Steve Hemingway

I have read Brearley and Myers. I have read a lot of books on enterprise and busines. I have read quite a bit of economics. In none of those places have I previously come across an analysis of what makes an optimal size of a firm.

I remember years ago reading something about the ease of communication and enforcing laws being a determinant of the size of countries or empires. Obviously there are problems with this when we look back on the Roman and British Empires, and think about the internet and modern communications.

On the face of it, with the market and prices being such perfect instruments for organising economic activity, it is not clear that firms are needed at all. Scott Adams of Dilbert fame has a large brand that has no employees, and I am fairly sure that Scott works at his PC in his dressing gown. How come the bosses of IBM and and Exxon do not do this?

The answer is to do with transaction costs: the price of using the price mechanism. It may be perfect, but it is not free! The argument is that the explicit arms-length contract that would have to be entered into to make someone a reasonable substitute for an employee is so complicated and costly that you really wouldn't want to bother unless the job was very simple (like operating the works canteen, or doing the cleaning).

I buy the general argument, but I'd like some numbers. I was reading a book, 'The Origin and Evolution of New Businesses' by Amar Bhidé. It simply observed that Oscar Mayer, the leading restaurant vendor of hot dogs in the US was a tiny fraction of the size of MacDonalds (and had a much smaller proportion of the market for hot dog vending market). This it put down to the influence of the founder, Ray Croc, suggesting at the very least, very slow convergence to equilibrium in these kind of markets.

This is one of those questions that business-school types seem to be uncurious about. Maybe it genuinely is a question that is not worth asking, but it would be nice for someone clearly to articulate why.

References

Wikipedia article on this topic, references Coase, who had the seminal insight.

Econtalk discussion of this with Mike Munger - highly recommended.

I don't think Economists think enough about software. I have never seen a professional economist discuss microeconomics of software production. Many businessmen fail to understand the nature of software, assuming that it can be produced in the same way that production line workers produce refrigerators, or building contractors produce tower blocks, or, possibly film producers produce films.

Two blog entries discuss the marginal cost of production of software (an new line of code?) here, and here, the second by the excellent geek Ben Laurie, the first reached through reading the comments on Ben's post.

I am not 100% sure I agree with each (which particularly look at the Open Source movement, rather than software development in general), but they are certainly not far from the correct analysis. As Baudel states, rather eloquently: "Software distinguishes itself from other works of the mind, such as music, in that its originality is by no means a part of its value or utility.".

What is certain is that to create software is to respond to a noble calling.

This letter by Tim Congdon is worth reading.

The key para is:

The second mistake is to assume that, whenever a sum of money is mentioned, an identical flow of resources is implied. In due course the allocation of money to a task does indeed often result in a flow of resources, but not always. Loans can be extended to acquire existing capital assets and repaid from the sale of those assets, and the only resources involved are the time and energies of a handful of bankers, lawyers, surveyors and so on.

Basically he's saying that replacing commercial loans with ones from the BoE and treasury is not a transfer of resources, and may not cost anything. This is clearly right as long as the assets are not that bad quality, as NR insists. I guess it is that any buyer like Olivant or VM are likely to make an offer based on a fairly pessimistic valuation of these assets. It stands to reason then, at least in my mind that the BoE might as well continue to provide capital to NR for at least a couple of years at which point the real quality of the assets should be much more apparent. To sell the bank in a panic now will surely get the wrong price. As long as the existing shares are trading the owners have the option of hanging on or selling out now and at least getting a little for their holding.

It is far from obvious to me why the 'do nothing more' option is not acceptable. There are mumblings about state aid, but a loan at a commercial rate, or a guarantee of of a loan from someone else, is not a subsidy, surely? Congdon says that the BoE loans are at a penal rate. I guess that the governments unseemly hurry to get shot of NR might mean that they know something that we don't - that the credit crunch is going to get much worse, and that we are still heading for that Minsky Moment that George Magnus keeps writing in the FT about.

I wonder if it would be better banks were required to buy deposit protection insurance commercially. I just feel that it would have been much less likely for NR to implode as it did if a commercial insurer was looking at the risks that it was running. Obviously insuring credit is a dangerous business as MBIA and Ambac have proved, but the political fallout would have been much less severe if it hadn't been the BoE / FSA / Treasury which had screwed up.

"Does Education Matter?" is the title of a book by Prof. Alison Wolf of Kings College, London. It is a wonderful book.

Oddly enough I just read this profile of Marcus Ospel, chairman and previously CEO of UBS. He left school at 17 and this didn't prevent him from rising to the top and hanging on there for a very long time.

