Monday, May 26, 2014

Arsonists in charge of the fire brigade

A favourite economic justification for state action is to deal with externalities--the effects on people of some action or transaction that they were not willingly a party to.  The problem with this is that the coercive nature of the state makes it a prime creator of externalities: since it has coercive power, it can force consequences on people they have not agreed to. While said coercive power makes the state, at least in theory, able to deal with externalities from private action, in practice, it makes the state a prime generator of externalities. Tyranny (taking the modern pejorative meaning, not the classical Greek technical meaning), the extreme version of forcing consequences on people they have not agreed to, is, after all, systematic negative externalities.

Democracy is supposed to make things better, by making all voters part of the political bargaining process. The problem with that is much of the art of representative politics is using the coercive power of the state to provide benefits to folk who do notice (and care and effectively politically express that noticing and caring) while shifting the costs onto those who do not. In other words, generating visible positive externalities paid for via not-usefully-noticed negative externalities. Politicians are entrepreneurs of externality. Appealing to politicians to deal with problems of externalities in general is rather like putting arsonists in charge of the fire brigade.

Which is not to say there is no benefit to democracy: a whole lot of externalities that undemocratic regimes impose are usually avoided because visible negative externalities have a rather harder time getting through when all voters are part of the political bargaining process. Nobel Memorial Laureate Amartya Sen's point that democratic countries do not suffer from famines is well taken and part of a wider process. (As Calomiris & Haber point out in Fragile by Design, democracies are less susceptible to extreme versions of the inflation tax than weak autocracies, for example.)

Of course, if groups of voters are permanently locked out of the effective political process, then the advantages in political bargaining that democracy permits will be somewhat attenuated. If folk have a weak sense of there being a common public sphere in which bargaining takes places (and is supposed to be stuck to), including various categories of other folk as not acceptable bargaining partners, democracy will also have difficulties having getting social traction to operate against even obvious negative externalities.

The jihadi critique of democracy as blasphemous is precisely because changing the law to reflect social bargains is to infringe on Allah's sovereignty, as the only legitimate law is Shariacreated by inference from the actions and words of Mohammad, God's final Messenger and Guide. More generally, taking as an affront to treat non-believers the same as believers, or folk of x skin colour the same as folk of y skin colour, rather gets in the way of effective broad social bargaining via the democratic process.

The above thoughts on politicians in representative democracies and externalities were inspired by Calomiris & Haber's discussion of the sub-prime crisis in Fragile by Design: the Political Origins of Banking Crises.

Imprudent community investment
Calomiris & Haber make it very clear that how the Community Reinvestment Act (CRA) came to operate was a central building block in the sub-prime crisis. Regulatory changes which (finally) allowed national branch banking in the US led to a wave of bank mergers, as firms tried to gain the too-big-to-fail subsidy--the implicit government guarantee which meant you could take higher risks with less capital coverage (i.e. seek more profits for any given level of capital backing). A classic example of what economists call moral hazard.

Mergers had to be approved, however, and so an alliance was forged between megabanks and community activists, notably ACORN. If megabanks undertook partnership arrangements with activist groups such as ACORN to have CRA programs run through said advocacy groups, then they would testify that the banks were "good citizens" and help get approval for the bank merger in question. If banks refused to play the game (or tried to have their own bank-run CRA programs), the activist groups would testify against the bank merger in question.

So, a winning political coalition was born. The banks got regulatory approval, the activist organisations got funding for their client base (and themselves) and politicians got credit support for low income constituents. All ultimately guaranteed by the taxpayer, but no-one consulted them. The megabuck-activist-urban politician coalition played the externality game very well. Positive externalities to people who noticed--and voted, donated, or advocated--and negative externalities to people who didn't.

The Clinton and Bush II Administrations, as well as a majority in Congress, liked this game of taxpayer-sponsored cheap credit to worthy groups so much they kept upping the ante. Regulatory and other pressure was put on Fannie Mae and Freddie Mac, government sponsored enterprises (GSEs), to "broaden" their credit provision--i.e. take on riskier and riskier low income would-be home-owners. With activist groups such as ACORN advocating and testifying in favour. The result--as having one set of standards for CRA recipients and another for other mortgagees would raise all sorts of awkward questions--was to massively shift upwards the level of risks of mortgages across the board. Which also helped protect Fannie Mae and Freddie Mac from regulatory challenge, since lots of middle class voters happily hopped on the (much) cheaper housing credit bandwagon and would not have appreciated having the cost of their home loans suddenly go up because regulators got antsie. (Thus, studies which compare CRA and non-CRA credit recipients miss the macro-point.)

