Should Lord Stern remember some economics?

After Lord Stern’s comments about becoming a vegatarian to save the plant, I suggested he should be consistent and become a vegan. A post by Martin Livermore on the Adam Smith Insitute blog got me thinking that maybe Lord Stern would be advised to remember some lessons from economics. After all, as an economist, Lord Stern was employed to do a cost benefit analysis of tackling global warming. The report was only able to reach its conclusion that we should do something now by taking an extreme view of future temperature change (thus overstating the benefits of any remedy) and seriously understating the costs. Mostly this was by failing to apply an appropriate rate of discount to future costs and benefits.

Since then Lord Stern has become increasingly alarmist. If instead, he applied some of the tools of his profession he would conclude the following.

 

1. Most of the largest greenhouse gas producers are things that have an inelastic demand – such as petrol and fuel to heat one’s home. Therefore the costs will tend to exceed the benefits.

 

2. There are diminishing returns to emissions reductions. Small decreases can be achieved easily. At home most can save a bit by better insulation in the loft, or by turning town the thermostat by 1 degree. Car fuel consumption can be reduced by driving more economically. Bigger savings are less easy, without fundamental changes in lifestyle, which for the majority would mean a significant drop in living standards. For instance,

- switching from frozen and chilled foods to dried and tinned foods.

- switching foreign holidays to camping in the back garden.

- From travelling by car to work to spending three times as long going by public transport, or catching pneumonia cycling.

 

3. Large government projects tend to overrun on costs, and under-perform on benefits. The bigger and more idealistic the project, the larger the (proportionate) discrepancy between plan and outcome. International projects tend to overrun more than national one, as consensus is only achieved by compromise fudging. For the greatest trans-government project of all time, this risk alone should lead to the complete abandonment.

 

4. Complex models tend to fail most in their forecasting when you need them most. Consensus economic forecasts made in 2006 for 2009 would have predicted growth, not biggest slump since the 1930s. Yet compared to economic, climatology is more complex and still in its infancy as a subject. Further there is no competitive market in forecasting to encourage improvement and revision in the light of new data. In economics reputable  forecasting is a valuable commodity. In Climate Science, one is paid to agree with the consensus.

Nationwide and Halifax house price recovery is fragile

The recovery in house prices reported in the Nationwide and Halifax indices underlies a significant issue – that many existing borrowers would see a much higher rate of interest if they moved mortgages. As an example, my own repayment mortgage is currently 1.9% annual interest rat, or 1.4% above base rate. If I moved house Nationwide’s best deal on a tracker is 2.44% above base rate for 2 years and the reverts to 3.9%. There is also a nearly GBP 900 fee. Halifax are similar- 2.69% above base rate for 2 years, then reverts to 3.5%. A GBP 1200 fee here.

These are the cheapest deals, for a loan less than 60% of the house price and are competitive in a thin market. Halifax reports August 2009 approvals were 51% lower than in August 2007. The Nationwide’s measure of private housing sector turnover rate is now 4% , from a peak of 7% and a low of 3%.

As the driving force for the Housing Market is people upgrading to a better house, there may be a considerable number of people delaying moving house for this very reason. It is better to save for a new house by paying down existing borrowings than move to the more expensive house.

Paradoxically, a rise in base rates may prompt a narrowing of this differential and therefore perk up the housing market. The reason being that the marginal cost of moving will have diminished. However

-  there are other reasons for the low levels of housing activity – uncertainty over jobs and the need to pay off debt.

- a rise in interest rates may tip many existing hard-pressed borrowers towards selling. In particular buy-to-let landlords who have seen rents diminish this year.

Financial Regulators are as fallible as the rest of us

John Redwood, in defence of the banker’s, asked whether the regulator’s in the part four years has engaged in socially useless activity.

Unusually, I came to the defence of the regulator.

Regulators, even if nominally independent, work within the current political & economic climate. They would not have called for increasing capital requirements during the boom, as there was no visible reason to do so. After all, we had “ended boom & bust” – due to the prudent handling of our economy by the then Chancellor. Where was the risk factor that justified such a measure?