A lot of the book is concerned with the business of vocational training in the UK and the baleful influence of the CBI on government policy. The internal contradictions in the system that lead to uncountable NVQs ('No Value Qualifications') the training courses of many of which were developed at large cost never to be gained by a single employer.

Alison Wolf what seems to be a unique combination of an economist's outlook and an education professional's deep understanding of how the education industry is structured. She points out the existence of tradeoffs that politicians seem compelled to turn a blind eye to, such as the impossibility of having a nationalised higher education industry with soviet tractor factory style targets which is nevertheless expected to deliver excellence.

Her survey of the international scene is very good, and even better is her analysis of why aspects of an education policy that is successful in one country cannot be easily imported into the UK. Not least is her explanation of why the German system of apprenticeships, which has been so successful, cannot be transferred successfully to the UK. As usual the point is that there is competition to get an apprenticeship in Germany, and therefore employers accept apprentices, not because of the skills they have acquired (e.g. BMW employs a lot of qualified bakers) but because the qualification has value as a positional good.

Unfortunately the book is not recent enough to talk about the Swedish system, the great white hope for UK primary and secondary schools. The book is eloquent in explaining why bureaucrats react to personal incentives, just like the rest of us, and not purely to achieve the goals of their organisations. I learned that there is a whole discipline dedicated to understanding this divergence (between public and private incentives) called public choice theory.

I have failed to do justice to this book. It is full of insights. You should read it, and not partial and distorted summaries, such as this.

I saw a quote recently about liquidity. An old hand was saying that it was a slippery (!) concept that even smart new traders didn't readily grasp until they didn't have any and then it became frighteningly clear.

I think the same realisation is dawning on me and a lot of other 'sophisticated' investors concerning equities. There is a widely held view that equities are solid, 'real' assets. I even heard a guy who worked for the equities division at UBS once make the comment that he worked for the bit that traded solid shares in blue-chip companies, not flakey bonds and risky fixed-interest products. The essence of equities is that they are a residual claim on the cash flows of a company after all the other claims have been met in full. They are, thus, more junior than the most junior subordinated deferrable preference shares, and certainly more junior than the most unsecured debt.

I think that part of the problem of understanding the nature of equity comes from the idea that the shareholders 'own' the company, as evidenced by the fact that they alone have a say in who the directors are, whether a takeover offer should be accepted, and whether they wish to be first in the queue to provide more capital through a rights issue. The success of the company is evidenced principally by the share price going up, without much attention being paid to the other creditors.

The alternative view, as discussed in books like Brearley and Myers, is that, in fact, the equity holders have a call option on the assets of the company, and that the strike price of this option is the value of all the other more senior obligations of the enterprise. This is clearly the case: if bonds issued by a company cannot be redeemed, then the bondholders are given all the assets of the company instead. Of course creditors form a queue and it may be that other creditor rank ahead of the bond holders, but clearly the people at the very backmost position in the queue are the shareholders.

This explains why shares are not always a good investment in times of high inflation. The idea that shares represent 'real assets' suggests that a good purging dose of inflation, as we are probably facing right now, should be good for shares. For a company with real assets - say a large manufacturer with extensive factories it owns itself - this is probably true. The problem is that other forms of credit tend to get expensive and risky in times of high inflation, so that the head of the queue are taking more of the gross cashflow. Certainly once inflation gets a hold, creditors need to be protected against the macroeconomic uncertainty of real returns and will, overall, make their credit more expensive.

In a rising market in an environment of rapid economic growth, gearing, both financial and operational, have been sought after. The amplification of profits 'attributable to shareholders' have been welcomed by boards and investors. The fact that the variance of returns, i.e. the risk of the investment, has been amplified too has been brushed aside as an of purely academic interest. The fact that Modigliani and Miller pointed out that risk-adjusted returns to equity holders were not enhanced by gearing is never mentioned by corporate financiers or boards of directors. This is no trivial observation - the pair were given a Nobel Prize in Economics in 1985 for discovering it.

Now of course we all see how clear sighted these gentlemen were. We understand that capital adequacy ratios for banks are not there just to give structured finance experts an incentive for devising more and more Byzantine off-balance-sheet ways of holding assets. We are beginning to understand why Mssrs Glass and Steagall were not simply spoilsports. We understand that it is not an unalloyed Good Thing for companies to use all of their net cashflow in buying back shares rather than paying dividends no matter how tax-efficient and EPS flattering it might be.

We have enjoyed the party while it lasted. The hangover is going to be a severe one.

At about the time I was born, two US professors looked at how gearing affects the value of a firm. They discovered that like a lot of "businessman's economics" the idea that shareholder value could be improved by the firm taking on any particular amount of debt was flawed. This is a blindingly simple insight as the discussion in Wikipedia makes clear. The two professors' names were Miller and Modigliani. Imagine two firms, identical except in respect of their capital structure. One geared, the other one not. The returns to an investor will be the same given that an investor can choose to gear his own investment in the ungeared firm by forming a portfolio composed of the equity combined with the appropriate number of bonds.

