On free trade and free markets

Jonn Elledge had a nice piece in the New Statesman about free trade. The question he poses is how Brexiteers can exalt free trade but want to leave the most developed free trade area in the world, the EU. The answer he gives is to distinguish between ‘free to’ and ‘free from’. When economists talk about free trade they mean free to trade, which is what the EU has achieved through regulatory harmonisation in particular. Brexiteers mean ‘free from’ in the sense of trade free from government intervention.

I think we can go beyond what Elledge says and make exactly the same point about the term ‘free market’. A Brexiteer might think of a free market as a market free from government interference, including government regulations. An economist would be more likely to talk about a free market as one where people were free to trade in a socially optimal way. The state might be required to make that happen in many ways.

To take just one example, markets can sometimes not exist because of information asymmetries, but if those asymmetries are removed then people can beneficially trade. (Economists will immediately recognise this as Akerlof’s famous market for lemons.) Removing those asymmetries does not necessarily require government, but government could play that role. If it did, we would have a free market as an economist would define it, but only as a result of what some on the right might call government ‘interference’. As Mariana Mazzucato would argue, the state can also create markets through organising research and development.

Two governments that harmonise each others regulations can create better markets in both countries by increasing competition. Equally there are other government measures that make markets work better. The most obvious example is to reduce monopoly power, which reduces prices and increases the quantity traded in that market. In truth the idea of a market completely free from government is semi-mythical: all markets work within a legal framework created and enforced by the state. When some people complain about government interference in markets, and eulogise ‘free markets’, they are really just complaining about forms of interference they do not like and are using the notion of freedom to glorify their distaste.

Nevertheless, I think this distinction between ‘free to’ and ‘free from’ its perhaps a way of resolving something of a paradox that I talked about in my neoliberal overreach piece. The paradox was whether Brexit can be described as neoliberal, as it involves the apparent illiberal destruction of a free trade area. If you see neoliberalism in practice or ‘in action’ as not so much a coherent (if flawed) unified theory (as here, for example), but rather a collection of views that encompass not just free trade but also promotion of the market and dislike of certain market interference, then neoliberal overreach can occur in any of those dimensions. [1]

So those like Osborne who wanted a smaller state so taxes could be lower (and perhaps for other reasons to) went for austerity as a means of achieving that. Those, like most Brexiteers, who wanted less regulation (including no state interference in how they personally avoid paying tax) pushed Brexit, even though it involved reducing the ability to trade. What Colin Crouch calls corporate neoliberals turned a blind eye to growing monopoly and rent extraction.

While all three groups were happy to eulogise free trade and free markets, conflicts arise over the interpretation of free. For the Brexteers free trade means freedom from government interference, while for Osborne it meant free to trade. For corporate neoliberals free markets means markets that are free from government limits on monopoly and attempts to avoid rent seeking, while ordoliberals want the state to control monopoly so markets are free to work for society.

Today for most people most of the time the idea of freedom generates positive emotions (although that itself is a social phenomenon, as Adam Curtis among others explored.) It is therefore a word worth expropriating for a political cause if you can. But by noting that conflicts arise between ‘free to’ and ‘free from’ we can perhaps see that all politicians are doing is trying to promote a form of freedom that suits their cause.

[1] In an interesting piece, Will Davies argues against the need to want to define political or social terms precisely as if they “connect cleanly and unambiguously to some object”.

Uber and the anti-regulations bandwagon

The news that Tfl, the regulatory body for transport in London, had banned Uber because of regulatory failures brought out the usual suspects to support or condemn the move. In addition, the company organised an online petition to reverse the decision, which half a million people have signed. Tyler Cowen declared: “The new Britain appears to be a nationalistic, job-protecting, quasi-mercantilist entity, as evidenced by the desire to preserve the work and pay of London’s traditional cabbies”, and plenty of others took a similar line.

What always strikes me on these occasions is how people can jump to conclusions without any evidence. Now it is certainly true that licensing authorities can be captured by, and therefore favour, incumbents and therefore stifle innovation. They can artificially restrict numbers to drive up prices, although Tfl do not do this. But the fact that this happens sometimes does not mean it is happening every time. Equally companies like Uber can believe that they are so big and popular that they can ignore regulations, regulations which are designed to make the market work. [1]

It is important to note on this occasion that Uber have not complained about the regulations. Instead they initially said they had complied with them. Surely the time to write articles condemning Tfl’s decision is after Tfl lose the appeal brought by Uber in the courts.

However there is public evidence in this case. We do know the that as recently as August, a Metropolitan Police Inspector wrote to TfL about his concern that the company was failing to properly investigate allegations against its drivers. Between May 2015 and May 2016 the police investigated 32 drivers for rape or sexual assault of a passenger. It appears there has been at least one case where the police allege UBER allowed a driver that had been accused of sexual assault to stay on their books, leading to another ‘more serious’ attack on a woman in his car. Here is part of the inspector’s letter:

“My concern is twofold, firstly it seems they are deciding what to report (less serious matters / less damaging to reputation over serious offences) and secondly by not reporting to police promptly they are allowing situations to develop that clearly affect the safety and security of the public.”

Uber’s boss yesterday apologised for the mistakes they had made. Whether these mistakes are serious enough to warrant revoking Uber’s license the appeals process will decide, or most likely Uber will be allowed a new license on condition that they start taking regulations seriously.

