Good economics require action - not clever speeches and good intentions

I KNOW many readers here are not entirely convinced by my stating that economics can solve anything if left alone. Let me give you some thoughts.

Many years ago a University student at the LSE (great place by the way, the London School of Economics) called Bill Phillips decided to model the national economic processes of the United Kingdom.

The machine, called The Phillips Machine, also known as the MONIAC (Monetary National Income Analogue Computer, or Phillips Hydraulic Computer) was relatively accurate with coloured water sloshing about through tubes and adding to savings, increasing interest rates, changing taxes and all sorts.

I remember seeing it. But it had a flaw or two which sometimes resulted in it producing the equivalent of the AI advice to eat a rock a day for good health.

But the point was that as a way of illustrating cause and effect it worked just fine. As long as the person who was controlling it didn’t mess about with it too much.

And, in the same way that a school takes its lead from the head-teacher or an enterprise from the CEO or chairman, and hopefully they deliver good things, if that “head” makes a misstep or two, things very rapidly fall apart. Fiddling with the machine (for example changing two things at a time) mostly resulted in a flooded floor.

And that’s what has happened here in the UK. The coloured water sloshing about has sloshed all over the floor because the interest rate water has shot out the top – as has the one depicting taxes and government interference.

As LBJ (Lyndon Baines Johnson) said: "You do not examine legislation in the light of the benefits it will convey if properly administered, but in the light of the wrongs it would do and the harms it would cause if improperly administered."

‍I’m absolutely certain no one has looked at results but only at the one side of the equation. The law of unintended consequences reigns supreme, especially as things get more complicated. The essence of a “good deal” is that both sides are satisfied. If one side isn’t, then it isn’t going to work the way originally envisaged. I’m pretty sure ideology rather than rational thought and investigation has produced the current perfect storm.

In the same way that the conductor of an orchestra at an opera has to control all the parts (musicians, lead singers, chorus) so those controlling the nation’s finances can’t let parts get away from them.

Violins too loud so you can’t hear the singers? Playing too fast so singers have to hurry and mess up? The Conductor has to take them in hand and return them to the righteous path. But wait, I hear you cry, if there was no conductor it wouldn’t work!

But I hate to tell you it would.

Belgium, during its existence, has had lots of periods when it had no government at all and no one directing its monetary policy. At one point it lasted nearly two years and, within that period, exhibited the best performance in the EU (bar Germany).

Money (the carrot or the stick) influences our behaviour much more effectively than well-intentioned speeches.

I’m also fascinated that commentators equate Liz Truss and Rachel Reeves as both trashing the economy. Neither is true of course, and they approached the problem from diametrically opposite viewpoints.

Far be it for me to praise Liz Truss, but she had the right idea – cut taxes and grow the economy. I won’t go into why it wasn’t allowed to work – or at least try.

On the other side of the equation, Rachel Reeves has gone for piling UP taxes and spending the (borrowed) money on non-productive outcomes. Every time you meddle, you create work, waste time and lose money. Remember the coloured water sloshing about the floor?

I am indebted to Matt Kilcoyne who has written an excellent article about the California fires and the evils of proposition 103 in 1988. It seemed like a great idea. Insurance companies had to justify their prices – classic consumer protection. Except it didn’t pan out that way.

As Mr Kilcoyne’s article makes clear “Insurance companies weren’t simply prevented from raising prices – they were blocked from using modern catastrophic risk modelling to assess future dangers”.

‍Now insurance companies have to turn a profit or go bust (as does everybody else) and this was a recipe for bankruptcy. So more than half the insurance companies stopped doing it at all and effectively left the State to pick up the slack. Result? Only about 10% of the devastation is covered at all. When reality bites it is not just an adjustment, it’s an earthquake followed by a landslide – and usually another earthquake.

As Mr Kilcoyne reminds us “Friedrich Hayek taught us, prices aren’t just numbers – they’re information signals that coordinate complex human behaviour”. Fine words butter no parsnips, as my Granny used to say, and this is the very essence of the problem of people with good intentions.

If you distort the market and don’t allow it to function as a market clearing mechanism, when it is no longer sustainable far more damage will result. You cannot regulate away economic truths and reality.

The only good thing is that sometimes market distortions give outstanding opportunities for profit – but that’s another story. It was Ken Clarke, erstwhile Chancellor, who remarked that “the last person you want in the Treasury is an Economist”, and unfortunately that says it all. 

Keep on fiddling and soon enough we’ll have the IMF at the door.