Tuesday 16 April 2024

The UK smoking ban: can paternalism be justified?

Every day I tell my toddler off for doing something he shouldn't.

He has no idea why playing with plug sockets are bad but light switches are ok, or why running off into the middle of the road is bad but running around the garden is fine. He just needs to do what I say as I am his Dad and I know better than him, it is for his own good.

At some point, he will grow up and be able to decide for himself that playing with plug sockets is fine due to the UKs impenetrable socket design, or that running off into the middle of the road is not all its cracked up to be.

When society imposes restrictions on freedom we call it paternalism, and most of the time we react like my toddler: having a massive tantrum and moaning about it in the comments section under unrelated Daily Telegraph op-eds. 

The UK's smoking ban policy, which will ban all tobacco products for my son and anyone else born after 2009, has invariably had similar reactions. But I think it is perhaps the most interesting piece of legislation in my lifetime.

Tobacco is a drug that is perhaps unlike any other. It is a mild stimulant like caffeine, but extremely addictive like heroin. It has one of the biggest negative health impacts of anything that we currently do and has a huge weight of evidence behind this fact. Not even injecting plutonium can come close. It is a kin to snorting asbestos. But it also has relatively few negative externalities as a result of fire retardant furniture and not being allowed to smoke indoors.

The argument of whether we should ban something is difficult. If people understand the risks, why should we ban it if it is their choice? Especially if there are hardly any negative externalities. Crossing the road is dangerous but we still allow people to doit.

One argument is cost: smoking costs the taxpayer more than the revenue it brings in due to cancer treatment etc. But if people do not smoke and get cancer, they will still die and get something else which costs money. Although figuring out the cost to the economy is a bit more complex than this, a lot of the figures you see about how much smoking "costs" society doesn't take this into account. 

The best argument for banning smoking


I have a lot of childhood friends who smoke. Every single one of them said to me when they started they would quit when they were older. Some of them did, most of them didn't. Nearly all of them are trying to quit, have tried to quit and couldn't, or have moved on to vaping (more of that later). 

All of them regret ever having started. And this, I think, is the killer argument for a smoking ban that makes it not such a simple debate about informed decision making but it also raises an interesting question. Does regretting something mean you shouldn't have done it? This sounds kind of odd as that is the kind of definition of regret, right?

So lets say you start smoking when you are young and at some point, when you are older, you start to regret it. But at some point leading up to this you presumably enjoyed smoking. Does the fact that you regret it now, a bad feeling, outweigh all those positive feelings you got when you were younger?

I am no philosopher, but as an economist we often use rudimentary utilitarianism to think about decision making. If you could quantify all these feelings and add up all the positive ones and negative bad feelings, what would the overall outcome be? It is not so obvious.

However, when we choose to start smoking, even if we knew we would regret it with 100% certainty we may still start smoking because we discount the future. That is, we care what happens to us in the near future at a higher level than the distant (something which also comes up in climate change debates).

But even then, why do so many people think they will be able to give up? Perhaps people are overconfident or na├»ve? Or they simply do not know what being addicted to something is like, or how good they will be at overcoming addiction? 

Either way, it is extremely difficult to make the argument that people make informed choices when so many people end up regretting the choice they have made.


Banning smoking incrementally is not the same as banning smoking 

The most interesting thing about this new law is the fact that it only applies to people born after 2009.

If were to ban tobacco for everyone, it would be very different. Those addicted to tobacco would have great difficulty seeing their supply cut short. Also, and this is important, some people genuinely do enjoy smoking and have no regrets. They would suffer the most with an outright ban. 

Under the proposed legislation, all those born after 2009 do lose out on the the right to find out out if they enjoy smoking.

Where it gets a bit conceptually complicated is that the biggest losers of this generation are those that would have ended up smoking and have no regrets.

But as it is impossible to know ex ante who these people are, and given that the expected value (the most likely outcome) is that those who end up smoking will regret it, you can argue this generation will benefit from the ban on average.

The debate then become how much of the loss in the right of you finding out if you end up one of those who does not regret smoking outweighs the expected benefits of the ban for most people.

What about vaping?

If you ask most people about vaping, they think it is just as bad as smoking. This is a total failure in public health and is likely to cost countless lives. There is no such evidence that it is anywhere near as dangerous.

An interesting question here is why people think vaping is as dangerous as smoking? My hunch is as follows: smoking is putting chemicals into your body, vaping is also putting chemicals into your body in a similar way, ergo it is just as bad. I doubt people think nicotine patches are as bad as vaping, for example.

But when you tell people that vaping is not as bad as smoking, the response is there is a lot of uncertainty and no long-term studies on vaping. But you could make the exact same argument about the covid vaccine, yet the vast majority of people took it. What is going on here? 

What I will say is that selling something as highly addictive to kids is extremely wrong, even if it is not bad for their health. Perhaps if the UK state wasn't so weak at enforcing existing laws - you know, by actually prosecuting vaping shops that sell to kids - then they would not have to do things like banning flavoured vapes.

Summing up

I know some people have looked at the practicality of imposing the ban (what about tourists who smoke?) but these feel a bit cheemsy to me. 

I do take the point that there will be a black market for tobacco and that it will have negative effects such a fuelling crime. However, I can't see this having a particularly large effect, especially as there is already a black market for tobacco as it is.

I am not 100% sure whether this law is the right thing to do, but I certainly would not want my son to smoke. Other than that, he can pretty much do what he likes. 



