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This pandemic may lead to more trade barriers, but is that such a bad thing? Opinion

This pandemic may lead to more trade barriers, but is that such a bad thing? Opinion

The current crisis dominates everything, from trade to everyday life. But, within a relatively short space of time, it will pass. What next? What will be the “new normal” after coronavirus?

A key policy aim across the west for many decades since the Second World War was to reduce barriers to international trade. But it seems likely that the crisis will reverse this longstanding trend. There were already signs of it slowing down.

President Trump is trading accusations with China on who is to blame for the coronavirus pandemic. Of course, this mood can swing.

But an important new phrase in US government circles is “decoupling”. American supply chains have become increasingly dependent on China in the past 20 years or so. The talk is of breaking this dependence, probably by using new trade barriers.

Within the EU, national governments have reasserted domestic sovereignty in a dramatic way.  The authority of the European Commission has been reduced, and it will not be easy to restore it.

The instinct of economists is to recoil in horror whenever they are confronted with the idea of barriers to trade. These are regarded as being unequivocally a Bad Thing. But their own discipline shows that matters are not necessarily so clear-cut.

Over 60 years ago, the theoretical journal the Review of Economic Studies — then as now a desired outlet for academic economists — published a paper entitled “The general theory of second best”.

Richard Lipsey, one of the authors, went on to write a best-selling textbook. The other, sadly dead now, was Kelvin Lancaster. He was a highly original thinker who in the opinion of many should have been given the Nobel Prize.

The paper is set in the highly abstract context of what economists call general equilibrium.  Everyone behaves exactly in accord with economic theory. Supply and demand balance in every market, so there is no unemployment, for example. It represents the theoretical ideal of the efficient allocation of resources.

If there were only one barrier to such a perfect state of affairs, getting rid of it would lead to a better outcome. Lipsey and Lancaster asked the simple question: if there were more than one, what can we say if just one of these is eliminated?

Their answer was quite devastating — so much so that economists who encounter this famous article as students look it firmly in the eye and then try and forget it.

They showed that there was no theoretical presumption that the economy would be more efficient if an imperfection were removed but others still remained.

In the real world, there are of course many deviations from this abstract, perfect world. This means that there is no presumption in economic theory that bringing in some restrictions on trade will make things worse. It is an empirical and not a theoretical issue.

Just like the UK leaving the EU, what really matters is the domestic response to changes in the external environment. A bit more protectionism across the globe could stimulate a new wave of innovation in the west, as we look to rely on ourselves rather than China.

As published in City AM Wednesday 25 March 2020
Image: Cargo ship via Pxfuel is licensed for free use.
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To pay for this crisis, the government must keep in mind Ricardian equivalence

To pay for this crisis, the government must keep in mind Ricardian equivalence

John Maynard Keynes could certainly craft a neat phrase.

In the Second World War, he wrote in his pamphlet How to Pay for the War: “It is only in a free community that the task of government is complicated by the cause of social justice.”

The impact of the coronavirus pandemic is similar to a war. Governments have to spend more on some stuff (bombers or ventilators) and restrict access to resources for other activities (in WW2, petrol was rationed, now sports events restricted).

In the current crisis, many otherwise viable companies will go to the wall as demand for their products and services drop. Already, the airlines are clamouring for a huge bailout.

Rishi Sunak’s loan scheme is a very good start, but it does not go far enough.

Looming over all of this: how should all the extra spending, extending even further than the loan scheme, be paid for?

Another great British economist, David Ricardo, was also fascinated by the question of how to pay for a major war. In his case, it was the Napoleonic wars in the early nineteenth century.

The government could either raise taxes or issue bonds to cover the increase in spending.

Ricardo argued that the effect on the economy would be the same regardless of which method was used. If increased government spending was financed by taxation, total demand in the economy would be unaffected. Military spending would rise, but private spending would fall.

According to Ricardo, the issue of government bonds would also have no effect. The bonds give rise to a stream of interest payments in the future and at some stage have to be repaid. So taxes in the future would be higher. A rational agent would anticipate these higher taxes. They would increase savings now in order to be able to meet them.

This concept, known as Ricardian equivalence, is hotly contested in macroeconomics even today. If it is true, so-called Keynesian policies for more public spending and bigger deficits simply do not work.

In the financial crisis of the late 2000s, the public sector deficit rose. Both the household and the corporate sector increased their savings, rather than running them down to maintain spending levels. So Ricardian equivalence is not as far-fetched as it may seem.

