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Thim Harford lambasts the Robin Hood Tax campaign:

The basic proposition of the RHT is that it is a tiny tiny tax which will raise a humongous sum of money. Nobody is really going to have to pay it – ‘coz it’s so very tiny – but if anyone does, it will be bankers. (If you think I am exaggerating go and look at the video again.) The tax may or may not be intended to reduce volatility. My tentative answer is: the RHT is a very large tax with an uncertain incidence. We don’t know who will pay it, but $400bn is a lot of money so let’s not act like it’s going to come from nowhere. It might reduce volatility but the balance of both theory and evidence is that it won’t.

I have much more confidence in my other conclusion: that the RHT campaign has little or no interest in the evidence.

My view on the Robin Hood Tax is here.  Duncan Green does not agree.

Laura Freschi at AidWatch lists four ways in which the brain drain from Africa is a good thing. Her analysis includes (a) gains to the migrants; (b) gains to the migrants’ families; (c)the benefits of exchange of ideas; and (d) the stimulation of the accumulation of skills.

This is consistent with what Michael Clemens at CGD has been saying for a while. (Take a look at his very accessible and interesting article in Foreign Policy, for example).

Yet it remains the received wisdom that industrialised countries should do more to prevent workers from moving from developing countries to rich countries.  There is an unappealing alliance between the development activists and the unions to limit the use of medical professionals in the British National Health Service.

It is becoming increasingly clear that preventing people from developing countries from accessing the labour market in developed country impoverishes poor nations in a the same way as preventing access to our markets for goods and services.  Yet this is a campaign that development advocates are strangely reluctant to take on.

No less a scholar than Bill Nighy urges us to support a “Robin Hood Tax” to take money from the bankers and speculators and give to the poor.

The Robin Hood tax appears at first sight to be a way to kill three fairly succulent birds with one stone.  It offers an attractive combination of:

1. Higher taxes on the wealthy, so reducing inequality
2. A curb on speculation and financial market excesses
3. More money for global public goods and aid.

All these are worthy objectives, but Robin Hood tax is not a good way to achieve any of them.

Branding a financial transaction tax as a “Robin Hood tax” which takes from the rich and gives to the poor is a brilliant piece of communications.  (Imagine if it had been called a “Class War tax” – this says more or less the same thing but somehow seems less appealing.)  A Robin Hood tax lures many people who care about social justice, and want to spend more on international development, into opportunistically supporting the introduction of a tax on financial market transactions.  But before we are seduced we should take a hard look at whether it will achieve what we want.

Stand and Deliver!

The campaign would like us to believe that this tax will be paid by speculators.  That isn’t true, of course.  It is like thinking that beer duty is paid personally by the barman in the pub, or that Richard Branson personally forks out for your airline passenger duty.  The people on whom a tax is levied generally pass it on to someone else: their customers, employees, suppliers or shareholders.  We don’t know who will end up bearing a financial transactions tax, but it is likely to be all of us who meet the costs, as customers of firms that use financial markets, or savers whose money is invested in financial assets.  You should not assume that it will mean less champagne for people who work in the City: they may be in-bred aristocrats but they are probably smart enough to figure out quite quickly that they should pass on the cost to someone else.

If we want to tax the rich more, there are much more effective ways to do it than to tax financial transactions – ways which might actually fall on the rich, and catch a much bigger spread of rich people than a transactions tax.  For example, you could raise much more money from the rich by extending National Insurance charges to all capital income (eg interest, capital gains, dividends and rent) rather than imposing it only on labour income.  You could also abolish the upper earnings limit on National Insurance.  You could close loopholes for non-domiciles and people who use trusts to avoid inheritance tax; or simply raise the top rate of income tax.  You could treat all inheritance as income in the hands of the beneficiary, and tax it accordingly.  Any of these would be a more targeted and fairer way of increasing taxes on the rich than a financial transaction tax.