Of course governments continue to incentivise firms to gear by giving special tax advantages to debt finance relative to equity finance for reasons which are quite incomprehensible to me and clearly didn't help in creating the current fine mess we've gotten ourselves into. In principle an investing company (e.g. an investment trust) could itself benefit from the interest payments it makes on debt finance so presumably the theory actually may be valid in the presence of taxes.

The idea that risk is a knob that can be twiddled by the investor is one of the key insights which go into Modern Portfolio Theory which concludes that the market portfolio gives the best tradeoff of risk and return, and that any desired level of risk can be obtained by simply gearing it up.

The funny thing is that both these theorems, which seem pretty watertight to me, are dismissed by most real world practitioners of investment, because if market professionals behaved as if both of them were true there would be a lot less in the way of fees paid to the financial sector, both for those who arrange debt finance for companies and those who manage investments for clients.

To my mind this shows that the insights of Public Choice Theory are applicable to the financial sector. The sector behaves the way it does because of the strong incentives felt by the relatively small number of practitioners in it, even those incentives result in a net cost to the large number of savers and borrowers that the financial sector intermediates between. It seems clear that these perverse incentives have resulted in major misallocations of capital in the economy, e.g. from savers to unbankable US and UK housebuyers.

Politicians talk about new regulations so that this crisis will never happen again. I think it is pretty clear that they will miss the true cause of the crisis, because the lobbying group that benefits from the current structure of the industry is much better financed and organised than any group that ordinary providers and consumers of capital could possibly be. Committees will be set up which employ the very professionals who caused this crisis, do not understand why it arose, and who will propose the kind of detailed procedural regulation that creates large barriers to entry (and therefore ensures large economic rents to the financial sector) just like the mass or financial sector regulation that has been enacted in the past.

John Kay understands all these things and has recently written about Miller and Modigliani in the FT: Surplus Capital Not for Wimps After All. So does his former co-author Mervyn King, I'm sure. Kay also understands that regulation will simply not work, so he's definitely not going to get a call from Alistair Darling.

The Wikipedia article on the crisis grows by the day. The FT is constantly filled with news about the latest manifestation of the collapse in demand.

What worries me is that at times of crisis we look to strong men to lead us out of the mess. Arnold Kling in his recent podcast on Econtalk made the point that actually there is no economic theory to guide the likes of Hank Paulson, Ben Bernanke, Mervyn King, Gordon Brown et al. and that they really are making it up as they go along. Although it seems reasonable to preserve the financial system to allow the essential function of allocating capital and facilitating funds transfer and avoid the heavy costs of unwinding complex derivatives contracts entered into by failed investment banks, it is not clear that a transfer of huge sums from future taxpayers to the owners (and increasingly) to the managers of the banks is such a smart move in the long run.

The accepted wisdom in the 60's when we were faced with inflation was strong action. Similarly the problems of de-industrialisation in the UK at least, in the 70's, were addressed by industrial policy. The Great Depression lead to the setting up of a lot of institutions, including agricultural subsidies, Fannie Mae and Fanny Mac, and a mass of government intervention into private and public life that has never been reversed.

Looking at the home front, I am incandescent with rage that the utterly useless UK banks, which have treated their customers with undisguised contempt, and pursued a policy of ruthlessly reducing the pay (and therefore the quality) of their staff for years. I am indebted to Prof Robert Shaw for explaining how this works in his letter to the FT today.

It seems to me that what we need is not more regulation of banks, or indeed more subsidies, but more competition. The key to that is reducing the huge barriers to entry that still exist in running a bank in the UK.

This blog gives an update to the e-gold saga.

I have been a member of e-gold for a long time, but I haven't used it for anything serious, mainly because of a lack of counterparties. I was reminded of it when I listened to Russ Roberts latest podcast. It seems very odd to me that national central banks remain a nationalised monopoly provider of money. It seems obvious that there are plenty of candidates for money, and that the 'modern' reserve banking, with arcane rules for money creation all centrally controlled by a central banker, or cartel of them, can't be the right way to ensure good banking. The latest crisis certainly strengthens this conviction.

Anyway, I would recommend listening to Russell interviewing George Selgin about free banking (i.e. unregulated banking, not the absence of explicit charges for running current accounts). It's fairly clear that Russ doesn't 100% understand what George is talking about, which is what I think makes the Econtalk podcast so good. I should probably listen a second time, because I certainly got lost at various points. My previous experience of doing this, with other podcasts, though is that I am bored for most of the time and fail to understand exactly those points I mis-understood the first time through. Maybe I should get the book.