As GSE's, Fannie Mae and Freddie Mac also had (implicit) government guarantees. So, someone was paying for this upward risk spiral--the taxpayers providing the implicit or explicit guarantees. But they had not been told they were being dealt into this game.

This was all not good, but it was not enough to cause the eventual sub-prime meltdown. If prudential regulation had adjusted to force adequate capital coverage, then the final collapse would not have been anywhere near as bad. But that is precisely what the regulators did not do. They refused to pick a fight that would cause them nothing but grief--remember all those middle class voters hopping on the cheap housing credit bandwagon. Plus megabanks and activist groups all poised to testify that the nasty regulators were blocking the dream of homeownership to millions of low-income, minority Americans. And not merely poised--when various folk (Republicans representing rural electorates, concerned academics, Fed Chair Alan Greenspan) expressed concerns about the level of risk being taken on, groups such as ACORN testified and lobbied to make sure that the legislative changes from the reform push expanded the risk-taking.

It was, after all, all about helping poor Americans, particularly from minority groups, achieve the dream of home-ownership. Never mind the possible consequences, feel the noble intent.

Republican House Speaker Newt Gingrich was notably active in protecting the interests of the banking-and-housing coalition. Who were (particularly the GSEs) very good at recruiting key political staffers, putting projects in key Congressional districts, etc. As Calomiris & Haber point out, being cross-Party is part of being a successful policy coalition.

Then the house of cards collapsed and the taxpayers finally discovered what they had been dealt into. Though, because "Wall Street" and "easy monetary policy" copped the blame, the full understanding of how they had been fleeced does not seem to have sunk in. As Calomiris & Haber point out, the Dodd-Frank reforms don't really address the key issues, because the megabank-activist-urban politician coalition still has the numbers in Congress. Indeed, the Obama Administration is still playing the same gameThe housing-finance-subsidised-by-the-taxpayer-house-of-cards is being rebuilt as the "winning" coalition is still in place.

As Calomiris & Haber explain in detail, the US banking system has been perennially prone to banking crises because various winning political coalitions have ensured regulatory structures which make it so. All operating on the basis of positive externalities to people who notice (and count) and negative externalities to those who don't. A long series of the arsonists being put in charge of the fire brigade.

Calomiris & Haber also point out that various countries have successfully avoided bank crises. But that is a matter for another post.

ADDENDA To clarify, and in response to a comment, the above is about the sub-prime crisis. The causes of the Great Recession are another matter.  (The sub-prime crisis no more caused the Great Recession than the Great Crash caused the Great Depression: both global economic downturns were the result of disastrous monetary policies by central banks.)

[Cross-posted at Skepticlawyer.]

Sunday, May 25, 2014

The crisis of the Eurocrats

Is the title of a post by Paul Krugman (via) I (almost) completely agree with. My favourite line:
The bitter irony here is that Europe’s elite isn’t actually technocratic. 
The most pithily and brilliantly perceptive line:
And the European elite’s habit of disguising ideology as expertise, of pretending that what it wants to do is what must be done, has created a deficit of legitimacy.
Highly recommended. 

Thursday, May 22, 2014

The Jacobin impulse

What makes the decent Left decent is not that it is Left, but what it shares with decent folk who are not of the Left. Failure to grasp that leaves one claiming that any person of the Left is morally and intellectually superior to any person of the "Right": so Pol Pot is morally and intellectually superior to, say, Winston Churchill--which is repellent nonsense.

The problem with folk such as Pol Pot, Mao Zedong, Joseph Stalin, Kim il Sung and their ilk is not that they are not of the Left--for any such claim is nonsense on stilts--but that they are too intensively Left. That is, they partake of things which make the Left, Left but do so in unrestrained ways. They are, for example, not less committed to the ideal of material equality than other members of the Left, but more so. (No matter how profoundly self-defeating any commitment to as complete as possible material equality through state action is.) They are not less committed to the notion that the Left is where one finds moral purity and social-political understanding, but more so. They are not less committed to doing what it takes to achieve the goals of the Left, but more so.

Men of the Left.
Of course, admitting that the problem with such folk is that they are too intensively Left can be very uncongenial, for it says that not only is being of the Left not an automatic ticked to moral and intellectual superiority but that there are potentially deeply problematic things within what makes being Left, Left. That much of the appeal of being Left is a sense of moral and intellectual virtue is fairly obvious--the tendency to personal abuse in response to critiques of the Left, the insistence that one cannot critique the Left unless one makes it clear "the Right" is worse, etc are pretty good markers that a sense of superior identity is being affronted in critiques of the Left. (And the greater the fear that there is something to the critique, the more resort to exorcising emotion in response.) 