Friday 1 March 2024

Surge Pricing, Wendy's and Fairness.

The burger chain Wendy's has been in trouble over plans to introduce surge pricing. This is when prices adjust to meet demand, so you may end up paying more for your burger and fries during busy periods. 

Surge pricing, alternatively know as dynamic pricing or price gouging, is a form of price discrimination and takes on various forms. Brian Albrecht does an excellent job of covering what it is. I would suggest you read his blog, even if you think you know what surge pricing is.

However, what I want to talk about it is why exactly people think surge pricing is unfair.

In some ways, we don't mind price discrimination if it benefits us. Happy hours in bars for instance or when you get an off-peak train tickets. However, I am not sure people view this the same as price gouging. These prices are upfront and transparent.

I think the situation most people view as price gouging is when you go into a store expecting a certain price, and suddenly they are much higher. This is especially the case if you made a special trip to the store on assumption of paying that price.* If prices become unpredictable, it would likely have a negative effect on demand for your product anyway (this is similar to the brand loyalty argument of why firms do not price gouge).

Alternatively, if you go into a store and see a huge queue, you might still be annoyed, but you are not going to start ranting about this being grossly unfair like you would if the store was price gouging.

On the face of it, waiting in line, and price gouging are not so dissimilar. Those that have a greater desire for the good are more willing to wait in line or pay a higher price. Even though waiting in line still incurs a cost (time is, in fact, money) I think there is a difference. 

Waiting in line is seen as the great leveller. It doesn't matter how rich you are, you still have to wait in line (although it does favour those that are time rich e.g. pensioners). So paying a high price for busier periods may not reflect your need for the good, but your ability to pay. 

From here, you could go down the rabbit hole over the efficacy of surge pricing but ultimately, most people simply think surge pricing is unfair (even after you have explained the logic).

A taxi driver could theoretically charge someone a lot of money if they were dying and needed to go to the hospital. But most people think this is asshole behaviour. As a society we want to discourage asshole behaviour for a variety of reasons. It is why people reject offers they feel are unfair in the ultimatum game even if this means turning down free money.

In economics, what we deem as fair or not can be viewed as a preference and preferences are what determines demand.

So the simple reason companies do not offer surge pricing is because it is not profitable for them to do so.

Getting annoyed with people that think surge pricing is unfair is like getting annoyed with people for preferring apples over oranges.




* Perhaps this is why people don't get annoyed at Uber so much as you can just simply check the app on your phone and potentially make other travel arrangements if the price is too high.



Tuesday 25 April 2023

Policies for the Young that will never happen

The older you are, the more likely you are to vote. Young people simply don't turn up for elections. This relationship seems to hold across countries and time. 







It isn't so clear why this is. One idea is that once people get used to voting, they continue to vote for the rest of their life. Sadly, this relationship makes the rest of this blog completely redundant: what political party in their right mind would target the young? 

So here is a non-exhaustive list that I will edit if anyone has any additional policies or suggested improvements. I wouldn't think to hard about it though, these policies are like deciding on the colour of the curtains... once we have colonised mars.


Policies for the Young


1. Rebrand/Abolish Tuition Fees.

Tuition fees annoy me because so many people misunderstand them. Firstly, the £9k figure only covers half of educating home students - the rest is funded by the taxpayer.

Students loans are not like normal loans. You can't go bankrupt if don't pay it back. You only start paying it back if and when you earn over £27k.*

Saying that students should be put off put off by this "debt" is like saying they would be put off by a progressive graduate tax - which essentially this is.** As a start, I would simply rebrand the current system as a "graduate tax".

If I were to go further, it would be to give young people that don't go to university access to funds for education and training . This way it would strengthen the argument to fund post-18 education through general taxation (and not have to complicate things with graduate taxes etc).

Finally, I would also have an independent body that provides accurate information on pay and destination of graduates for each course/university. Yes, there is more to university than jobs and money, but preventing potential students from seeing this information feels unfair.

2. Get Married Wherever You Want

I got married in the gardens of Durham castle on a lovely sunny day in summer 2019. Well, technically, I didn't get married there. 

In England marriage licences not only have to be given out by specific people, but specific places as well. This means either you have to spend money lugging your guests around from registry offices to other venues or pay a fortune to somewhere that has managed to get a licence and a suitable venue at the same time.

There isn't a good reason why you can't get married in your own garden or your local pub. It would make weddings cheaper and more enjoyable.

On my wedding day we had to repeat our vows inside the castle itself, about 100m away from where we said our vows for the first time, in front of the very same people. The garden didn't have a licence but the main hall of the castle did. We actually had to repeat our vows for a 3rd time as they were not sure if that particular part of the hall had the licence!

3. Digital IDs

Every few years Tony Blair comes out of the woodwork to propose ID cards and everyone mocks him for it. But you know what, if you are young, you need to carry ID with you basically all the time.

If you want to buy booze or get into clubs or, even simply buy paracetamol, you will be asked for your ID. 

I don't think this should be a physical card (although it can be an option I guess) but basically an app you open on your phone. Obviously this could be used for age verification but other things too such as your driving licence.

If you want to register for things like bank accounts or mortgage applications, or just get by in life you often need to have things like proof of address. If you rent, as most young people do, this is a massive pain. It benefits older homeowners that don't move very often and are less tech savvy. 

Having a UK digital ID could hopefully do away with a lot of form filling and I actually think a carefully designed one could reduce identity theft.