Traditional banking is occupying my hours a lot a the moment, certainly too many for me to spend long writing this. So I'll have to stop.

As I understand it, Schumpeter coined the term 'Creative Destruction' in relation to the need for new players to provided new products and services and thereby raise the productivity of the economy. The idea was that it was necessary for pioneers like Henry Ford to see the potential of the motor car, and to create firms that provided it, because firms that made horse-drawn buggies would just never adapt to the new technology, no matter how clearly individual managers saw the advantages of the new technology.

I checked on Wikipedia and discovered that Amazon, still by a large measure the largest of the online retailers, started selling books online in 1995. Clearly there were a lot of websites running before this, but Amazon had to solve problems of authentication, secure payments, identification of customers etc. which were not needed by the likes of Yahoo!. Twelve years on, banks, whether in the UK or Hong Kong, behave as if the revolution presaged by Amazon never happened. I find that to do some simple transactions from my Hang Seng account in HK I have to send pages of paperwork. Admittedly the forms may be downloaded and printed by me, but I still have to sign them with a pen, provide a copy of my ID and post them to a branch.

This clinging on to old ways of doing business would doom banks like Hang Seng (a wholly-owned subsidiary of HSBC, not exactly a minnow), if Amazon ever entered the banking area. However the heavy regulation of banks ensures that the barriers to entry are just too high. So customers are stuck with a 70's banking environment in the 21st century. Call centre operatives the world over seem to be programmed to explain that these outdated ways of operated are for the customers benefit ('for your security') although clearly they are no such thing.

It seems to me that the time is over-ripe for a proper, free, narrow, commercial, global, internet bank to emerge. The current situation is akin the the Mediaeval guild system where the incumbents reap large economic rents from their state-awarded oligopoly position. The amazing thing is that we just don't seem to care.

Downing Street are taking the unusually brave step of actually engaging with the public, albeit only through YouTube. The idea of "Ask The PM" is this: think of a question you would like Gordon Brown to answer, then post it on YouTube and the most popular entries will be answered by the Prime Minister himself. The above short clip is designed to force GB to justify his policy.

Note that I am not necessarily opposed to a wealth transfer from my generation to later ones.

I have just read "Digital Britain - the Interim Report" by Lord Carter and a bunch of the usual suspects. It makes deeply depressing reading, and illustrates, to me, the futility of having reports like this.

It's hard to know where to begin criticising it. It is written in the most contorted language:for example, "In the final Digital Britain Report, we will establish whether a long-term and sustainable second public service organisation providing competition for quality to the BBC can be defined and designed, drawing in part on Channel 4's assets and a re-cast remit. It would be a body with public service at its heart, but one which is able to develop flexible and innovative partnerships with the wider private and public sector. While it makes sense to begin by looking at public sector bodies- Channel 4 and BBC Worldwide- the Government is currently evaluating a range of options and organisational solutions for achieving such an outcome. "

It is fairly obsessed with the BBC, which it mentions 65 times, almost once per page, even though clearly this is at its heart an analogue organisation. It seems to take the view that the internet has grown in the UK largely without needing any help from the government, now it is large and important it will have to be closely regulated, controlled, restricted and managed by the public sector if it is to survive. One of the most outrageous parts of the report concerns net neutrality, which bizarrely it decides would be a barrier to the growth of the net: "Internet Service Providers can take action to manage the flow of data - the traffic - on their networks to retain levels of service to users or for other reasons. The concept of so-called 'net neutrality', requires those managing a network to refrain from taking action to manage traffic on that network. It also prevents giving to the delivery of any one service preference over the delivery of others. Net neutrality is sometimes cited by various parties in defence of internet freedom, innovation and consumer choice. The debate over possible legislation in pursuit of this goal has been stronger in the US than in the UK. Ofcom has in the past acknowledged the claims in the debate but have also acknowledged that ISPs might in future wish to offer guaranteed service levels to content providers in exchange for increased fees. In turn this could lead to differentiation of offers and promote investment in higher-speed access networks. Net neutrality regulation might prevent this sort of innovation. "

As Eric Raymond has pointed out the real problem is the monopoly position that the telco's have of controlling the local loop, which, of course, as you'd expect from a monopoly situation, very low investment.

I wrote to my MP, and in order to pad this first post in ages, I thought I'd copy the letter here:

FOR THE ATTENTION OF:

Barbara Follett MP

Stevenage

Thursday 5 February 2009 Stephen Hemingway

[my address removed]

stephen.hemingway@gmail.com

01438 221370

Dear Barbara Follett,

I was appalled at the decision of the authors of the Digital Britain Interim Report to oppose enforcement of net neutrality. It seems to me quite clear that allowing ISP's to charge content providers as well as content consumers will damage the essential "level playing field" environment that the internet currently offers to content providers. I strongly urge you to support legal enforcement of net neutrality and oppose the recommendation of the report.