It does not help that Left-and-Right is a problematic dichotomy. There is, in a (very broad) sense, the Left, because an overt commitment to equality (albeit variously conceived and to varying degrees of intensity) is a unifying value of the Left. There is no such unifying value on "the" Right, which includes folk who emphasise very different values, conceptions of people and politics. No amount of narrowing intensification of the politics of, say, Milton Friedman will get you to the politics of Adolf Hitler.

Where the Left goes seriously wrong is when it gives into the Jacobin impulse. The terms "Left" and "Right" arose in the French Revolution, that transforming accident of history, which also gave us the original Jacobins and set in motion the Jacobin impulse.

Make something worse -- add Robespierre
The Jacobin impulse is to take the moral purpose and social understanding of one's project to be so complete and all-encompassing, that no divergence from it is to be permitted and no restraint in action needs to be entertained. It is total politics--both in the ambit of its social reach and the means it is willing to employ. Adding the Jacobin impulse to any political project makes it (much) worse.  

Thus, adding the Jacobin impulse to nationalism gives us Fascism. Adding the Jacobin impulse to Aryan racism gives us Nazism. And adding the Jacobin impulse to socialism gives us Leninism and its cognates. (As Lenin himself explained.)

Robespierre -- showed folk the make-it-much-worse way.
The Jacobin impulse arose out of the very origins of the Left and is the most tempting to folk of the Left. Merely adding in the Jacobin impulse does not, however, make one of the Left--attempts to claim that Fascism and Nazism are "really" Left-wing movements are too tedious for words. Both movements may have appropriated their approach to the ambit and actions of politics from the Left, but their projects were not projects of the Left. There were (and are) left-nationalism and left-racism, but both nationalism and racism had long since escaped into very non-Left forms by the time Mussolini and Hitler were adapting Lenin's political methods to their particular political projects. 

Thus the realities of the Great War convinced Mussolini that the collectivism of nation was more powerful than the collectivism of class. But that moved him from the hard Left to the "third way" of Fascism, turning Mussolini-the-socialist into Mussolini-the-creator-of-Fascism.

The editor of Avanti, man of the Left. (Later, not so much.)
Nevertheless, the notion that one's moral and political understanding is so correct, one's goals so virtuous, and what has been created by the past so flawed, that any means can be employed to pursue them; that there is no nook or cranny of social life that should not be subject to the liberating project's transforming touch; that is a temptation that speaks most naturally and most profoundly to people on the Left. Which is why the Jacobin impulse arose out of the origins of the Left.

But the Jacobin impulse makes any project it is added to worse, because no one has anything seriously approaching that complete a level of moral purity and social understanding. Nor is any project, or its practitioners, immune to the corruptions of power--so to seek total power is to end up totally corrupt. While to commit to unrestrained means is to commit to unrestrained evil, as the core of morality is restraint in one's actions towards others.

Hence the Jacobin impulse is to be fought in all its forms. Even the petulant and petty Jacobinism of the US campus dis-invitation tendency. What is specifically wrong with such dis-invitations I will leave to Prof. Stephen Carter of Yale University to say much more humorously and effectively than I can. 

[Cross-posted at Skepticlawyer.]

Saturday, May 17, 2014

The vicious logic of equality

The Left likes to view itself as the champions of equality, compassion, tolerance and support for the oppressed. As with many people, my most dramatic experiences of the Left are of people who are entitled, self-righteous, vicious and nasty.

Some of the latter has been on display in the recent round of commencement addresses in US campuses, where the banning of "heretics" from speaking at US campuses continues to get (via) nuttier and nuttier (while remaining nasty, entitled, self-righteous, vicious and ultimately self-destructive). The science of climate has become infected with the same vicious heretic-hunting, as the recent experience of Prof. Lennart Bengtssom has shown. 

Status through equality
But I have long since realised that ostentatious commitment to equality has a huge status advantage--since social life is so multidimensional, one can always find another "axis of equality" to push. Why is that a status advantage? Because the more committed to equality one is, the more morally virtuous one is.  If one sort of equality becomes generally supported, then one shifts to another to keep ahead in the moral purity stakes.