I would, however, make this digital ID entirely optional simply because there are many people concerned with privacy who have read at least one book by George Orwell. You would have to find away to reassure users they are not being tracked, and I think that could be quite a hard sell for some.

But just like with contactless payments, there will be a lot of grumbling at the start but eventually come round to how easy it is and it just becomes the norm.


4. Reform Local Democracy

The main issue I have with local democracy is this is that it is entirely dominated by people who have a lot of time on their hands or who have a bigger incentive to take part. Who might this be? No prizes for guessing older, homeowners.

This is what the make-up of parish councillors look like - it is basically a club for retirees. 



While I think there is an interesting debate on who has the right to decide what happens in a local area, the power is so overly skewed in favour of a certain group of people and results in NIMBYism.

Not exactly sure how fix this so suggestions welcome.

5 Childcare

"But there has been a policy on this" - you cry! Well, there has, but quite a lot of the policy focuses on subsidising demand rather than thinking about boosting the supply of childcare. But it really is a huge cost, and can be anywhere from £10k-£20k a year and that's even if you get a place. It is why having Grandparents near by raises fertility. 

If people are weighing up the financial costs of having a child, in a high-income country, then I think something has gone wrong.

6 Housing

So much has been written about this already: we need to build more houses. 

7. Anywhere but London

In the UK, London is the place to be. It feels so much more exciting and bigger than anywhere. All the exciting jobs are there; music, restaurants, you name it - it's there. Lot's of graduates move there and end up living in cramped houses, with over an hours commute. But it doesn't matter, because London is exciting. You are happy to be part of it all. But then commutes become long and you realise you are not really taking advantage of this massive city and end up spending all your free time in a 1 mile radius surrounding your house.

The issue comes when thinking about where to go outside of London, the jobs are not as exciting, and you feel like your missing out on something. But what if I want to go to British Museum - I can't do that in Manchester or Leeds? (You say this to yourself despite not having gone there in over 10 years). London is the free gym membership you never use. You want to keep it, just in case.

Personally, I wouldn't want to ever live in London again. I did it for 6 months but I found the commute really sapping. My commute in Durham is a 20 minute walk along the river being overlooked by the cathedral. I can meet any of my friends in less than 5 minutes and am in the countryside in no time at all. It has excellent pubs and is a 10 minute train ride in to Newcastle which has really good restaurants and an amazing music scene. 

So then why isn't everyone clamouring come and live here? I think it all boils down to two things: jobs and public transport.

I will develop this a bit further (suggestions welcome) but a good start would be for the government to make a centre outside of London - not just randomly spread across different cities.  



9. Compulsory Voting

My last policy is a potential solution to all of the above. If everyone was pushed/incentivised to vote, even if that included an option that says "I decline to vote", I think politicians would start focussing more on issues facing young people.  

If anyone has any evidence on what compulsory voting does with respect to politicians targeting the young I will add it here as I couldn't find it in my extensive literature search.***


*The policy has now recently changed again and it is £25k for students starting this year. It has changed about 4 times, which makes it really annoying giving blanket advice to graduates about their loans. 

**It is not technically the same as if you leave the country you are still liable for the loan. However, I would say it is more similar to a tax than a loan. 

***1 minute of Googling.

Saturday 22 April 2023

Is "Greedflation" happening? I'm sceptical

What is causing current inflation?

There are a number of articles saying that rather than a wage-price spiral, it is being caused by companies increasing their profit margins. In fact, even some people at the ECB are taking this view. 

When you do Econ101, one of the first things you learn how companies maximise their profits. It is also probably the first time you think economics is very far away from reality. Do companies really find their marginal revenue and equate to their marginal cost? Not a chance.

What actually happens is people think about their "mark-up". The price they sell it at vs the amount it costs. So if I sold coffee for £1 and it costs me 10p to make then my mark-up is 90p. But what price should I charge? Well, crucially this depends on demand. If you charged £100 for your coffee your mark up would be £99.90 - but no one would buy it. If you charged 11p for your coffee you would selling 100 cups of coffee would make you £1 in profit.

What I am saying here is that demand matters. If you mess about with your price a bit you will probably hit a nice sweet spot where you get the most profits (you are doing MR=MC without knowing it!).

So this is why I find it hard to buy that profits are driving inflation. Just because companies raise their price doesn't mean they will be able to sell the same amount as it should lower demand. Even if you are more likely to buy a product if you think inflation is a reasonable excuse, at some point demand is going to fall. This is especially true if wages are not rising as you literally can't afford it. You can only be spun a yawn by companies so many times before you run out of money.

You might not buy the wage-price spiral story (for what it's worth, I don't think this is what's happening now), but the reason why inflation persists in theory is that when prices increase, workers demand wage rises at least in line with inflation, which then increases demand and pushes prices up further an so on and so forth. There isn't a mechanism like this in "greedflation", there is not really a way for it to spiral.

But what about necessity goods like food, you have to buy food!? Well, yes. But it would mean we should be seeing prices fall in other areas as people spend more on food. Also, if companies are just crying wolf over inflation why are some not undercutting each other? 

Supermarkets are notoriously cutthroat when it comes to competition on price, so your story needs to explain why suddenly firms have discovered their market power and also are tacitly colluding with each other to maintain high prices. 

I don't really have an issue with profits being the cause of inflation - I just don't know how this is meant to work. At the moment, it is a slogan looking for a theory.