Reducing volatility

Financial markets play an important role in the real world by channelling our savings to investments with higher returns and enabling us to share risks.  In well-functioning markets, allocating money to businesses that meet the needs of their customers and so make a good return tends to benefit all of us – whether we are investors, customers or employees of these firms.  For this allocation of resources to happen well, the prices of financial assets had better reflect their true underlying value, at least most of the time, and we are all worse off if financial asset values deviate for long periods from what the underlying businesses are really worth.  But there are plenty of structural problems in the financial services industry that make it likely that financial assets may in fact be mispriced some of the time.  These include the incentives created by bonuses (for example, linking bonuses to the value of a deal as predicted by firms’ financial models rather than the value that is eventually realised) and the rise of institutions that are “too big to fail” and therefore enjoy the implicit subsidy of a public guarantee.

However, it is hard to see how the existence of speculators, arbitrage and – most of all – liquid and highly traded markets make financial markets less effective.  In most cases, we would expect markets with lots of buyers and sellers to do a better job of identifying the underlying value of assets than markets with relatively few transactions.  Speculators generally make money when they correctly assess that a market price does not reflect the real value of the asset. George Soros made money from Black Wednesday when he judged that the value of the pound in the Exchange Rate Mechanism did not reflect what it was really worth (because the government was trying to sustain a higher value for the pound).   By betting on that judgement, Soros helped to bring about the change in price that he was predicting, and so accelerated the alignment of the asset price with its true underlying worth.

A small turnover tax is likely to deter the small-scale arbitrage that helps to reduce the short-term discrepancies between prices, making markets marginally less transparent and  slightly less efficient.  It probably won’t make any difference to the big misalignments, such as asset price bubbles. The short term gains to traders from buying in a rising market will far exceed the cost of any turnover tax, so they’ll continue to get behind bull markets. Their behaviour is only likely to be moderated if they can be made to bear some of the costs of the future correction, instead of just getting the rewards when the bubble inflates.  It is theoretically possible that a reduction in turnover will make a market more stable and less volatile (this was James Tobin’s point about “throwing sand in the wheels”), but it is the less likely outcome; more likely the opposite is true.

If we want our financial markets to work better, we should be looking at the causes of the volatility and misalignments.  It is not the number of speculators, or the number of transactions in which they engage, but rather the incentives they face. Asymmetric bonuses which reward gains but do not punish losses encourage risk taking and short-termism.  Institutions that are too big to fail will take bigger risks than they would without the implicit guarantee of a bail out. Insufficient competition between financial firms allows rent-seeking by monopolists.   The privatisation of gains but socialisation of losses creates perverse incentives.  If we want to tackle financial instability and misallocation of resources we need to address the root causes, not reach for a tax on transactions which is likely to hinder, rather than help, the ability of markets to correct themselves.

Raising money for good causes

So by now you think I’m being prissy.  So what if a new tax does not redistribute money from the rich or make financial markets work better?  It will raise a shed-load of money by taxing transactions in a way that nobody will notice, and we can use that to do good things on poverty and climate change. If taxation is the art of plucking the goose with the minimum of hissing, surely this is a sure fire way to get some money out of the system to spend on development which is woefully underfunded?

Well, not really.  Good taxes are not just taxes that nobody notices, but taxes that tend to discourage people from doing bad things and encourage people to do good things; which add to rather than subtract from economic efficiency.   There are lots of taxes that citizens don’t pay directly – such as corporation tax and employer national insurance contributions – which nonetheless add to the burden on ordinary taxpayers and the size of which is a matter of political debate.  Adding a new tax is not going to make citizens more willing to see an increase in the overall tax burden.

Aid spending is pitifully small relative to need.  As a nation we are spending much less than we should if we want to live up to our commitment to spare no effort to ensure that poverty is reduced, that mothers do not die while pregnant, that children go to school and that everyone has access to the water and health care that they need.

The amounts in question are tiny relative to total government revenues. Aid is a small fraction of overall spending and could easily be increased without any new taxes.   The limit to aid is not lack of available money, but the lack of agreement that this is a priority for spending more of the nation’s money.  Too many people believe – wrongly, in my view – that aid is not effective; that it transfers money from poor people in rich countries to rich people in poor countries; that much of it is lost in corruption or waste; and that it does as much to hinder as to help countries to grow and lift themselves out of poverty.  Those attitudes are not going to change because we have introduced a new tax.