Support for equality can thus degenerate into a fairly vicious status game. A point that applies to virtues generally, including those the Left is ostentatiously attached to. So the status game of ostentatious morality--the game of feeling morally entitled and self-righteous--generates vicious and nasty behaviour in the name of compassion and tolerance.  Robespierre's reign of virtue (which showed how to transmute alleged virtue into terror and viciousness if enough ostentatious self-righteous entitlement is applied) resonating through history, including the pale and pathetic mirrors thereof provided by petulant and privileged youth on US campuses.

Unequal equalising power
Equality specifically has a deeply vicious potential logic to it, for if equality is applied to the material things of life (beyond welfare state redistribution), then pervasive power has to be applied to ensure people do not exchange or work their way into unequal outcomes. This then sets up a profound inequality--between those to be equalised and those who do the equalising. Not merely an inequality of power (though that drives much of the consequences) but also an inequality of status and moral-historical "understanding".

The compulsorily equal and their equalising hereditary owner.
The most extreme version of this is in North Korea's bizarre dynastic Stalinism, where one family is deemed to have such transcendent status and moral-historical understanding that the entire apparatus of state (which has essentially subsumed the entire society) is directed according to their purposes. A family that includes an eternal President as well as an eternal Secretary-General and whose current ruling avatar is the third generation of such transcendent guides. All in the names of creating the perfectly equal society utterly free of every last element of exploitation and alienation. But the Kim dynasty has just turned into a dynastic principle the underlying logic of complete material equality and entitled moral purity.

This dynastic Stalinism has created a Party-state-society which is, of course, also a standing offence against such complete material equality as the ruling elite (particularly the ruling dynasty) live lives of great luxury. But that is an inevitable consequence of the gulf in power and status between those to be equalised and those doing the equalising. We can see the same logic in another state committed to material equality which (not coincidentally) has also applied the dynastic principle to leadership of the state: Cuba, were an ailing Fidel Castro has been succeeded by his younger brother Raul Castro.

If people want to see the society described by the film Elysium in real life--a small elite living luxurious and privileged lives while the masses live in the midst of decaying economic ruin--then all they have to do is to go to Havana, Cuba. As writer Michael J. Totten describes.  

Elysium: presenting us with a post-Castro Los Angeles.
Great imbalances in power have consequences: a perennial consequence of huge power imbalances throughout history has been a small elite living a luxurious existence and masses living in want. Despite the worship of "correct" historical and moral "understanding" in certain circles, equalising intentions are absolutely no protection against that perennial reflection of human nature. That the logic of material equalising generates great power inequalities is much more important a causal factor than the alleged motivation behind the power inequalities. The means chosen utterly overwhelms the alleged motivation. Indeed, this is the problem with the notion that the ends justify the means: the ends are mere intentions in the mind, the means chosen are what affects the world. So, the disastrous effect of utopian ends comes from the absolute nature of the thereby justified means

If anything, the creating-equality motivations make the effect worse, since material equality is so all-encompassing a goal there is no part of social life that power cannot justify reaching into while full equality without any exploitation or alienation is so ostentatiously "noble" a goal that almost any status game can be justified for its power-practitioners.

Elysium may or may not have been intended as critique of American capitalism: as such it is a failure. To take only one basic point, a fundamental pattern of capitalism has been the diffusion of technology through society, not its elite monopolisation.  But as a description of what a society formally dedicated to complete material equality ends up being like, the film is spot on, as North Korea and Cuba demonstrate.

The Emancipation Sequence, the long fight for equal protection of the law--from the battle against slavery and for Jewish emancipation, Catholic emancipation, votes for women, women's liberation, civil rights, queer emancipation--has been a noble and ennobling series of events in human history. But that is a world away from vicious logic of equality that leads to Havanna's Elysium on Earth, the dynastic Stalinism of North Korea or the pale, pathetic distant mirrors thereof in what the petulant and privileged fortunate heirs of other people's struggles get up to on US campuses.

ADDENDA: Yale law Professor Stephen L. Carter provides a very funny "thanks for not disinviting me" which makes some serious points on the way through.
[Cross-posted at Skepticlawyer.]

Tuesday, May 13, 2014

The free banking illusion

Reading Fragile by Design: The Political Origins of Banking Crises and Scarce Credit by Charles Calomiris and Stephen Haber continues to stimulate. As one comes to appreciate how immense the damage done by central bankers has been--causing the Great Depression, Japan's "lost decades", the Great Recessio, the Eurozone crisis--[which, I should clarify, is not the subject matter of Fragile by Designfree banking (in the sense of a banking regime without a central bank) becomes more and more attractive.