Friday 31 March 2023

In defence of the midwit

You have probably seen the midwit meme on social media. It often looks something like this...




The idea is to mock people who have overly complicated or counterintuitive takes. You know, the sort of person who claims "hot drinks cool you down on a hot day".

I remember first hearing about this during the pandemic with the criticism being that the government were effectively trying to play the "clever clever" midwit approach that defied basic common sense.

My view, however, is that the sort of person who gets called a midwit has three important features going for them: accepts things can be complex and counterintuitive, has a deference to expertise, and are more open to changing their mind.

The first thing to note is that some things are counterintuitive and complicated. I could easily create something that looks like a standard midwit meme but the midwit has the right take.

Trying to convince people that transport doesn't take up much of the CO2 involved in food production is hard for a number of reasons.

When you imagine carbon emissions, the first thing that comes to mind is probably something like exhaust fumes. Fumes are smelly and dirty. So it isn't difficult to associate them with something that is a bad thing. When you think about buying food, you know the food has to get there via some sort of transport that spews out these fumes. Buying food from New Zealand is really far away, so you would expect it to produce more fumes. All of these arguments are easy to buy and the logic is easy to follow.

The thing is, most people don't really have a good idea in what is involved in food production. Any guesses as to how much energy it takes to provide water or fertilisers for certain crops and animals? Or what about the different crop yields you can obtain from different types of land? This creates a much more fuzzy picture in your mind so any argument that involves these steps is going to be harder to buy. It is a classic case of vibes rather than size.

The second thing the midwit has going for it is deference to expertise. This is certainty not an in vogue view in what I see going around the wonks on twitter, and for good reason. Accepting what experts say uncritically leads to all sorts of problems, and this was especially so during the pandemic with all the behavioural science stuff and overconfident takes.

Yet on balance, I think trusting and deference to experts is probably better than being critical of them as a default position. For the most part, the people who are sceptical of experts are usually people that have already decided what their prior view is and are hard to convince about anything: think lockdown sceptics etc.

This all leads me to my last point which is that as the midwit can accept counterintuitive and complex takes, as well as deferring to experts, they should be more open to changing ones mind. For example, convincing someone that hot tea doesn't in fact make cool you down on a hot day is far easier than convincing them that distance still matters for trade in the service sector.

So, to summarise my view:


Tuesday 22 November 2022

Can Queuing Theory Explain the NHS Crisis?

The NHS is always in crisis. But I think with A&E waiting times pushing 12 hours, this certainly feels like crisis territory to me.

So what is happening? Well it seems to be to do with a lack of hospital beds - you can't admit someone if there isn't a free bed spare.

I had a look at the data and it turns out that bed occupancy has increased over the last 10 years, but only from 85% to 87.5%. I was a bit puzzled by this until someone mentioned these figures only capture availability of beds at midnight - occupancy rates can frequently hit 100% within a 24-hour period.

Still, I could quite seem to get my head round why we were seeing such long waiting times. That is until, I read about queuing theory.

Queuing theory is just as it sounds, it is the study of queues. This sounds extremely boring until you read some of the results...



This seems totally implausible! How can adding just one more teller reduce the waiting times to this extent?

We have all had to wait in a queue that seems to take forever. Inevitably, just as your edging closer to the counter, the person in front of you tries to return an item. To make matters worse, the employee can't find the right code and then has to call over their manager. You stand their tutting, clutching your muesli. 

With queues, there are number of things that can increase waiting time. The first, is the amount of people that arrive in a queue. Although usually there is a nice steady flow, people arriving every few minutes or so. Sometimes lots of people arrive at the same time due to random reasons (this resembles a Poisson distribution). Yes, the average may be 1 person every minute, but it is not improbably that 10 people arrive at once.

Another thing that can affect waiting time is the person queuing. Sometimes you only have one item and others you have a whole weekly shop.

Then you have the point of service. For example, adding more servers will decrease the amount of waiting time.

But why does adding another server reduce queue time dramatically in the above tweet? Well, one reason could be that if someone is taking ages to be served, adding another person at the counter allows one line to flow more quickly. As a result, people will self-select into the fast-flowing line and fix the backlog.

If, however, you don't fix the problem quickly, it is likely that queue continues to grow which creates a huge backlog and makes things more complicated. In a way, it is very similar to the game Tetris.


Tetris is very easy when you are in control. You just rotate the shapes around, complete your lines and keep things ticking over nicely. The problem comes when you make a mistake, or a difficult shape comes out, or things get a bit faster. Suddenly, you find things getting out of control fast. You are forced to make suboptimal decisions and before you know it, it's game over.

This is exactly what happens with queues. Once you let the queue get out of hand, it is difficult to put it right again. Sure, adding extra servers can help, but they are more helpful at the start when you can put things right again quickly as you can get back to normal service faster. But if you leave it too late, the queue is extremely large, then sorting out the mess is much, much harder. 

This can be the hard round. I think the reason for this is that most people think relationships are linear. It seems logical that if one bookshelf can store 50 books, then adding another one will store another 50 books. But just because a lot of relationships in life are linear, doesn't mean they all are. Linear thinking is probably why understanding how the coronavirus can suddenly get out of control was so difficult for many people.

We can actually see this non-linear relationship occurring in healthcare. Notice, how rejection rates (which you can think of as a proxy for queuing) increase exponentially when ICU wards get closer to full capacity. You should read the full paper (which is easy to read) to understand exactly why this happens as it is really interesting.