What worries me in this case is the lack of any self-awareness of those who piled in to condemn the regulator without any evidence. Ten years ago the world experienced a devastating financial crisis that was due, at least in part, to a failure of regulations and regulators to do their job that was in turn due to political pressure from those who took a similar attitude to regulations as those championing Uber. And just three months ago around 80 people lost their lives in London from a fire that almost certainly was the result of a failure to comply with regulations.

Regulation bashing has since the financial crisis become one more example of neoliberal overreach. When the two political parties that brought us neoliberalism have today brought us Brexit and a President who seems to want to start a nuclear war, it is time for neoliberals to be thinking about reform rather than just playing the same old tune. Thinking about all that and the 500,000 who signed the pro-Uber petition brought to mind a song of a well known nobel laureate called Talking WWIII Blues, the last verse of which is

Well, now time passed and now it seems

Everybody’s having them dreams

Everybody sees themselves

Walking around with no one else

Half of the people can be part right all of the time

Some of the people can be all right part of the time

But all of the people can’t be all right all of the time

I think Abraham Lincoln said that

“I’ll let you be in my dreams if I can be in yours”

I said that

[1] There is also the question of why Uber rides are cheap, and whether it is making losses simply to drive out the competition, but that is a different issue. 

Why macroeconomists, not bankers, should set interest rates

More thoughts on the idea that interest rates ought to rise because of the possibility that the financial sector is taking excessive risks: what I called in this earlier post the BIS case, after the Bank of International Settlements, the international club for central bankers. I know Paul Krugman, Brad DeLong, Mark Thoma, Tony Yates and many others have already weighed in here, but - being macroeconomists - they were perhaps too modest to draw this lesson.

To most macroeconomists, the theory of monetary policy is pretty straightforward. Interest rates should be set at a level which closes the output gap, which can be defined as the level of output and unemployment that will keep underlying inflation constant. We can call this real interest rate the Wicksellian natural rate. The difficulty is not in the concept, but in the practice of putting numbers to this concept when inflation is noisy, the output gap is hard to estimate, there are lags in the system etc etc.

But, respond those putting the BIS case, wasn’t that what monetary policymakers thought they were doing in 2007, and look what happened next. Monetary policy cannot afford to ignore the financial sector, and the risk of excessive lending and bubbles that subsequently blow up the economy. There are signs, they say, that what happened in 2007/8 may be happening again now, so we need to raise rates to prevent another crash, even though there is still a negative output gap and inflation is below target.

Which might seem plausible, until you notice what is going on here. The implication is that a financial crisis only happens because interest rates are set at the wrong level. The Great Recession was all the fault of the Fed, who kept interest rates too low after the 2001 recession. The gradual deregulation of the financial sector in the decades before? - not an issue. The widespread misselling of subprime mortgages? - these things happen. All the other examples of misselling and fraud? - boys will be boys. An industry that profits from a massive implicit public subsidy? - we see no subsidy. Classifying subprime products as AAA? Massive increases in bank leverage in the 00s? - all the result of keeping interest rates too low.

When those putting the BIS case tell you that macroprudential controls (a.k.a. financial regulations) are ‘untested’ and ‘uncertain in their impact’, what they are really saying is that the financial system cannot be regulated to make it safe when interest rates are low. There is no evidence for that proposition, and a lot of history that says otherwise. We do not have to accept a deregulated financial sector which has the power at any moment to derail the real economy. But of course most working in the financial sector hate regulation. They have an interest in perpetuating different stories about the Great Recession. If you spend too much time around bankers, there is a danger that you come to believe these self-serving stories.

But, you might say, what harm would a modest increase in interest rates do? Again, basic macroeconomics, which I have not seen anyone putting the BIS case address. Raising rates implies in current circumstances a larger negative output gap, which will reduce inflation further below its target. As happened in Sweden, and accurately predicted by macroeconomist Lars Svensson. Two things could then happen. First, interest rates come back down again (in Sweden’s case by outvoting the governor for the first time since it gained its independence in 1999), but the cost of lost resources and higher unemployment created in the meantime can never be redeemed. Second, interest rates stay high for long enough that the public will conclude that the inflation target has in reality been revised down, and we risk converging to a deflationary steady state (technical discussion here), or in non-technical terms a Japan-like lost decade or more of low output and deflation.

To see clearly why this makes no sense, consider the symmetric case. Suppose someone argued, when inflation was above target, that we should not raise rates, but instead allow the output gap to be positive. I suspect those currently making the BIS case would scream disaster – it is the 1970s all over again. So why is that wrong but doing the same thing in reverse OK? In fact it is worse than that. If long run expected inflation rises, a central bank can always signal its true inflation target by sharply raising rates. In the opposite case it may not be able to, because of the Zero Lower Bound.

I like to praise the current UK government when I can. In setting up a Financial Policy Committee that is separate from the Monetary Policy Committee they did exactly the right thing. This formalises an assignment: macro prudential policy to control financial sector excess, and interest rates to control demand and inflation. Most macroeconomists know this makes sense. But the financial sector has a pecuniary interest in pretending otherwise. Those that get too close to that sector should be kept well away from setting interest rates.