Especially as there are two excellent examples of how successful free banking can be, both covered in some detail in Fragile by Design. The first is Scotland from the late C17th until the mid C19th, when the privileges of the Bank of England were (partially) extended into Scotland, and Canada from the 1860s to the creation of the Bank of Canada in 1934. In both cases, free banking generated stable, efficient banking systems able to provide high levels of credit to their economies.

No, a monopoly in issuing banknotes is not a necessary
feature of a stable banking regime.
Case closed therefore? Alas, no. Central banks are ubiquitous in modern economies and for a simple reason--no state is willing to forego the financing advantages having a central bank gives it. A tame banker is a boon during fiscal emergencies--this is why they were created, starting with the oldest, the Sveriges Riksbank (founded 1668, the fourth oldest bank still in existence), and the second oldest, the Bank of England (founded 1694, the ninth oldest bank still in existence).

In both the above cases of free banking (Canada and Scotland), the free banking regime operated under the shelter of a central-bank-financed state. In the case of Scotland, part of the United Kingdom from 1707 onwards but sharing a common monarch since 1603 (apart from the Interregnum, when they still shared a government), the English-cum-British war machine, debt-financed as necessary via the Bank of England since 1694, protected Scotland and its free banking system (as Calomiris & Haber point out). In the case of Canada, part of the British Empire, Canada and its free banking regime was protected by the Royal Navy, also debt-financed as necessary by the Bank of England since, well, 1694.

Royal Navy: financed through the Bank of England,
also protecting free banking Scotland.
So, both the flagship cases of successful free banking regimes are also examples of why they are so rare. It is possible to have a free banking regime--in a subordinate jurisdiction protected by a central bank debt-financed war machine.

Since states are not going to give up their central banks, the trick becomes to determine the best policy regime for a given central bank to operate under. NGDP level targeting--maintaining a smooth trend in aggregate spending/aggregate income--is the best on offer at the moment.  As Lars Christensen points out, it would mean that the business cycle was entirely driven by supply shocks; as Scott Sumner points out, it would allow policy to largely leave things be; and, as the experience of Australia and Israel demonstrate, can lead to very flat business cycles even during other people's (demand-shock caused) Great Recessions.  (Yes, technically, the Reserve Bank of Australia runs a broad inflation targeting policy regime, but it largely operates as an aggregate spending smoothing policy regime.)

So, free banking: lovely idea, not going to happen. And the standard examples of why it is a lovely policy idea also demonstrate why it is not going to happen (except in subordinate jurisdictions able to have their own banking arrangements protected by central bank debt-financed as necessary war machines).

[Cross-posted at Skepticlawyer.]

Sunday, May 11, 2014

Catholicism against success (bargain keeping monarchies, or not)

Protestant monarchies have a much better survival rate than Catholic monarchies.

The ultimate willingness of the British monarchy to support broader rather than narrower social interests--in the Reform Bill crisis of 1832 and Parliament Act crisis of 1911--was in stark contrast to the performance of Bourbon monarchy in 1789-1792, the Hohenzollern monarchy under Wilhelm II (despite his support for protective legislation) or the House of Romanov under Nicholas II. Of course, the execution of Charles I and deposition of James II might have been learning experiences for the British monarchy. (In 1981, Juan Carlos of Spain proved he had "got the memo".) If there was one thing Charles I, Louis XIV and Nicholas II had in common, it was that you could not make social deals with them that stuck.

The failed Protestant monarchy in bombastic mode.
Noting that--with the exception of the (restored) Spanish and (created) Belgium monarchies--all the surviving monarchies of Europe are either Protestant (UK, Netherlands, Denmark, Norway, Sweden) or tiny (Luxembourg, Liechenstein, Monaco), with Catholic (Italy, Portugal, France, Austria) and Orthodox (Russia, Greece) national monarchies having a much higher failure rate than Protestant ones (Germany), suggests that being able to engage in (and keep) broad social bargains is a survival trait in a monarchy. (Being overthrown by Soviet occupation or Soviet-supported post-Nazi insurrection--Bulgaria, Romania, Hungary, Yugoslavia, Albania--can be discounted.) The Protestant "naked before God" all-in-this-together outlook, including different time perspectives, being an advantage over the Catholic & Orthodox absolution-available, hierarchy-rules approach.

I once heard a Serbian historian observe that edicts of religious toleration in Protestant Europe tended to stick, while those in Catholic Europe were not worth the paper they were printed on. A point that has wider implications, perhaps.  Those absolution-granting "deals with heretics don't count" priestly intermediaries may not have been a good long-term survival bet for monarchies.