This does raise the question as to why we didn't build a vast number of spare beds? I think it boils down to my bete noire, the anti-waste mindset. Having hundreds of unused beds does not seem like efficient use taxpayer money, especially when they will be rarely used. 

The irony is we are going to have to spend a lot more money than we would have done if we never let the problem get out of hand in the first place.





Friday 14 October 2022

A Decade of Bizarre UK Economic Policy

If you want to beat the markets, the old adage of "buy low, sell high" is not a bad place to start. To sum up a decade of Conservative economic thinking, they appear to have gone for "sell low, buy high".

The conservative party under Cameron ran the 2010 election on the idea that Labour crashed the economy. The idea was that Labour had spent too much which led to unsustainable levels of debt. Although it was somewhat true that the debt to GDP ratio crept upwards during the New Labour years, the biggest jump occurred during the bail out of the banks as a result to a sub-prime mortgage crisis which started within the US.

"The spent too much" part is debateable and depends a lot on your politics, the "crashed the economy" part was a lie. Blaming the previous government for economic woes is nothing new. New Labour frequently referred to previous conservative government as "the boom and bust years".

Cameron's soundbite was appealing to responsible voters everywhere: we all know someone who is bad with money, gets into lots of debt and struggles to pay bills. I vaguely remember Sky news running a ticker of government debt writing it out in its full 1,500,0000,000 or whatever. 

There was a view at time that the UK could end up like Greece, which was going through a crisis of its own due to lying about the levels of government debt. In reality, this was an existential crisis of the Eurozone: why should Germany bail out the Greeks? Eventually the European central bank would step in to help Greece. But the idea that the Bank of England would not immediately be the lender of last resort to the UK was as absurd then as it is now.

In normal times, the economy is "managed" by the Bank of England who set interest rates. For example, increasing rates when inflation is high, decreases demand in the economy which should help lower prices. 

The huge recession that followed the financial crisis led to rates at extremely low levels to try and increase demand within the economy. The problem thought was that it is difficult to decrease rates lower than zero. There was, however, another way we could have increased demand in the economy...government spending.

Now many people will have certain moral and political views about austerity. From an economics point of view, austerity is simply a way for governments to reduce their budget deficits. It is now, for better or worse, associated with spending cuts. But tax rises would have the same effect. Either way, you are taking money out of the economy which will reduce demand.

So at time when demand was very low, the Cameron government decided to pursue austerity which took demand out of the economy. The rate at which the government could borrow at was extremely cheap and economic orthodoxy* would say it would have been a good time for the government to spend. Now, this "spending" didn't have to come through investment. It could have been tax cuts!

Then there was Brexit.

Brexit is a tricky one because in terms of the economic impact of Brexit, the consensus was clearly it would make the UK poorer. But economics is not just about incomes, it's also about preferences. If people were willing to trade-off sovereignty for income then so be it.

Fast forward to the present day and we are faced with a different situation. Inflation is high and the Bank of England has raised rates at the fastest we have seen for 30 years. Interest rates are no longer at zero and the debt to GDP is near 100%. 

Whether the high levels of government debt is a concern or not all depends on whether lenders think the path of debt is sustainable. There is no optimal level of debt as such but the general consensus is that it should come down. How fast this process needs to be is again something up for debate.

Truss has argued that the only way out of this mess is growth. In order to repay back the debt we need the economy to grow so we get more tax receipts and pay down the debt. This requires a bit more steps in logic from voter. It is also a complete shift in what they were told by the Cameron government 10 years earlier. It does, however, happen to be true.

Truss has gone about seeking this growth through tax cuts. Now one would think that tax cuts would simply add to demand and thus add to inflationary pressures that the UK is already seeing. But her argument is that these tax cuts increase supply. These supply-side measures are meant not only to grow the economy but also reduce the price. If you magically found a way to increase the amount of apples that would grow on trees, we would have more apples at lower prices.

The difficult here is that not many people actually believe these tax cuts will increase growth as the evidence for them is weak. Even if you an ardent supply-side supporter, will these tax cuts translate into the large increases of growth needed? I very much doubt it.

This is possibly why the markets have reacted badly to the budget - the tax cuts will do little and lead the government on an unsustainable path of debt. 

There is a case (from an economic management perspective) that it would have been much better if Cameron and Truss would have swapped places. Rather than "buy high, sell low" it would have been a lot better if we "bought low and sold high". Which is why I find the whole thing utterly bizarre. 



*I know there is some debate here over economic "orthodoxy" as some economists in the profession were concerned about debt levels. 


Sunday 9 October 2022

Vibes vs Size: Bacon, Lightbulbs and £15,000,000

Last week I was amazed to read an article in the Guardian which talked about a pub "cutting energy costs" by switching off their lights and using candles instead. Throughout the article there was absolutely no mention of the fact that this could save the pub probably no more than 1-10p (without even factoring in cost of candles). 

Why is it not well known that lightbulbs, especially LED lightbulbs, don't actually consume that much energy?* 

I recently ran a couple of workshops on statistical literacy and science communication with people from different academic backgrounds and one thing that came up was effect size.** 

When people read in the newspaper, about say bacon being linked to cancer, what do people actually do with this information? Do they eat less bacon as a result? Because even if bacon is linked to cancer, you have to eat an awful lot of bacon for there to even be a small risk and it still won't get anywhere near to the effect size of smoking.***

So one theory we came up with is that people essentially just work off vibes. That is, in order to understand the world they categorise things into simple "good" thing or bad" thing. Seeing the world this way is much simpler and easy to remember than effect sizes. We all doit. There are just so many things in the world we have to remember so we have to find some simple heuristics to help us.