Traditionally, wars have mainly been paid for by the government issuing debt. In the Napoleonic wars, Bank of England data shows that government debt as a percentage of GDP rose from 100 to 150. In the First World War, it went from 20 to 110, and in the Second, from 130 to 250.

A similar massive rise now might simply be offset by an increase in private sector savings. Demand would fall even further than it is doing.

Sunak’s proposal is to make loans to any business that wants them, large or small. But the repayment period needs to be longer, say 10 years. The company could pay these back as and when it chose. Otherwise, the outstanding loans would be converted into equity in the company.

The loans would therefore either be repaid or backed by an asset. The principles of sound finance would be maintained, and businesses would survive.

As published in City AM Wednesday 18th March 2020
Image: Rishi Sunak via Flickr is licensed for use CC By-ND 2.0
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How mathematical models attempt to predict the spread of disease

How mathematical models attempt to predict the spread of disease

The various pronouncements on coronavirus are a source of puzzlement to many.

On the one hand there are lurid predictions of millions of cases and hundreds of thousands of deaths. On the other, while the actual numbers are growing, they seem tiny so far compared to the scale of the predictions.

Almost 100 years ago, two Scots, Anderson McKendrick and William Kermack, developed an apparently simple mathematical model to explain and predict the spread of viruses. This abstract model remains the basis of our modern understanding. It gives insights not just into the spread of diseases, but how things like fake news disseminate on the internet.

These economists proposed that people at any point in time are in one of three conceptual states.

The first defines those who are susceptible to any particular virus. For example, a certain type of person may be susceptible to rumours that Elvis Presley is alive. It is not clear yet who is susceptible to Covid-19. It seems to be affecting most demographic groups, but the World Health Organisation pondered last week that children might not be susceptible, for example.

The next category is those who are infected, which is straightforward enough. The final one is “recovered”. This could mean genuinely recovered, or actually dead — at any rate, no longer susceptible.

Kermack and McKendrick set up three non-linear differential equations to describe how a virus might spread. Their apparent simplicity disguises a fiendish complexity.

From the names of the categories, it is known as the SIR model — susceptible, infected, recovered.

A major uncertainty is whether to use this model or its SIS variant.  Here, the final “S” also means susceptible. The SIS model means that people can get re-infected. The common cold is a good example.

The key part of the system is determining how many susceptibles any given infected person passes the disease onto before he or she recovers. In turn, this depends on how much the susceptibles and infected intermingle (hence the drastic quarantines in China and Italy), the probability of catching the virus from a single contact, and the length of time someone is infected.

Basically, a virus will spread if a sufferer infects on average more than one susceptible. The current number for Covid-19 seems to be between two and three.

Typically, solutions of the model start with a very small number of cases relative to the size of the population. Then, very quickly, these accelerate dramatically.

Imagine a city of one million. People are only infectious for one day and infect two susceptibles. Someone catches the disease. There are only 128 cases at the end of the first week. But in less than three weeks, everyone will have had it.

Modern versions of the model look more closely at how people intermingle in reality, and use big data to map infection patterns. This is the basis for the search for so-called “super spreaders”.

In practice, predicting the course of any particular virus is a challenge. My sympathies lie with those who have this task. But a 100-year-old mathematical model tells us that the very large numbers we read about could easily become reality.

As published in City AM Wednesday 11th March 2020
Image: Monitoring Passengers by  China News Service via Wikimedia is licensed for use CC BY 3.0
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Priti Patel vs. Philip Rutnam: It’s in Britain’s interest that bureaucracy does not win

Priti Patel vs. Philip Rutnam: It’s in Britain’s interest that bureaucracy does not win

The reverberations around the resignation of Sir Philip Rutnam, the top civil servant at the Home Office, continue.

Priti Patel, the home secretary, is receiving a barrage of abuse.

Labour’s John McDonnell has pronounced that he cannot see how Patel could carry on. He raised the possibility that she might be in some way “suspended”.

It seems to have slipped the shadow chancellor’s mind that he himself was keen to carry out a purge of economists in the Treasury and Bank of England if Labour had won the election. The officials which remained would have required “re-educating”.

But right now it doesn’t really matter what Labour thinks. The salient point about the criticism of Patel is that it is coming from the serried ranks of the metropolitan liberal elite. The Guardian newspaper has been in a total lather. The BBC’s coverage has hardly been impartial.