[Cross-posted at Skepticlawyer.]

Saturday, May 10, 2014

An awkward wrinkle in Bagehot's dictum (or Circeronian public policy)

Bagehot’s Dictum (aka Bagehot's Rule)—that [in a financial crisis] the central bank provide money at higher interest rates to illiquid financial institutions if they are solvent (their assets are greater than their liabilities) but lets insolvent financial institutions (their liabilities are greater than their assets) fold—has, as it is usually summarised, an awkward wrinkle. Tight monetary policy can make financial institutions insolvent by increasing their liabilities and destroying their assets. As a commenter on Scott Sumner's blog nicely put it, the US GFC bailouts were as if the Fed punched financial institutions in the eye and then offered them a steak until the swelling went down.

As this post points out (citing an excellent paper [pdf] by Brad DeLong), Bagehot’s own formulation does not have that problem, since he argued for lending against what would be good collateral in normal times.

Sir Robert Peel (1788-1850)
I can very much recommend DeLong's paper to anyone interested in these issues. Having read it, I believe I was a little harsh in a preceding post on Sir Robert Peel and his Bank Charter Act (1844). Sir Robert seems to have known exactly what he was doing, insisting on 100% cover ratio for Bank of England banknotes (i.e. all its banknotes being entirely backed by gold) with the presumption that the law would simply be overridden in emergencies, thus creating a lender of last resort which was completely credible but could act as required in financial crises. Which is what happened. During actual or potential financial crises, Chancellor's of the Exchequer would issue suspension letters, suspending that part of the Act.  

Now, there is no basis in English law for suspending a statute--in whole or in part--simply as an executive act but, as DeLong says, it was apparently taken as a case of Salus populi suprema lex esto ("the needs of the people are the supreme law") and everyone just let it go through to the keeper. 

I stand by my comment that the banking school was more correct than the currency school on the basis of price level shifts with specie-convertible currency but that was not the point of what Peel was trying to do, though he no doubt found the support of the currency school helpful.

[Cross-posted at Skepticlawyer.]

Wednesday, May 7, 2014

Banking privilege as social bargaining: a nice case study

Have been reading Fragile by Design: The Political Origins of Banking Crises and Scarce Credit by Charles Calomiris and Stephen Haber. It is an excellent, and highly readable, history of banking: slides from a presentation explaining the basic thesis of the book are here (pdf). The information in the book also explains a puzzle of economic history.

Technologically, the key inventions of that set off the Industrial Revolution occurred in the later C18th. Yet, as a mass economic phenomenon, the Industrial Revolution does not really start until the 1820s. The banking history set out in Fragile by Design--that English industry was starved of credit--explains why.

Plentiful public credit
The Bank of England (BoE) was set up in 1694, to be the Crown's banker, remaining privately owned until 1946. Its role, in return for various privileges, was primarily to help the British state finance the "second hundred years war" (1689-1815) with France, which it did with brilliant success. Britain was able to spend its rival into the ground. 

The BoE's role was not to provide general private credit. In fact, the bargain struck with the BoE strangled private credit in England. No other joint-stock bank was allowed to operate within England and other banks were limited to partnerships of a maximum of six partners.

Thus, up until the 1820s, the entrepreneurs of the early Industrial Revolution in England and Wales had to essentially finance their expansion out of their own profits. 

A sign of how limited private credit was in England and Wales was that, from 1694-1825, the Bank of England changed its bank rate, on average, once every 19 years. Not exactly the sign of a dynamic credit market. (The BoE website has a complete record [pdf] of the bank rate going back to its founding.)

Free banking Scots
Scotland was in a very different situation. Prior to the Act of Union (1707), Scotland had established the legislative framework for a competitive banking industry, under a system of free banking. The result was a dynamic, innovative (and stable) banking system. Scottish banks pioneered branch banking and Scottish business had good access to credit. 

By 1825, the BoE's privileges were increasingly looking like they were no longer worth the public policy costs. France was clearly beaten. The staggering British public debt--which peaked at 268% of GDP (pdf) in 1821--accumulated in the French wars had to be paid for. (The joke at the time was that half the debt had been accumulated pushing the Bourbons off the throne of France and the other half putting them back on.) The growing manufacturing interest wanted better access to credit. Scotland provided an object lesson in what was possible. 