The development industry is right to say we should spend more on aid, but we are losing the argument.  Instead of addressing the criticisms by demonstrating how aid is effective (and taking steps to make it more effective where it isn’t) we are turning to a Robin Hood tax apparently in the hope of bypassing public opinion.   Because the chattering classes (which clearly includes me) have failed to persuade enough men and women that it is a good idea to spend more money on aid as well as on the National Health Service and schools, we are apparently hoping to go over their heads, by setting up a source of funding over which ordinary people will have no control

But that is not how the system works, nor should it be.  The nation’s willingness to give money for development will be decided by whether we demonstrate the results, and whether we can really convince people that their money is being properly used.  Introducing a new tax dedicated to what we think are good causes may give aid a temporary boost, but if people are not convinced that they want their money to go on aid they will quickly demand that budgets elsewhere are reduced accordingly.   In the long run, this will have the opposite effect: a tax part of which is dedicated automatically to development will engender even more complacency in the development industry about the need to demonstrate to taxpayers how their money is being used.

Building support for development is not merely a communications challenge, as is often implied by the hand-wringing of the big aid agencies: it is a reality challenge.  Not only do we have to show people how their aid is used, we actually have to make aid more effective, more transparent and more accountable, so that we drive up performance.

Dambisa Moyo is right that bad aid does not work; but she is wrong to claim that all aid is bad aid.  She is wrong to claim that aid does more harm than good. There is a lot of hugely effective aid which transforms people’s lives every day.  But the aid industry lacks sufficient mechanisms to drive bad aid out of the system, to spend more money well, and to be able to demonstrate conclusively its results.  This, rather than a Robin Hood tax, should be the agenda for genuine progressives who want to see more money being spent on international development.

I have explained here before another reason why a Tobin Tax is a bad way of raising money for aid.  Financial markets tend to be highly cyclical – there is a lot of turnover in rising markets in economic booms, and the markets tend to go quiet in recessions.  So the revenues of such a tax would be highly cyclical – more money for development in global economic booms, less in global downturns.  Yet aid should be the opposite. It is needed most of all to protect the weak and vulnerable from economic downturns.  Aid is already too cyclical, exacerbating the impact of global economic fluctuations on developing countries, reinforcing the effects of changes in revenues from commodities, investment and remittances.  The last thing developing countries need is for aid to become even more cyclical than it is today.

Conclusion

The backers of the Robin Hood tax are on the side of good and there is no denying their commitment to social justice, nor their genius for communications and popular engagement.  We certainly need what the tax seems to offer: more redistributive taxation, a curb on financial market excesses, and more money for aid.

My reservation is not that the Robin Hood tax is too ambitious or that it cannot be negotiated. It is that it is the wrong way to address these problems.   Each of the three objectives is better addressed directly than through the blunt instrument of a tax on financial transactions.  We need to build a consensus that there are minimum standards of living below which no person anywhere in the world should be allowed to fall, and that those of us who are fortunate to live comfortably should all make a modest contribution to that.  This should be part of the social contract in a democratic society, and it should be part of the mainstream system of taxing and spending.   Robin Hood stole from the rich and gave to the poor at a time when we lacked institutions to tackle poverty and redistribute income.   A Robin Hood tax is no more a lasting solution to financing poverty reduction than was the approach of Robin Hood himself.

Update:  Duncan Green from Oxfam has responded here.  We agree that this is not a good way to curb the excesses of the financial services industry.  Duncan reckons “the banks” will pay a good part of the tax: presumably he means the shareholders.  If so, why not just levy an additional profit tax on banks?  I think his strongest argument is that in a world of second best, this is the best available option for raising more money.   I think that is a mistake. We can and should make the case for aid to be financed properly; and I do not believe that raising money this way will add additional funding to development in anything but the very short tem unless we address rather than try to sidestep people’s concerns.