For example: Fruit, fish, red meat, vegetables. I am pretty sure in your head you already categories these things into "good" and "bad". 

If you have ever been on a diet, counting calories is a real pain. To do it properly you have to not only look up the calories of each ingredient but weigh them out. This is why people often use a simple good/bad heuristic to make decision when they are on a diet. Fruit and vegetables are "good" so people on diets eat lots of them, even if that fruit is orange juice (which can have more calories than coke). 

If you think this is easy and it's just that people are stupid, how many calories would you say are in a large Domino's garlic and herb dip? And even if it is easy for you to quantify and remember effect sizes, for a large population it isn't. The thing that often happens in these sorts of situations is that the people who find it easy just say "look, it's easy" and think the people who find it hard will magically find it easy too.

This is why we need to think of ways to make heuristics as easy as possible based on the way people actually behave rather than trying to change the way they behave. If people work off vibes, then maybe think about the vibe that will be most effective. Tom Forth suggested electric things that get hot use a lot energy which is not a bad vibe to put out.

It would be good therefore if the government were to put out some simple heuristics so people would have a good grasp of effect sizes. But as my showbiz cousin pointed out, the government seemingly don't understand effect sizes themselves if it thinks £15 million is a huge amount of money to spend on an energy saving campaign (it is the equivalent of 0.0025% of the energy bills bail out). 

So in short: if people make decision based on vibes rather than size, we need to find the vibes that reflect the size.



*When you point this out to people they say "Yes, but every little helps". It is quite difficult to change someone's mind on this. To them doing a bit of good is better than doing no good at all, which is true. But in reality, it is just cope to make themselves feel better about putting on the heating rather than wearing a sweater. People like to feel good about themselves and you are just pissing on their chips.

** I think the lack of attention to effect sizes is partly down to academia. We are so concerned with establish correlation and causation that we forget the most important thing to people is often effect size. 

***I actually know someone who became a vegan for health reason and still smoked!

Sunday 2 October 2022

Why did the £ drop to its lowest ever level against the dollar?

Right, I am not going to lie. To understand what happened last week is extremely difficult to explain as you need to understand a few things before we even get to fully understand what happened. By a few things, I mean you would have to learn half of my 2nd year economics undergrad course and even then it would be hard going.

Firstly, I think it is helpful to read about how interest rates are used to control the economy, managing the trade off between inflation and unemployment. 

I then think it would be useful to understand what quantitative easing is  and money creation in general but not as important. 

These two things are hard enough as it is, before we get to the world of exchange rates and gilts.

Why do exchange rates move around in the first place? Well an exchange rate is simply the amount of one currency you would exchange for another. So at it's lowest last week, £1 would at point get you around $1.04. We tend to usually pay attention to this when we go on holiday. But primarily the exchange rate is important for trade and investment, it also works a lot like any other good.

Let's say pork pies become the must have global item and NY fashion models are demanding them on their riders along with champagne and caviar. As demand rises for pork pies from the US, they obviously can't pay the good people of Melton Mowbray in dollars, so they need to obtain pounds in order to pay for their gelatinous treat. As there is a fixed supply of pounds circulating, this leads to an increase in the price of the pound to dollars, this price is what we call the exchange rate.

What effects exchange rates frequently is interest rates. If the UK decided to raise interest rates, then people from abroad would want to take advantage of this higher rate and buy government bonds. There would be a demand for pounds which would increase the exchange rate and strengthen the pound. 

In the UK, we call government bonds "gilts" (as a result of the paper contracts having a gilded edge, apparently). These usually work a lot like the fixed-term bonds you can take out with your bank. The longer the bond, the higher the interest rate you would get. The "yield spread" is an important indicator. It measures the pay-out difference between short-term bonds and long term-bonds. A higher spread indicates the investors are more concerned about the economy in the long-run, and makes it more expensive for the government to borrow.

Now some investors will want to buy and sell currency to take advantage of small differences in price. Let's say it was suddenly announced that unemployment in the US was lower than expected, immediately the dollar would rise. The reason being is that investors think it is more likely that interest rates will rise as a result (you should now understand this if you read the first link in this blog) and people from the UK will buy US government bonds.

But why don't investors just simply wait until the Federal Reserve (the name of the US central bank) actually announce an increase in rates? Well, this is because you can lose out.

Lets say the exchange rate of pounds to dollars is 1.20. We expect the pound would get weaker against the dollar if there were a rise in interest rates in the US. As demand for dollars rises, we may think the exchange rate will end up around 1.10 in the future. So if I buy it now, I get a better deal. I can get 10 cents more for every £ I buy then if I waited (I am buying at 1.20 then 1.10). But because all investors have the same idea, the exchange rate moves extremely quickly to this new exchange rate. This is because the faster you act, the better deal you can get as you can buy closer to the old exchange rate! This process is known as arbitrage. 

Now of course this is just an expectation of the way, things work. It could turn out that interest rate rises don't actually happen in the US for various reason. The point is, these currency markets take into account future information as there is money to be made. When someone says something in the future is "price in", it means markets have already taken account of this and it is reflected in the price.

So why did the pound fall to the dollar in late September 2022? Well, trying to explain movements in the market is something we should be not overly confident about. It is quite complex to unravel everything even if the narrative sounds plausible. The first thing to note, that in the US interest rates are high and increasing, so there is already a lot of demand for dollars. 