Changing the bargain
So, the Parliament began to chip away at the BoE's privileges. The Country Bankers Act (1826) allowed the BoE to open branches in major cities, giving better access to its banknotes, and other joint-stock banks were allowed to operate in England--but not within 65 miles of the BoE's Threadneedle St headquarters. This greatly improved access to credit for businesses in England and Wales. The Industrial Revolution began to take off seriously. During the period from 1826 to the passing of the Bank Charter Act (1844) (aka the Peel Act), the BoE changed its bank rate on average about once every 2 years. So, there was somewhat more vigour in the BoE's wider credit activities.

But the English hybrid banking system (a large privileged bank, lots of small banks shut out of the main credit market) proved to be somewhat unstable. There were bank crises in 1825 and 1836-7. Hence the "Peel Act" of 1844. Alas, giving the BoE a monopoly of new banknotes in England and Wales while insisting on 100% gold coverage for its notes--in accordance with the views of the currency school--did not provide the stability hoped for, as there were further bank crises in 1847, 1857 and 1866. When the 100% cover ratio requirement (that the value of all notes issued had to equal its gold holdings) became too much of a constraint, the regulation was simply suspended (or ignored).

The banking school understood the operation of competitive banking and convertible currency rather better than their, politically better connected, currency school rivals.

But the BoE did become a lot more active in broader credit markets--it changed its bank rate on average just under 5 times a year until the election of Abraham Lincoln as President led to the American Civil War and cotton blockade that made matters much more complicated. (From 1860-1866, the BoE changed its bank rate an average of 14 times a year--it had taken 145 years for the BoE to make its first 14 bank rate changes.) The BoE also began to grope towards a lender of last resort role, leading to the resolution of the BoE's court of directors of March 11 1858:
That habitual advances by Discount or Loan to Bill Brokers, Discount Companies and Money Dealers being calculated to lead them to rely on the assistance of the Bank of England for their security in times of pressure; Advances to Bill Brokers, Discount Companies and Money Dealers shall be confined to Loans made at the period of the Quarterly advances, or to Loans made under special and urgent circumstances which shall be communicated by the Governors at the earliest opportunity to the Court for its approval.
In other words, the BoE would be less helpful during lending booms and more discriminating in crises. In the last great British banking crisis until the GFC, the Overend & Gurney crisis of 1866, the BoE lent to those financial operations it viewed as solvent but illiquid but not those--such as Overend, Gurney & company--it viewed as insolvent under, what became known as Bagehot's dictum or Bagehot's rule. From then on, the British financial system was remarkably stable, weathering problems such as the Barings crisis of 1890, until the Global Financial Crisis of 2007-2008.

Social bargaining state
What we see in the earlier history is a rather nice example of social bargaining. The BoE is established in a rather narrow social bargain between it and the Crown. However, the Crown was able to borrow because it was a credible debtor--the constraints from the power of Parliament after the Glorious Revolution (1688) enabling it to be so. The BoE bank bargain thus feeds into a wider social bargain between the Crown and those represented in Parliament.

The development of a market for public debt (culminating in the consol from 1751) had two effects. First, it more reliably and extensively freed the English-cum-British state from the constraints of current revenue (since it could spend against future revenue now). Second, it provided an extensive elite interest in the success of the state, since they held its debt. A state they substantially directed, through Parliament.

Come the successful conclusion of the Napoleonic Wars, then the trade-offs begin to shift, as previously noted. The debt burden expanded the state's interest in developing the economic capacity of the society it derived its revenue from. So, the BoE bank bargain was re-negotiated via the mechanism of Parliament to broaden access to credit. As the Industrial Revolution took off, the British economy expanded dramatically, as did revenues, making sustained repayment of the debt increasingly easy. So the debt-to-GDP ratio shrank dramatically even as the state-revenue-to-GDP also shrank (though nowhere near as dramatically).

The economic success of the Parliamentary-bargaining British state in developing British society to sustain it was striking. In 1820, using Angus Maddison's data, the British economy was less than a sixth of the Chinese economy, by 1870 it was half the size of the Chinese economy and by 1913 it was about the same size of the Chinese economy. (By 1950, it was considerably bigger than the Chinese economy.)

The greater capacity to effectively socially bargain was the British state's great advantage over its French rival. Indeed, the inadequacy of the French monarchy's social bargaining mechanisms to manage its debt burdens is what eventually brought down the Bourbon monarchy of France.

Calomiris & Haber point out that is an advantage to be able to entrench social bargains in law, so they don't have to be continually re-negotiated. Not an option available in Islam, greatly reducing the chances of Islam developing any sort of indigenous Parliamentarism.