Net neutrality may not be a big political issue in the UK right now, but it certainly is in the USA. Barack Obama's clear and unequivocal support for net neutrality was, in my view, a major reason why he had overwhelming support from bloggers and the "digerati" who are becoming increasingly influential in forming political opinion, whatever Hazel Blears might think. 

To my mind it's a clear choice: allow BT, Virgin Media and their ilk to set the agenda or support something that will, when it understands the issues, be overwhelmingly supported by the electorate.

Yours sincerely,

Stephen Hemingway.

Y-Combinator is a very interesting startup. Based on four trends:

1. One is hardware. Moore's law has made computer hardware effectively free.
2. Internet has made promotion free: used to have to buy advertising or PR firm; now word can spread more quickly.
3. Programming languages have gotten more advanced, more abstract; don't have to do as much work to get a given program done. Used to be that to build a startup you had to have a team of developers, five or six people writing C++; doesn't work to have that many partners, so had to hire them. Now, you can do it with just the founders, if 2-3 or them are programmers. Don't need to raise money to hire people. That's the reason there are so many more startups, and the reason they are more mobile. Anyone can do it.
4. Don't have to raise money to build a factory; don't have to be plausible, old, well-dressed to raise money. Presumably partly because so many manufacturing/other capital requirements can be leased incrementally.

It does seem a good time to start a startup. As Paul Graham has pointed out, firms like Apple and Microsoft started in the teeth of deep recessions.

I don't know where the name 'Y-combinator' comes from, but could it possibly have something to do with a chromosome that the large majority of young people (wannabe entrepreneurs, presumably) shown in the slideshow share that is absent from half the population?

HM the Queen famously asked academics at the London School of Economics why nobody saw the credit crunch coming. In fact, if the Queen took an interest in these things, she would have realised that professional economic forecasters are often spectacularly bad at forecasting big changes in GDP growth, exchange rates and practically any other macroeconomic parameter you can think of.

Medical doctors, abdominal specialists, are worse at their job of diagnosing illness than a simple algorithm based on Bayes's Theorem. Professional clinical psychologists are worse at predicting patients' behaviour than their secretaries. Political pundits are no better at forecasting political developments than the average lay-reader of the Economist, and both are much worse than a simple linear model [see Expert Political Judgement]. The voting patterns of the Supreme Court of the United States are better predicted by a simple statical program than by legal experts. Monkeys throwing darts at the FT pick better-performing stock portfolios than professional fund managers.

We know all these things, but we still look up to experts to tell us what to do, whether we are an individual investor, or Gordon Brown asking what to do about those troublesome banks. Given the problems experts have predicting the future, how can we possibly be confident that their recommendations for influencing the future will remotely reliable?

This podcast is extremely thought-provoking. It is an interview with Clifford Winston who did some research into the question of what really happens when governments act to correct what they perceive as market failure.

Our own prime minister sees market failure everywhere and is hyperactive in creating new laws and taxes to correct this market failure. Interestingly there is not much evidenced-based analysis of the outcomes of this intervention. Perhaps you will not be surprised to hear that Winston, whose book can be downloaded free from the American Enterprise Institute for Public Policy Research Regulated Markets website, concludes that intervention usually is not justified in economic terms.

What you might be surprised to hear is his conclusion that he can find no example of cases where regulation had a positive payoff. Before you dismiss this conclusion out of hand, at least listen to his interview with Russ Roberts to hear his evidence.

Various types of market-failure correcting interventions are examined, but the one that sticks in my mind is the anti-trust legislation. As Dr Winston points out, recent high-profile cases brought under this were aimed at Microsoft and Intel. If they have true monopoly power, it sure doesn't seem to be reflected in above average performance of share price!

If you follow the Econtalk link you will find a link to the downloadable version of the book. I had some trouble following this link in Google Chrome and I have not read the book. It does sound as though it is worth a look.

There are a lot of articles around saying how scandalous the behaviour of bankers has been. This is one of the better ones.

There is a massive barrier to entry into banking, erected largely by the FSA and similar regulatory agencies around the world. Although bankers complain in public about these agencies, in private they congratulate themselves and their politician stooges for enacting the legislation that give rise to these agencies. Ostensibly these agencies exist to protect the public. In practice they exist to make it prohibitively expensive for entrepreneurs to start up new banks and break into the industry.