 If a Regulator had called for tougher rules, he would have been lambasted by the press, and criticized by most expert economists. Financial Experts would say capital requirements could be lower, as risk was now diversified throughout the global financial system.  Politicians would have said that such unilateral action would jeopardize London’s position as the World’s No.1 financial centre. If the Regulator had sufficient stature, then the £ would have gotten a bit jittery, and some shares in the banking sector would have taken a tumble. A government spin doctor would have come out we a speech saying “what I think you will find the Regulator actually said was .…” – and then say something that was the opposite, or renders the comments meaningless.

After a few days of ducking the issue, the Chancellor would have given his full support, followed the next day with the Regulator’s “voluntary” early retirement (or movement sideways).

A similar picture was with the Central Banks. By cutting interest rates after the dot.com bubble burst and again after 9/11 we obtained an asset price bubble. The US or the UK were not going to call a halt by raising interest rates, as it would have been both politically unpopular and raised exchange rates. The normal market adjustment, with a mild recession was averted. The long-term consequence was system imbalances becoming so large that the eventual correction nearly wrecked the financial system.

 The lesson to be learnt is not tougher and/or more detailed regulation. It should be a humility concerning our powers to intervene, as they can have consequences that we cannot foresee. Furthermore, markets have rushes of exuberance that will, sooner or later, be corrected. Avert the market correction and you build up trouble for the future.  Interventionism does not cure the problem of imbalances, merely delays it.

MARKETS WILL ADJUST. BEFORE OVERRIDING TO COUNTER FLUCTUATIONS,  YOU SHOULD FIRST BECOME OMINISCIENT.

Alan Greenspan convinced everyone that he had achieved this status, but turned out, in the long run, to be wrong.

The biggest current imbalance is in the housing market. The slide has been halted by near zero interest rates, but will resume when those rates get back towards normality. Why do I say this when average house prices are around the long-term average of four times average earnings? Because interest rates are well below their long-term average for existing borrowers. When they revert to around 5% that new borrowers are paying, and when unemployment peaks at 3 million plus (with some coming from the state sector), then the supply of houses will exceed demand.

300,000+ per annum dead due to Climate Change?

The claim by the Global Humanitarian Forum that over 300,000 people per year is unsubstantiated and most likely false. It is based on a selective reading of data and should be challenged. In particular, the assumption that 40% of the increase in disasters is climate change related and the implication is that we should severely curtail greenhouse gas emissions to mitigate it.

 

The case studies from the full report (here) illustrate why.

-         Hurricane Katrina (p.21). Latest evidence is that there is most likely a link between global warming and hurricanes, but the nature is unknown. It may be temporary whilst temperatures rise. The deaths and much of the economic destruction in Hurricane Katrina was a result of poorly-maintained levees breaking. The human costs (lives and $) was due to a powerful hurricane hitting land on a major population centre. The probability of any one hurricane doing this is very low.

-         2003 European heat wave — 35,000 deaths (p.33).  Unique events cannot be easily adapted to. Contingency plans have been put in place, but in almost 6 summers since there has been no repeat. However, higher temperatures mean than winters are milder. In the UK alone there are thousands of deaths amongst the elderly with elderly every time due to extremes of cold. So the net impact of global warming (even with more extreme conditions) could be a reduction in climate-related deaths.

-         Ethiopian drought and flooding (p.32). The report quite rightly points out that many of the population is malnourished, there is severe water shortages and there are frequent droughts. However, they fail to point out how this is increasing as global temperatures rise. If my memory serves correctly, there has been no famine matching that of 1984, despite the population having increased. There was also a large famine in 1973. Unless there are strong counter-arguments to the contrary, any climate change may have had a positive impact. The counter-arguments are that a) There has been economic growth in the last 25 years. Although still one of the poorest countries on earth, there is sufficient wealth around to cope with famines. b) Aid agencies have structures and plans in place to avert potential disasters. c) There is no longer a pro-Marxist government pushing through collectivization of agriculture and placing obstacles in the way of relief efforts.