One argument that aid sceptics like to use – often without really understanding it – is that aid damages recipient countries through a macroeconomic effect known as “Dutch Disease”.  The issue has been raised again in a new working paper: so let’s go back to basics and think about what is going on and whether recipient countries are being harmed by aid.  My conclusion is that it is highly unlikely that aid could be harmful overall to a country’e economic development through Dutch Disease, and that – notwithstanding how it is sometimes presented – the econometric research does not imply that it is.

Raghuram Rajan and Arvind Subramanian argue in a new CGD Working Paper that aid inflows reduce the relative growth rate of exportable industries; and they find some evidence that aid inflows cause a real exchange rate appreciation. They say that this effect helps to explain why there is, in their view, little robust evidence that aid leads to economic growth.  Raghuram Rajan and Arvind Subramanian are both smart people, but I don’t think the evidence they present leads to the conclusion they want us to reach.

Where we agree: trade is good for growth

I am pretty sure that everyone agrees with the following:

• The growth of trade is good for growth and development.
  There are essentially no examples of economic development that have not involved rapid export growth.
• In a static welfare sense, exports are a cost not a benefit.
  Exports are the price a country has to pay to be able to afford imports.  In a static world (just comparing two states of the world, rather than thinking about what causes economic growth) a country is better off if it can make fewer goods for export and still afford the same level of imports. (Normally this isn’t possible but it happens in the special case of a country receiving foreign aid.)
• There are dynamic benefits from trade which might come from exports, imports, or both.
  We know that trading economies grow more quickly than closed economies.  The long-term compound effects of this growth are a key driver of development.  We don’t know if the dynamic benefits of trade come mainly from exports (e.g. because firms which compete in foreign markets are forced to raise their productivity) or mainly from imports (e.g. because capital goods like machines, and intermediate goods, are imported; imported products are copied locally; knowledge and skill are imported).   If exports and imports both go down, this is likely to be bad for the economy. But if exports go down and imports go up, we don’t know what effect this will have.

The direct impact of foreign aid

Foreign aid has both direct impacts (it increases particular kinds of spending and consumption) and indirect impacts (the changing composition of the economy may affect long-term growth; or the investments financed by aid may effect growth).  Let’s look first at the direct effects.

• The immediate effect of using foreign aid must be to increase the real value of imports relative to exports.
  You don’t need a regression to tell you this: it is an accounting fact. Aid is a gift of goods and services from abroad, or foreign currency which can only be used to pay for imports now or in the future.  Aid means that people in the recipient country get to consume things made abroad that they do not have to pay for with exports.  That means that the direct effect of using aid must be  some combination of (a) additional imports and (b) a shift of productive resources (e.g. people and land) from producing for exports to producing for home consumption without forgoing imports.   So the ratio of imports to exports must rise compared to what it would have been without the aid: there is no way to stop this other than to stop giving or using aid.   It also means that exports must fall as a share of income as a direct result of the aid.  This is not the Dutch Disease effect: it is simple arithmetic.
• The size of the effect on exports depends on the way aid is used
  How much imports will increase and exports fall depends on two things: the composition of the additional demand, and the extent to which there are unemployed resources in the economy.  Some of the aid arrives in the form of goods and services from abroad (e.g. food aid, foreign consultants).  Other aid is spent directly on additional imports (e.g. pharmaceuticals, project vehicles, building materials). These additional imports have no effect on exports.  But some aid is spent on “non-tradable” services, such as paying for teachers or construction workers, who are employed locally. If there are unemployed people who are able and willing do these jobs, then total labour supply increases and there is no effect on exports.  But if supply is scarce, as it might be of skilled labour, then the scarce inputs (e.g. labour) for these activities have to be pulled in from the tradable sector (e.g. export industries). This competition for scarce productive resources increases the price of non-tradables relative to tradables, and may result in a contraction of exports (compared to what they would have been).  This is the Dutch Disease effect.
• These direct effects unambiguously increase income and welfare of the recipient country.
  All these direct effects are welfare-enhancing.  There is an increase in imports that does not have to be paid for  which increases incomes and consumption.  Exports go down but only because the resources that were needed to produce them are shifted to non-tradable production, while the imports they were needed to pay for continue.  National income goes up by the value of the aid. (Somehow people seem to forget that income equals what is produced locally plus the value of the aid; so even if local production fell, it would need to fall by more than the value of the aid for incomes to fall overall).