The result of this barrier to entry is supranormal profits. Profits beyond the normal costs, including the cost of capital. These supranormal profits accrue to the scarce resource. Normally this would be the shareholders, the owners. Increasingly these are not rewarded, because the gatekeepers to these profits are the managers. In theory the board is the agent of the shareholders, but since they face essentially no incentive to provide more return than shareholders can get investing in other similarly risky assets, the residue is kept by them.

Financing costs for banks are in any case much lower than any other firm because of their special relationship with the central bank, and because savers have few choices when it comes to finding an investment that guarantees (courtesy of the government) a full return of capital.

Sadly the only solution to this problem of excess rewards to bank boards is to treat banks no differently to other enterprises, as described here. Unfortunately our leaders, and the population as a whole, have been mesmerized, to use the apposite word coined by Simon Jenkins, into thinking that such an approach to regulating banks would be suicidally reckless.

Until we resolve the problem of the power of the bankers we are, I fear, doomed to follow the exact path trodden by Japan, in the two decades since it's financial crisis of 1992.

This article by Jamie Whyte explains why it is such a bad idea for the state to interpose itself between willing producers and consumers, but also why the structure of politics makes it impossible for politicians not do exactly that. As Whyte says Alas, there is no prospect of an end to this waste, even if politicians understood it. When invisible costs are incurred for the sake of visible benefits, a politician will never consider them too great..

Terry Arthur, the author of an IEA estimate of the magnitude of this deadweight cost puts it at two-thirds of the value of tax collected, or, well over half a trillion pounds by my calculations. It seems astonishing that the bulk of those commenting on this article seem to think that this is a price well worth paying to avoid the cash nexus. This is typical of the responses:Human life has many "irrational" qualities that you ignore at your peril. Wives don't "pay" husbands to remain loyal fathers, Children don't "pay" parents to cook their meals for them. Friends don't "pay" each other for their company. Surely given the recent calamities it is clear that the gross simplification and standardization that has been brought into the understanding of human society needs to be radically changed, and that the "science" of economics needs to redefine what it can and cannot do. Then again, asking for humility and depth from a economists is like asking for an apology from a banker: a little futile..

So far so familiar. What is deeply depressing are the comments on Whyte's article. Even though this is the Times, not the Guardian or even the Morning Star the authors of the comments seem to believe that what is right and appropriate in a family environment (providing for other family members without the promise or receipt of payment) can be scaled up to work at the level of the state. Hayek called this "The Fatal Conceit". Sadly it appears to be as widespread and strongly held as ever.

This article by the evergreen Samuel Brittan shows how bad we have been hit in the UK. On a reasonable estimate, UK production is now down ten percent compared to where it would be if we had sustained the very modest 2.6% pa growth that it is estimated is consistent with non-accelerating inflation. Per capita real incomes are obviously worse affected than this since the population is clearly not dropping, whatever stories the government puts out about eastern Europeans all flooding back to Poland and the Baltic States.

A couple of years ago many commentators invoked Hyman Minsky as a guide to what we should do. As I understand his work, we cannot escape the bad effects of recessions without a large public sector to provide the 'automatic stabilizers' which maintain demand that would otherwise wither. I don't think any economist would argue against the dire effects on productivity that results from having the government account for so much (55%) of total spending in the economy. I think the massive damage to our output shows that this is a price not worth paying.

Of course, politicians are not interested in this sort of analysis. Spending other people's money to buy votes is just what they do.

This article explains how US drones operating in Afghanistan are having their unencrypted signals picked up by the Taliban for the cost of a satellite dish and a $26 piece of software.

It is typical that electronic hardware developed, typically at unbelievable cost, for the military has lower functionality than you can buy in your local branch of PC World. Who would, these days, not bother to encrypt his wireless router with at least WEP if not WPA?

Years ago I remember talking to someone who designed printed circuit boards for a living. He explained that the boards that were being used for military satellites were a generation or two behind boards in the then-current production of mobile phones. As Adam Smith observed, the bigger the demand for a product, the cheaper it is produced. Our image of a supply-demand curve is that as the quantity demanded goes up so does the price. But of course a big demand translates into large volumes of production which then allows the development of more specialisation and investment in production equipment. To hand-craft a cheap modern car would cost millions, even using current metal working equipment. Because there is huge production there can be whole factories devoted to production of the tiniest component which then is available at fantastic quality for very low price.

Thanks to FGH for alerting me to the drone story.

Austin Mitchell is the only Labour MP whose blog is in my blogroll. He's old and ill, and held in complete contempt by NuLab and its acolytes. His blogging is less frequent and scrappier now, but he does continue to speak truth unto The Net.