                         

The implication from my reading of these examples is that even if they are wholey due to climate change, the way to mitigate them is a targeted response at the local level. In the 3 cases above, it is unlikely that similar scale weather events would cause similar scale disasters, as there are now contingency plans in place. Further the evidence of earthquakes is that the most deaths occur in the poorer parts of the world. A similar-sized earthquake to that of China in 2008 or Bam, Iran in 2003 replicated in California or Japan would not cause the same number of deaths because of better buildings. and better emergancy services. And these are as a consequence of much greater wealth.

In terms of deaths through hunger, the greatest famines in the 20^th century were due to authoritarian governments and wars. The suffering under various communist regimes trying to instill their various brands of utopianism should be a cautionary tale to trying to regulate the world economy. This was based on the certainty that theirs was the perfect system, implementation was not an issue, and those who disagreed were deluded, or in the pay of the capitalist class.

The vast reduction in the proportion of the world’s population suffering hunger is partly due to the green revolution (higher-yielding crops and better types of agriculture of the 1950s & 60s – not the organic fad of the rich countries) but mostly due to sustained economic growth promoted by globalization. The growing countries (China & India, along with others) have turned their backs on state control and embraced globalization and let enterprise flourish. A consequence of that growth has been a massive rise in greenhouse gases. A government managed reduction carries the very great risk that the growth will be reversed, with a consequent increase in human suffering far greater than 315,000 live per year. For these reasons, analysis of the impact of climate change need to be better justified before they form the basis of policy decisions.

 

 

Other Sources

1. The Economist made similar comments when the report came out, commenting that the 40% of the increase in disasters is climate change related is arbitrary and also that money thrown at the problem will not necessarily provide answers. They do not point out the risks to the global economy, nor the local solutions to mitigate the impact rather than global reductions in greenhouse gases.
2. Christopher Booker in the Telegraph said “Then there was the 103-page report launched by Kofi Annan, former UN Secretary-General, on behalf of something called the Global Humanitarian Forum, claiming, without a shred of hard evidence, that global warming is already “killing 300,000 people a year”. But Mr Annan himself had to admit that this report, drawn up by a firm of consultants, was not “a scientific study” but was “the most plausible account of the current impact of climate change”. He contrasts this with recent evidence that the planet has not warmed, and the recent cold winter.
3. Robert Pielke Jr (of wattsupwiththat) gives a more scientific (and thorough) debunking of the basis of the report, concluding “This report is an embarrassment to the GHF and to those who have put their names on it as representing a scientifically robust analysis. It is not even close.” Referred to by Delingpole in the Telegraph and Climate Depot

Climate Change Camp – for good or evil?

The Tax Payers alliance have a posting on the Climate Change Camp set up in Blackheath.

 

Here is my comment:-

 

The comment you make is a fair one. Before proscribing a painful and potentially harmful course of treatment, an ethical doctor would

-         check the diagnosis is accurate – both in type and to the extent.

-         Make sure that the treatment is likely to improve the condition of the patient.

In a similar vein

-         The assessment of the extent of the climate change is not helped by failing to examine validity of the data or statistical analysis.

-         Nor by ignoring contrary science.

-         Nor by ascribing every bit of extreme weather to anthropogenic factors.

-         Nor by ignoring the benefits of warming (e.g. less old people dying in the winter cold)

-         Nor by assuming that a global policy is both the best available and that it will improve the situation.

-         Nor by ignoring the harmful effects of oppressive taxes and regulation. You could reduce economic output and bankrupt the government. This could lead to the collapse of public services (with many dying as a consequence) and millions permanently unemployed. In the emerging nations, reduced output will lead to the mass hunger from which many have just escaped. It will also lead to an increase in wars.

 

To establish that climate change is the “biggest threat the world has known” needs substantiation. In the last century the cause of every major famine was either caused authoritarian government policies or by war. On the other hand, global growth ensured that, for the first time in human history, the vast majority of the worlds population can live free from hunger as a normal state of affairs, and each generation can look forward to better livings standards than their parents. For those who believe in peace and helping the poor should make sure that these achievements are not reversed.

