UK may in reality be a rational response to artificial incentives created by government policy.

It is perhaps not that low saving causes welfare dependence but the prospect of welfare that causes low saving. Benefit claimants with more than £6,000 may face steep deductions in means-tested payments. If they have over £16,000 they may receive nothing. And when they reach old age, the availability of means-tested pension credits means low to middle income savers will be barely better off than their spendthrift contemporaries.

Another issue is long-term residential care for elderly. While savers will lose their assets, including their home, non-savers on state benefits will generally receive care free of charge - this is a tricky issue but, at the very least, those who do not save should not be able to expect a guarantee of the same standard of provision as those who pay for themselves.

All in all, the incentives for deferring gratification and saving are very weak. This problem should be addressed urgently through the reform of pensions and benefit systems in order to restore the social and economic benefits of a low time preference culture.

Britain now faces its worst ever peacetime fiscal crisis, yet our politicians seem incapable of grasping the seriousness of the situation.

Indeed, when Andrew Lansley suggested recently that a 10% cut in public spending would be required under a Conservative government, he was widely lambasted.

In reality a 10% reduction is unlikely to be enough, while Lansley’s proposal to ring-fence expenditure on health, schools and overseas aid will almost certainly be unaffordable. Indeed, this proposal to ring-fence such expenditure means that a 10% cut in other expenditure will not cut borrowing below the current projections at all!

Next year around one in every four pounds spent by the government will have to be borrowed. This is clearly unsustainable and needs to be addressed urgently to avoid jeopardising economic recovery.

All government borrowing crowds out private sector investment and thus government borrowing stunts the much-needed growth of the productive sector. There is also a real danger that debt will have to be issued at much higher interest rates, thus raising the cost of funding and increasing government spending further.

Increasing taxes to address the crisis would not be a wise decision. The tax burden is already at historically high levels and raising it further would discourage economic activity and would be unlikely to raise much extra revenue.

 
A substantial cut in public spending is therefore the only practical option, going far beyond what has been mentioned so far by Conservative Party spokesmen. And to achieve savings of sufficient magnitude it will be necessary to address the major areas of government expenditure: welfare benefits, pensions, health and education. It is difficult to understand why areas such as foreign aid are sacrosanct, given the well-known damage to the development of the poorest countries that arises from the over-provision of aid.

Unfortunately, the “vote motive” means that politicians are reluctant to be honest about the scale of the debt crisis facing the UK. Future generations do not vote and many of those who will bear the burden have not yet been born. The short-term outlook and self-interested behaviour of politicians, combined with an unwillingness to take the necessary action, are likely to have severe long-term economic consequences.