This post makes a very valid point: that if Tony had got his way and we entered the Eurozone ten years ago, our economy would now be completely screwed. What he does not say, however, is that in order to get out of this mess we're going to have devalue the currency and have a raging dose of inflation. This will save the economy, but only by sacrificing the savings of the old and the middle class, but since when did Gordan care a damn about them?

Three white-collar convicts are chatting over their daily prison meal.

"What are you guys in for?" asks convict one.

"I set my prices too low and was convicted of predatory pricing" says convict two.

"Funny, my prices were higher then my competition and they hit me with monopoly pricing" says convict three.

"Ha! My prices were exactly the same as my competitors and they threw the book at me for collusion" says convict one in response.

This is a joke shamelessly stolen from the What the Hell do I Know? blog.

Basically, the argument is that there is no evidence that "competition authorities" have ever actually done any good in terms of levelling the playing field between producer and consumer. The reason is that cartels and monopolies naturally implode as economic rents attract the interest of firms in different industries, and different countries. Of course trade barriers in the form of tariffs slow down this process, and heavy regulation of the industry within a country also does. Clearly, in the case of services that Google provides, neither of these factors apply.

The political class of course is much more comfortable launching this kind of investigation than one into competition, say, in banking services, or utilities, or telecommunications services, fixed or mobile, or broadband provision, because the management of companies in these industries have taken great care to develop strong relationships with politicians. Did I really say that?

A tax on FX (and possibly other) financial transactions is spectacularly bad. Generally all new taxes are bad, as at least the winners and losers from the old taxes have their gains and losses capitalised and stable. This article from the TPA is the most comprehensive demolition job I've come across, but generally every serious article that has been written about it has concluded that it is a unusually bonkers idea.

I know that Milton Friedman made some comment about the fact that he'd never seen a tax cut that he didn't like, and that reducing taxes had the effect of 'starving the beast' (of big government). I don't think that even he would have argued for a government that didn't raise tax for defence and the administration and enforcement of the law. My personal view is that most transfer payments (which, strictly speaking, are not government spending at all) are justified, and these are going to be a big part of spending for a long time to come.

We already have a tax on transactions: stamp duty. This is a disastrous tax, which John Major, when he was chancellor, promised to abolish. So much for promises made by politicians - from the Right or the Left. Sadly, I notice that some Tories are in favour of the tax. Once upon a time the Conservative Party wanted a smaller state.

Read This article by Simon Jenkins.

He points out that banks and bankers have done very well indeed out of the bailouts that have characterised the response to the 2007 credit crunch.

I agree with everything that Simon Jenkins says, but I think we have to examine how we got into this mess. We have given quantities of money to the banks that are enough to bankrupt the country. This is because banks have huge influence, which is linked to the fact that they get such favourable treatment from the government. From the banks' point of view this is a virtuous circle. From the point of view of the rest of us, it is a disaster. The massive regulatory burden makes it very difficult for new startups to challenge the banks, which lead to their supranormal profits. These excess profits do not need to be paid to shareholders, because they have nowhere else to go: they are captured by the employees, who individually become enormously powerful. It was not entirely a coincidence that Gordon Brown just happened to be at a cocktail party with Victor Blank, chairman of Lloyds TSB, when he was told that HBOS needed rescuing.

This would not matter so much except in that the state has developed taxation to an extraordinary degree, so that now it is quite feasible for the government to hand over about a tenth of the UK GDP just to prop up a few banks that should have failed. One hundred and thirty-one billion pounds is a lot of money in anyone's language: more even than it costs to run the NHS for a year!

Most governments live in a kind of parallel universe where there are no tradeoffs. They seem to believe that taxes can be increased without limit without compromising the ability of the productive sector to pay. Just listen to Peter Mandelson talking about all the jobs he is creating by increasing government spending on this and that, and try to catch the point where he admits that by increasing taxes and reducing the post-tax income of individuals, he will inevitably destroy jobs, now or in the future.

The problem with democracies is that they work by bribing electors with their own money. Or in the case of the Greeks, the taxes of of rich neighbouring states. The problem is that, eventually, this state-sponsored Ponzi scheme collapses in sovereign default or rampant inflation.

Darling's budget was the usual politics-as-theatre show that so damages politics as a means of deciding about things in a grown-up way. As usual it comes down to individual bloggers like Wat Tyler and independent pressure groups like the Taxpayers Alliance to make sense of what is happening.

The major problem is that we, like Greece, cannot run up debts indefinitely without suffering the consequences. That is, we, the taxpayers, cannot dodge the consequences, but of course the politicians can, with their 'resettlement allowances' and consultancy fees.