Pensions – The Missing Factor

We are told (for instance here and here, the major reason increase in the real cost of pensions (and the consequent demise of private sector final-salary pension schemes) over the last few years are

1. The increase in life expectancy.

2. Changes to accounting rules, meaning that companies have to include future pension liabilities in their balance sheets

3. The low returns from the stockmarket since 2000 – exacerbated in the current recession.

4. In the UK the 1997 Gordon Brown tax on the investment income of pension funds.

But the biggest cause of the rise of the pension deficits is the fall the long-term real rate of interest. This not only impacts on the compound returns to the pension “pot”, but also the size of the annual annuity that can be purchased on retirement. As a consequence, a fall of just 1% in the rate of interest might increase the contributions by 50% to obtain the same size pension. Always low interest rates benefit borrowers to the disadvantage of savers. Like sub-prime, pensions are another long-term hangover from the low-interest party since 2000.

In the UK, as a consequence of the low interest rates and high government spending we now have the following problems.

EITHER – We have low interest rates, meaning those working now have to save more for retirements

OR – We have higher interest rates, meaning higher taxes to fund the ballooning national debt and a steep fall in house prices.

The short-expediency of boosting the economy by low interest rates and deficit spending has reduced living standards for the elderly in the long term.

Cameron fails to understand the Booze Problem

ToryDiary reports David Cameron as saying yesterday

“We need to look at the unbelievable availability of very cheap drink, getting three litres of cider for £1.99, at all hours of day and night. We’ve got to do something about this and I’m exploring what we can do to deal with the drink that’s fuelling so much of the crime in our country.”

Please, please, Mr Cameron can you rise above the thinking of the Labour government?

On my ‘O’ Level economics course I learnt that raising taxes on booze was a good way of raising revenue, as demand is inelastic with respect to price. This is still true, so to plug the budget deficit they could look to raising the tax.

The other side of the coin is that it is a poor way to reduce consumption. For young people it may have more of an impact of their expenditure on alternatives (alcohol in pubs or nightclubs, clothing or car expenditure, or saving). For some it may be a Giffin good. Their consumption will increase on booze at home, and they will spend less on going out.

Minimum price is even worse. You may get people going up market,as the differancial between white cider and better alternatives diminishes. Also the quality may improve. But what will increase massively in the profit per unit to the retailer. Supermarket and Off-licence shares might rise is this is pursued.

 The social problem of alcohol will not be solved by stricter laws or by higher price. It needs a social change. It is only when large numbers of people stop believing that the best way to have a good time is to get totally pissed; and when it is seen as a weakness to lose control of one’s faculties. Then the consumption and the binge drinking will go down.

 Update 23 08 09

The Adam Smith Institute similarly see this as a social problem.

 

When clarification lacks compassion and justice

The current effort to “clarfiy” the law on assisted suicides will attain the opposite of its intention. The intention is to make society more humane, and promote human rights, by making it clear the boundaries for assisting loved ones who clearly wish to take their own life. An the boundary will be laid in such a way that they will no longer face prosecution. However, what of those who are pushed into it. The elderly parent going senile, or with degenerating physical condition. Will the onus be on them to go quickly rather than ruin the best year’s of their children’s lives? Or will they be feel pressurised or morally obliged to go, rather than exhaust their children’s inheritance in a care home?

Our laws are influenced by our moral environment, but they also influence it. It is better to leave alone, with the understanding that clear cases of compassionate assistance in suicide are not prosecuted. But the unspoken understanding is that if there is a suspicion of undue pressure, then the full weight of the law can be unambigously applied, without necessity of proving that pressure. This is both compassionate and just.

Maybe Nadine Dorries is right, in principle, in saying this issue should go before Parliament.  But Parliament is so weakenened at present that it will be whipped into place on the whim of the spin doctors. And those spin doctors like rules & regulations.