What are the indirect effects of aid on exports, GDP and income?

If the story stopped with the direct effects of aid, there would be no dispute.  A permanent inflow of aid worth 5% of GDP increases national income by 5% and the country is better off.  Now lets see what happens when that works through the economy.  Here are four indirect effects we need to consider:

• Aid may raise productivity and so increase the growth of both tradables and non-tradables
  If aid is spent well it can increase productivity in lots of ways: by providing infrastructure, educating people, increasing security, reducing disease etc.   In principle these effects on productivity and growth could be large (for example, getting rid of malaria has been estimated to add about 0.5 percentage points to the growth rate in countries of high prevalence).
• Aid may change the composition of the economy and so change the average growth rate
  If non-tradables increase as a share of total income, and if non-tradables tend to grow more slowly than tradables, then this will – as matter of arithmentic – reduce the average growth rate.  (This effect is an order of magnitude smaller than the above – at most about 0.05 percentage points on the growth rate).
• A country with a smaller export sector may enjoy smaller spillover growth effects.
  An increase in aid results in higher imports and possibly lower exports compared to the economy without aid. Because we don’t know whether the dynamic growth benefits of trade come mainly from spillover benefits from imports or exports, we don’t know whether this increase in imports and fall in exports will increase growth, reduce growth, or cancel out.  It is theoretically possible that this will have a significant negative effect on growth; but it may also have positive effects.
• There may be adverse political effects
  There is a set of worries about the political effects of aid: large aid inflows might weaken the social contract, sustain otherwise unpopular regimes, feed corruption, or disrupt the effectiveness and accountability of government. These are important and valid concerns, but they are distinct from the macroeconomic effects of aid through Dutch Disease, and we are not going to deal with them further here.

How big could the Dutch Disease effect be?

Suppose a country receives aid each year worth 5% of its GDP.  If the export sector had previously accounted for 10% of the economy, then even if exports are completely unchanged, the direct effect of the increase in the denominator is that exports drop to 9.5% of the economy. (The impact on GDP and GNI will differ according on how the aid is delivered and used.)

Subramanian and Rajan do not report whether or how they have adjusted for the denominator effect in their calculations.  If they have not adjusted for the increase in national income as a direct result of aid, this would explain why they find that exports grow more slowly relative to the rest of the economy when aid increases.  But since they are very smart people, we’ll assume that they have taken account of the denominator effect and simply forgotten to tell us about it.  So having adjusted for the denominator effect, the question is whether there are any long term effects on growth from any or all of the three economic possibilities described above (aid increases productivity; the composition of the economy changes; dynamic benefits of trade are lost).

Suspending our scepticism about cross-country growth regressions, and assuming they have adjusted for the growth of the denominator and forgotten to tell us how, let’s accept Subramanian and Rajan’s estimates of the impact of aid on the export sector. They find that an increase in aid of 1% of GDP leads to a fall in the growth rate of exportables of 0.5 percentage points.  Let’s look at what this means for the impact of aid on a country’s income and welfare.

For a country to be made worse off by an increase in aid of 5% of GDP, domestic production would need to fall by at least 5% (so that the loss of income from lower domestic production exceeds the benefit to incomes of the aid). How likely is this?

Well suppose a country without aid has exports at 10% of GDP; and then starts to receive aid at a constant level of 5% of its GDP. According to Subramanian and Rajan, the export sector will begin to grow at 2.5 percentage points a year more slowly.  Leave aside for now whether there is any impact on the growth of the other 90% of the economy, the impact on the exportable sector reductes total GDP growth by 0.25 percentage points a year.  It will therefore take about 20 years before the export sector shrinks by 5% of GDP, at which point total incomes have fallen to their without-aid levels.  Over that time, the country will have received benefits (higher income and consumption) from the aid, and it will take another 20 years of below-trend income before the country is worse off overall as a result of the aid.  So if the macroeconomic impact of aid were entirely on the exportable sector, and it were of the size that Rajan and Subramanian identify, in this example it would take about 40 years of aid before the country would be worse off overall.