This group see Rutnam as one of their own: a professional expert, conscientiously going about his business. Naturally, they regard his actions as sound, carried out in the interests of the nation as a whole.

An important part of economic theory takes a completely different view of the motivations of bureaucrats. James Buchanan was awarded the Nobel Prize in 1986 for his work in developing what is called “public choice theory”.

Public choice economics rejects the idea that bureaucrats act in a disinterested, objective way. They are no less selfish than the rest of us. Their primary motivation is not to serve the public, it is to further the interests both of themselves as individuals and of the bureaucracy as a whole.

The Home Office itself provides many examples which support this view. When tasked by ministers with deporting those without correct documentation, the bureaucrats did not try to track down, say, Albanian drug dealers. Instead, they minimised effort to themselves, identifying people who had lived here for decades but whose paperwork was not quite in order. The result was the Windrush scandal.

Some 20 years ago, I was involved in a project on crime for Charles Clarke when he was home secretary under Tony Blair. I discovered an influential group in the Home Office who believed that the number of criminal offences actually carried out was more or less constant from year to year.

It may have appeared from the data that there had been a huge increase in crime since the Second World War. On the contrary (according to these officials), this merely reflected changes in the propensity to report crimes. The actual level of crime, they purported, was the same in 2000 as it had been in 1950.

I was impressed by the brilliance of this hypothesis. It meant that no bureaucrat could ever be criticised for failing to control crime.

Of course, the view that people always act purely in their own self-interest is rarely completely true. There will be a mix of motivations at play. But in clashes between politicians and the bureaucracy, it is essential for democracy that the former win.

As published in City AM Wednesday 4th March 2020
Image: Home Office by  Steph Gray via Wikimedia is icensed for use CC BY-SA 2.0
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Citizens assemblies are no solution to the climate challenge — we need innovation

Citizens assemblies are no solution to the climate challenge — we need innovation

At first sight, long-term swings in individual seats in Australian elections are a definite niche interest, one for the real trainspotter.

But during a visit to Sydney University’s Complex Systems Institute, I noticed a fascinating piece in The Australian newspaper.

The Australian Labor Party had a good result in the 2007 federal elections, and a relatively poor one in those of 2019. Nationally, there was a swing of seven per cent from Labor to the centre-right Coalition.

In eight constituencies in Queensland — equivalent to some 30 seats in the House of Commons — the average swing away from Labor was over 16 per cent. All were held by Labor in 2007. All were won by the Coalition in 2019.

They had one key thing in common: in each constituency, coal mining or commodity extraction was an important part of the local economy.

We see exactly the same phenomenon across the west as a whole. Substantial groups of voters are very reluctant to pay the price now for policies which might yield benefits in terms of the climate a decade or more into the future.

Two decades ago, long before climate change became a fashionable topic, lorry drivers brought the UK to a virtual standstill in a protest against rising fuel prices. Much more recently, President Emmanuel Macron saw the streets of French cities in flames. The initial trigger which led to the so-called “gilet jaunes” movement was also proposed fuel tax increases.

So how can changes be made on a sufficient scale to address climate change in the light of this lack of democratic consent?

The liberal left in various countries sets great store by so-called citizens assemblies. A small group of citizens, reflecting the socio-demographic characteristics of the population, is selected at random to solve a particular policy challenge. One, set up by parliament itself, has been meeting in Britain on the topic of climate change. The 110 assembly members are encouraged to consider the topic in depth.

The liberal hope is that, guided by experts, ordinary people will come up with policy recommendations congenial to them. But this is only half the story. To be more convincing, the assembly members need to be made to live for a year or so experiencing the consequences of the policies they devise.

Anyone can advocate, say, an immediate ban on petrol and diesel vehicles in the abstract. But if you have to give up your own car here and now, you may come to an entirely different conclusion about what should be done.

But there is a silver lining. In Australia, this year solar energy costs are falling below those of coal and gas for the first time. A decade ago, they were over five times more expensive. As a result, households are installing solar panels in huge numbers. In the deserts, companies are building massive solar farms.

Hair shirts imposed on electorates by central planners will not work, and will instead spark democratic discontent. Ingenuity and innovation create the opportunity for a solution arising out of free choice.

As published in City AM Wednesday 26th February 2020
Image: Australia protest via Wikimedia by Takver licensed for use CC BY-SA 2.0
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