Amazingly the BBC put a lot of emphasis on the fact that the deficit for this year will actually come in slightly below the forecast £178 billion. No mention, naturally, was made of the off-balance-sheet liabilities that mean that the public sector debt of £1.4 trillion is actually only around half of the true figure. Yes, we are talking about £2.8 billion here. Just to put that in context, that means around £47,000 for every man woman and child in the UK. According to the ONS there are 22.76 million people employed in the private sector, which means that out of their taxes, and the taxes of their private-sector children they are going to have to come up with a sum of £120,000 each.

But it's actually a lot worse than that, because before long interest payments on the national debt alone will be costing 10% of GDP. The unfunded liabilities held off the balance sheet will also be growing at some inflationary rate, so will increase the burden just as much as the on-balance sheet liabilities. The end result is a huge, utterly huge, burden of debt for the country for a generation or two.

I know that Gids rambles on about how serious the deficit is, but I think that most voters just think 'yeah, yeah, yeah, but we can just introduce a caviar tax, or stamp duty on Rolexes and everything will be fine'. I suppose this is a rational response to the fact that there are around 40 million people in the UK who are either not working, or working in the public sector. Of these, approx 14 million are under 18, leaving 26 million voters who may well be dependent on the generosity of the government (i.e. the taxpayer) for their income. Obviously there will be some non-working spouses and people with private income in there somewhere. However, what we are left with is around twenty six million out of a total of 48 million voters who, on balance, will prefer to see taxes go up than go down. This is about 54%. No wonder all parties are being economical with the truth.

I have heard a theory that, actually, David Cameron would prefer to see Gordon Brown win the next election, on the basis that the pain and suffering that is going to be inflicted on the population, through 'cuts' and increased taxes is going to be so severe that whichever government is in power when this is happening will be then unelectable for a generation: the so-called 'poisoned chalice election' theory.

There is, of course, an alternative to all this pain. We look to that master of economic theory, Robert Mugabe, and let the pound take the strain, stitching up those nice Chinese lenders, but, as an unfortunate side effect, wiping out the savings and pensions of a vast swathe of the population through rampant inflation. Currently the gilts markets don't buy into this theory, but Bill Gross, who has made more than his fair share of good calls on government bond markets in his long career is not so convinced.

I have been in love with Dilbert for a long time. It's funny how popular he is, because it presumably means that lots of people understand the underlying message of the strip, which is that bad decisions happen all the time in real businesses because of perverse incentives experienced by everyone, but particularly by management.

I knew a guy who was, and possibly still is, in a senior management role who was a fan. I always thought of him as a bit pointy-haired, but he clearly admired the strip. Maybe he just saw the funny side of his own position.

The above strip (sorry if it doesn't fit properly in my narrow content column - just click on the image to see the whole thing on Scott Adam's site, is the first in a series about how the latest CEO drags along a series of cronies with him and puts them in senior positions for which they are ill suited. The joke is how management knows nothing about what the company actually does, but it's OK because they know about important things like negotiation and marketing, and tax planning, and mission statements.

I tend, as regular readers will have noticed, to try to understand what happens in the world of commerce using the tools of economics. I think that when it comes to companies and society, the tools of anthropology probably are as relevant. Dilbert is about inter-tribal conflict: the engineers against the managers, the senior managers against the workers, the engineers against the support staff, the engineers against the sales staff, and so on. We need to belong to a tribe, and we want to support other members of our tribe. Managers are not in the same tribe as shareholders, or ordinary workers and so are happy to screw both of them. The board at Goldman Sachs are, plausibly, in the same tribe as the workers, and, although they have pretty daunting initiation rituals, they do not treat them as badly as, say, the board of an engineering company treats the shop-floor workers.

I have to acknowledge a debt of gratitude to Flip Chart Fairy Tales for this insight into the idea of how tribalism is more important in setting worker compensation than anything strictly to do with added value and merit or even supply and demand for workers with the relevant skills. It seems that Barbara Wootton understood this and wrote about it in her 1955 book "Social Foundations of Wages Policy", which, unusually, seems difficult to get hold of.

Gillian Tett has said that her training in social anthropology was hugely helpful in understanding how the credit crunch developed. She studied for a PhD on the subject. I'd like a simple primer to get me started on understanding the basic principles of this obscure discipline. Anyone got any suggestions?

The Tories are having a go at the other lot for putting up NICs, again. The other lot point out that the Tories did it when they had a chance. They also point out that unemployment does not seem to go up when the tax is levied.

As Chris Dillow points out, both sides are being characteristically economical with the truth about NICs: because in fact, the incidence of this tax, like all the others, is not born by the intermediaries. Obviously there are questions of whether or not employers can pass on costs, and whether this is in the long run or the short run, but basically corporates do not pay taxes themselves: they pass them on to shareholders, or employees, or suppliers, or someone else. After all, a company is just a formalized scheme of arrangement between various classes of creditor.