In the UK, the trajectory of interest rates also seems high. But should this not increase demand for pounds? What's more, when the chancellor announced his new tax plans wouldn't that also add a stimulus leading to inflation, hence making it more likely interest rates would increase. Wouldn't this make the pound stronger? The simple answer is, yes. This is what we should expect. However, the markets may have been concerned that these tax cuts were unsustainable as they would be paid for by borrowing. 

This is something that George Osborne was worried about and subsequently imposed spending cuts as a result. (Although the macroeconomic conditions were very different 10 years ago  - interest rates were extremely low to the extent it was causing a problem called the zero lower bound. Oddly this resulted in not borrowing when rates were low 10 years ago and borrowing when rates are high now. Yes, this is as bad as it sounds.).

When debt is sufficiently high (and I am not sure we know how high really), markets worry that inflation will happen as a result and hence your returns are not as good, so many investors start selling off UK bonds which makes the pound weaker. 

There is a strong possibility that this is what happened to the UK. This is something that usually happens in the emerging markets when governments make unfunded fiscal promises. This perhaps wasn't helped by the governments derision of independent bodies like the Bank of England or the OBR. 

The government, however, disagree. They suggest their tax cuts are not inflationary (as in just increase demand) as they are designed to increase supply. If you increase the supply of something, you not only increase output, but you also lower the price. So supply-side policies will actually help with inflation as well as debt. This is because the economy will grow and you get more tax returns as a result. This why the government are so concerned with growth.

I actually think being concerned about growth and not just debt is a welcome move. However, I am somewhat sceptical that these can come from the tax cuts proposed, which I am also guessing the market also thought as well. I don't think they are evil or doing for their mates in the city (I wish I had friends like this). I think the government are genuine believers in supply-side logic, even if you think it is a totally mad thing to believe in.

If you have got to this point, well done. You can be rewarded by now trying to work out what happened with the pensions market, and why the Bank of England had to step in. Now, many people will say the Bank of England did QE in order to stabilise the market, but I think this is unhelpful. Especially because the Bank of England of course want to do the opposite at the moment, lower demand to control inflation. Yes, they did create money out of thin air but this is not really to increase demand. It was essentially to increase liquidity as the lender of last resort.

Liquidity is all about time. If you go to the shop and find out you have no money, you can't say to the shopkeep that you own a house so you are good for the money. You need cash to pay for it. So a liquidity problem is not necessarily about whether someone can afford it, but whether they have enough time to sell assets in something they can move on quickly like money. The more liquid something is, the more freely it moves (hence the name).

Now I must admit that I actually had no idea why the pension markets was going crazy. Higher interest rates should be good, as a lot of pensions invest in government bonds. The problem, as far as I understand it, was that pension investors "hedged" against interest rates rising so quickly. A hedge is a way of insuring yourself against something happening, hence the phrase hedging your bets. For reasons, I am not au fait with (finance is boring), this created a liquidity problem. If the Bank of England failed to act, a financial crisis was well on the cards and deep recession would follow.

Anyway, I hope this blog has made things a little clearer. But I can totally understand if you want to never think about these things ever again. 

Monday 11 July 2022

No, QE did not lead to inflation: an explainer

Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.
Milton Friedman 

I have seen the above quote a few times recently explaining inflation. Inflation, is a bit more complicated than Friedman put it. But more importantly, I think the quote can be a bit misleading. This is because a lot of people associate inflation with printing money. 

The most famous example of this is the Weimar Republic which printed large quantities of bank notes in order to pay reparations for WW1.  As a result, a loaf of bread in Berlin that cost 160 Marks in 1922 would cost 200,000,000,000 Marks in 1923.

When QE (Quantitative Easing) was proposed in 2009, some people were worried that this would result in inflation. After all isn't QE just a fancy way of saying we created money out of thin air? Some people think as QE has continued, it is in part responsible for the inflation we are currently seeing.

To understand why this view is incorrect, we need to understand how money is created. It is a common misunderstanding that money is backed by gold. This can come as a surprise to most people (a lot of conspiracy theorists actually start out with this fact).

So what is money? Well, the best way to think about money is debt. Lets say I wrote on a signed piece of paper I.O.U 1 pint. and I gave it to my you in the pub. The next day, you wanted to pay someone else, but you don't have anything else on you other than the I.O.U. Now because I am an upstanding and trustworthy citizen, this person would trust that I make good on promise of a pint, so accepted the IOU as payment (I have another blog on why trust is important for money - even Bitcoin!). In fact, this I.O.U could keep going round and round until someone came to eventually get a pint off me. 

What we have done here, is create money out of thin air.

During the middle ages in Britain, this is essentially how money worked. They would use a stick (usually hazelwood) and split it in half, one to the debtor and one to the creditor. Once the debt was paid (you gave them a ye auld homebrewed pint of ale) then the sticks would be destroyed. But because the split sticks were unique, you could trade them with other people in the same way the I.O.U was traded in the above example.

As most of the lending these days is done via banks, it "creates" most of the money we see today. Commercial banks don't print physical paper money but it is important to note that physical paper money only accounts for 3% of all money, the rest is held electronically by commercial banks. 

A common misconception is that banks get deposits in and lend them out (some even blame economists for this misconception). Banks, however, can lend without having the exact deposits to match in the same way that I can write an I.O.U for a pint without actually having the pint on me in that moment.