Developing society
A fundamental dynamic in the long run history of the state is states trying to develop the level and contours of social activity within their society that permits them to survive. They do this by establishing sufficient coercive dominance and providing public goods (notably external protection and domestic peace) and infrastructure (such as irrigation, roads, bridges, canals, dams, land clearance and reclamation) that encourages a high enough level of social and economic activity to provide them with revenue and labour.

Generally, any social bargaining involved was fairly passive. What developed in Europe (particularly North-western Europe) and Japan were rather more active levels of social bargaining. In the social bargaining with, and about, the Bank of England, we can see a state developing the capacities of its supporting society, being able to do so with dramatic success due to active social bargaining being embedded in its institutional structures. Including, making social bargains that expanded the ambit of social bargaining. It was not the archetypal autocratic state "sitting on top" of its supporting society--the ultimate expression of which was mandarin-ruled China--but a state which deeply penetrated its society and was penetrated in turn by said society.

We can also see how the pressures on public policy can shift, leading to a change in the operative social bargains. Including why the Industrial Revolution began in the 1760s but did not take off until the 1820s.

[Cross-posted at Skepticlawyer.]

Saturday, May 3, 2014

On the US world-role and the economic rise of China

This is based on comments I made here.

The World Bank reports that, on a purchasing power parity (PPP) basis, China's economy is set to become bigger than the US's while India has overtaken Japan.  China has declined the honour of being soon the world's largest economy.

The economic rise of China to becoming (at some stage) the world's biggest economy is the return of the normal pattern of world history. At least since the First Emperor (r.210-220BC), whenever China was unified, it was the world's largest single economy (with the possible exception of the Roman Empire at its height). 

Indeed, China was historically more economically "dominant" than it has any prospect of becoming in likely futures. According to the Maddison estimates, in 1820, over a third of the world’s population was in the Qing Empire, producing about a third of world GDP. This is the sort of economic “dominance” that is never likely to come China’s way again.

Economics and hegemony
Talk of the Chinese economy overtaking the size of the US economy inevitably encourages comment and speculation on the international role of the US (and of China). According to the Maddison estimates, the US economy became larger than the UK economy in 1872. The US economy did not become bigger than the Chinese economy until the late 1880s. The British economy did not become bigger than the Chinese economy until about 1910, by which time the US economy was more than twice as large as the British economy.

The US did not automatically replace Britain as the manager of the international state order simply because its economy became bigger. The Pax Britannica did not immediately become the Pax Americana. Partly, this was because adding in the British Empire shifts the economic balance. Mainly, however, because the US made little or no effort to become global hegemon or state-system manager. The US Navy, for example, remained considerably smaller than the Royal Navy until the Dynasts's War (1914-1919) and the Washington Naval Treaty (1922). 

Note that decades earlier, the UK had been easily able to beat the Qing Empire in the Anglo-Chinese War (1839-1842), the first of the Opium Wars. This despite the British economy at the time being about a fifth of the size of the Chinese economy and the population of China being about 16 times that of the UK. The difference was not Britain being able to draw on its Indian possessions, but that the British state had much higher capacity to mobilise resources. The British central government had over four times the revenue (pdf) of the Qing central government, with much greater capacity to borrow. Fighting an opponent with better military technology and organisation as well as much greater revenue: of course it was going to end badly for the Qing Empire. 

It is not merely economic or demographic size that counts. What matters is ability and willingness to project power. 

International role of the US
The biggest failing of US policy was remaking the world monetary order by creating the US Federal Reserve (by concentrating the US gold reserves, suddenly the new US central bank had about 27% [pdf] of all world gold reserves: 45% by 1923) and remaking the world state order by its intervention in the Dynasts' War and the Treaty of Versailles and then stepping back from the responsibility that came with its actions and power. The result was 1929-1945: the Great Depression, the rise of Nazism and the Dictators's War (1939-1945).

The period since 1945, when the US has taken much more of the responsibility that comes with its relative power, has been much better. Both for the world state order (i.e. general peace) and for the world monetary and economic order. On simple utilitarian grounds, an active US is to be preferred.

Not that it is a prospect any time soon, but a regime which gave us the Beijing Massacre, the Great Firewall of China, has had border wars with its neighbours, ruling a state-culture whose history was of conceiving other states as either tributaries or enemies and whose name for itself translates as “centre of the universe” [literally it means "central country" but culturally it is more like "centre of the universe"] is not a preferable prospect as global (or even regional) hegemon.  As, indeed, almost all the other states in its region agree.

[Cross-posted at Skepticlawyer.]