Labour’s aim to save £35bn

According to John Redwood, the Labour Government has plans to save £35bn a year. I posted the following comment.

 

 It is good news that the government is allowing for value for money as a consideration. But after twelve years of government, it is a bit late.

 A bit of quick beancounting might put this into perpective. If these are mostly savings they could have made earlier, and assuming they have always been a constant percentage of government spend, then labour’s delay has cost the  taxpayer around £325bn. If it has only built up since the spending hikes in 2001, the figure reduces to £150bn. However, for the government to admit this lower figure would be to admit that a large part of the spending increase was money down the drain.

 Another way of looking at the £35bn is to divide by the number of Labour MPs. It is nearly £100m per MP. As I have blogged before, this level makes the financial amounts of MPs expenses seem trivial.

 But even this annual £35bn only scratches the surface between the best value that can be theoretically achieved and the situation now. There is a lack of dynamism in government in changing service provision to the changing requirements; a lack of expertise in matching real individual (or local) needs to the money available; and a total lack of thought in relating costs to benefits for new initiatives. Add to the mix the strong interest groups in protecting the status quo, and many statutory encumbrances that add little value but a lot of grief, and you have the opportunity to spend a lot less, whilst improving the welfare of society as a whole.

 

To enlarge on why the scope for savings is much larger

 

1)      Much of the government services provided, whether education, health care or welfare payments are based upon a uniform specification. In education, there might be too much spent on some pupils, so that a very small minority will be missed out. The same goes for disability or housing benefit.

2)      Initiatives that flounder. Whether it is the drug addiction schemes that are less than 5% effective or the computer schemes that deliver many times over budget, years late and without the benefits specified.

3)      Lack of marginal analysis. A new initiative will look at the supposed benefits, but not the costs. For instance raising taxes on alcohol, tobacco and fuel may all have the desired results of reducing consumption, but the biggest impact is the reduction in living standards of those whose spend increases on these items. Last year I wrote extensively on the proposed congestion charge in Manchester. My major objection was the same issue. A low charge will be mostly absorbed by the motorists. Only a high charge will cause the majority to switch to public transport.

4)      Ignoring unintended consequences. The smoking ban in public places has triggered a massive decline in the number of pubs. The raiding of pension funds by Gordon Brown has contributed to the decline in final salary schemes. Avoiding recessions after the dot.com bubble burst in 2000 and after 9/11 mean that the boom was prolonged, causing greater grief when the boom finally ended. Doing “whatever it takes” to save the banking system, meant that the exchequer took on hundreds of billions liabilities that may result in massively increasing the National Debt.

5)      Ideological or political appearances. Whether it is “bobbies on the beat” or investing in renewables to meet climate change targets, costs are incurred for public relations, rather than to have any obvious effect. The excessive increases to doctors and nurses in recent years has added billions to the NHS wage bill.

6)      Lack of Expertise in cost negotiation. The government this month signed a £6.5bn PFI deal to widen 38 miles of the M25. In 2004 it was to be £4.6bn for 63 miles.

 

Another attempt at understanding cost control in government was here, where I applied the principals used in my weekly shopping to the issue.

John Major on the need to tackle the UK Government Deficit.

Former Prime Minister, Sir John Major, today laid out, in simple language, the scale of the problem with the nation’s finances in BBC interview

I may change the order somewhat but this is a summary of what he said.

- The scale of the government deficit is unprecendented in Sir John’s lifetime.

- If it is not tackled there will be a severe crisis when our national credit rating collapses, leading to a sterling collapse, leading to soaring interest rates.

Why are we in such a mess? Sir John Major blames it on the government running a deficit in the good times, so the total debt increased when it should have been reducing.

There are 3 ways that will bring the current £180bn  deficit down.

1. Increase Taxes – but even a 5% increase in the basic rate of income tax and 20% VAT rate will do very little.

2. Cut expenditure.

3. Economic Growth

It is expenditure cuts that Sir John advocates

UPDATE 7th July - Adam Smith Institute blog has an alternative report of Sir John’s Comments.