Now before you go all end of Fight Club on me, this does not mean the Bank of England has no control on this process. 

Your eyes may glaze over with a lot of financial jargon here but I will try and explain everything.

When the Bank of England sets it's interest rate, what it is actually doing is setting a repurchasing agreement rate with commercial banks AKA the repo rate. Commercial banks often want to borrow over the short term because they want to stabilise their reserve ratios. A reserve ratio is the amount they lend out to what they have in reserves. These reserves need to be "liquid" meaning they can be exchanged very quickly (cash is extremely liquid and can be traded straight away whereas a house is not as it would takes time to sell)

So a reserve ratio of 20% would mean a bank will have £20 in cash say to every £100 they lend out. This is important because banks that have very low reserve ratios expose themselves to a lot of risks such as bank runs.

So when the Bank of England lowers interest rates, what they are actually doing is lowering the rate at which commercial banks can borrow over the short-term which means banks are more likely to increase loans and hence...increase the money supply.*

So where does Q.E. come into this? Well Q.E. is a way of getting banks to lend out more when interest rates can't get any lower. Economists call this the "zero-lower bound" which is a stupid name, But after the financial crisis we hit the zero-lower bound in the UK and we needed to stimulate the economy. Basically, if you put rates any lower than 0%, like -1% you are paying commercial banks to borrow from you in order to get them to lend (this has actually happened in some countries). 

An alternative method to get commercial banks to lend more is to buy bonds off them. The Bank of England would credit banks with the cash which meant the liquid cash reserves of commercial banks increased. This commercial bank an incentive to lend out more to increase economic activity. The Bank simply created the cash out of thin air here, just as I did with the I.O.U. Once the bond is due, the cash is repaid to the bank and then gets destroyed (not literally, it is all done via something like Excel).

I can understand this is lot to get your head round, and I am not saying Q.E. is perfect. But what I want you to take away from this blog is that Q.E. is not some totally weird thing in terms of money creation, we have been doing it for decades with the central bank controlling interests rates. 

The idea that Q.E. is inflationary is largely down to people not understanding how money is created in the first place. 

* John Barrdear from the Bank of England helpfully pointed out that there are other ways the interest rate affects output, so I don't want to give the impression that central banks aim is to control the money supply here (most of us have moved on from the 80s). 

Wednesday 22 June 2022

The economics of unions

With the ongoing rail strikes I wanted to talk about the economics of unions. Why do some jobs have unions that you can join and others don't?

There is a simple answer to this: power.

This might sound surprising coming from an economist, but actually power is an extremely important concept for markets and we implicitly talk about it all the time.

When you hear economists talk about "competitive" markets or an increase need for "competition", the word conjures up images of John McEnroe getting in red in the face over an umpires decision. If you were to describe someone as "competitive", let's be honest here, you are saying they are a bit of a dick. The type of person who throw a monopoly board in the air if they lost.

I do think this another instance of a badly named word in economics. Competition in markets doesn't mean people actually having to be competitive in a sporting sense. All that has to happen is that no firm can have so much influence that they can determine the price alone: they do not have the power. No one can charge really high prices as there is always someone there to undercut that price. This is why we think monopolies, where we have a single producer, are bad. We think they are so bad in fact, that we have an office of fair trading that determines if markets are "competitive" enough. 

Just as there are markets for goods and services, there are also markets for work which we call the labour market. The question as to whether or not the labour market is competitive depends on a simple question: if you lost your job, how easy would it be to find another one? That is, how much power does your employer have over you. 

The reason why this is a problem, is that if an employer has a lot of power, they can give you lower wages then you would have in a competitive market. If there were a single provider of jobs, we would call this situation a monopsony.

If you think about the last time you got a raise at work, it might have been because you threatened to leave or even had an outside offer. But if you have a single employer, say you work for the NHS, how can you get an outside offer?* Unions are an attempt to rebalance this power, between the employer and workers. It is why public sectors has many unions for teachers, nurses and rail workers have unions. 

The slightly annoying thing about this is that public sector pay debates seem to come up time and time again. I would like the UK to follow a policy by economist Pedro Gomez who proposes two rules. 1) That the level of pay in the public sector should be slightly lower than the private sector due to higher job security. 2) That the rate of public sector pay should be the same over time. That is, if the average private sector pay rises by 2%, that public sector pay should increase by 2% too. This means that incentives to join the private sector over the public don't diverge over time. 

Of course you will have some debate about levels of pay in the public sector, if job conditions change or we need more nurses, for example. But talking about levels is a much better way to doit than talking about rates and avoids strikes like we are currently seeing.

Now I am not arguing that all unions and strikes correctly address this balance of power in either direction. But I wanted to highlight the economic justification for them.

What I do find slightly annoying, however, is when people give the helpful advice of "join a union" to any issue arising in the labour market. About 25% of those that are employed are currently in a union. Obviously not everyone who has the option of joining a union, does, but it won't make that figure much higher if everyone who could join a union, did.

Although decline in labour market power is one reason for bad jobs with low wages in high-income countries, it isn't the only. There are all sorts of other reasons these wages have declined such as globalisation and low productivity to name but two. Unions are not panaceas to low pay, but are certainty helpful in rebalances market power in some industries.



*Perhaps one of the most famous unions in the UK are in mining. The reason why the employer had power over workers here was due to the fact that if you lost your job in Durham say, you could not easily move to a Welsh mine. 


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