Could the country be worse off as a result of aid?

So according to the Rajan and Subramanian regressions, the impact on exports would mean that a country could be made worse off overall as a result of receiving aid, but it might take of the order of 40 years before the negative impact through exports is big enough to offset the direct benefits of aid.

But this is only part of the story. The overall impact on the economy depends also on what happens to the non-exporting sector.

In principle, the effect on the non-exporting sector could be negative.  The contraction in exports could lead to a negative impact on the rest of the economy because the country is deprived of  some of the benefits of having to compete in the world economy.

For the overall impact to be negative, the non-tradable sector would need to be adversely affected by slightly lower exports and this effect would need to be larger than any benefits from higher imports and any benefits from how the aid money is spent.

This is theoretically possible, but it seems highly improbable.   The non-tradable sector must be growing to some extent (since that is what is crowding out the export sector).  At worst, it might be growing less fast than the export sector is contracting (so that the overall effects are negative after even more than 40 years.)  But there are good reasons for thinking that the aid would accelerate growth in the non-exporting sector, at least to some extent.  There will benefits from higher imports, including access to intermediate inputs, skills, and machinery, and benefits to the domestic economy of competitive pressures from imports.  And at least some of the aid is spent in ways that should increase productivity – for example, by improving education and skills, reducing sickness, enhancing security, building transport and communications infrastructure, and improving government administration.  For the overall effect on the non-tradable sector to be negative, all these benefits would need to be overwhelmed by the harm done to the non-tradable economy because the export sector is a little smaller than it would otherwise have been.

Even a very modest increase in growth in the non-tradable sector resulting from aid would be enough to offset the impact on GDP of the contraction in the export sector.  In the numerical example above, an increase in growth of just 0.05 percentage points would be sufficient to offset the negative impact on exports.

Empirical findings

The Rajan and Subramanian findings tell us that the export sector contracts as a result of aid (assuming they have correctly adjusted the denominator effect); but the effect is small.  Other things being equal, a country would have to receive aid continuously for of the order of 40 years to be worse off overall as a result of aid’s impact on export earnings.  But the overall effect on the economy plainly also depends on what happens in the non-tradable sector.  This is an empirical question:  the impact on the non-tradable sector could be positive (because of the benefits of the additional imports, and the impact of aid) or negative (because the positive spillover effects of a vibrant export sector are reduced).  You need to look at the effect of aid on growth overall, not just on the export sector.

The stastical power of cross country growth regressions is not good enough to say very much at all about the impact of aid on growth.  But if you hold your nose, the most likely interpretation of the data seems to be that there is no linear relationship between aid and growth, but there is a non-linear relationship in which aid increases growth but with diminishing returns.   If so, then the data tends to be consistent with the theoretical arguments: aid may reduce exports a little, but nothing like enough to turn the overall impact negative.

Conclusion

Rajan and Subramanian would like us to believe that aid can cause dutch disease and so make a country worse off.  But their research does not support this conclusion: the common sense view that a country benefits overall from being given free money is more likely to be right. Their empirical findings tell us that aid leads to exports being a smaller share of GDP.  This we already knew, since it is a matter of arithmetic; and it does not prove that the country is worse off immediately or in the long run. There is broad agreement that exports are critical for development, but it does not follow, as is often lazily implied, that the arithmetical effect of aid of reducing exports as a share of GDP harms a country’s prospects for development.  Looking at the impact on exports alone, their results suggest that it would take about 40 years for incomes to fall in aggregate as a result of aid.  But the overall effect depends on how what happens as a result of aid to growth in the rest of the economy.   There could be an indirect effect on the rest of the economy from the contraction of exports, but there should also be positive effects from the expansion of imports and the productivity effects of aid. We don’t know the relative size of these effects, but seems likely that the total effect is positive overall (it is the expansion of non-tradables that causes the contraction of exports, after all).  There is some rather flimsy empirical support for this from the  evidence of cross country growth regressions, and none for the alternative view that the effect is large enough to outweigh the benefits of aid.

(See also David Roodman’s review of this paper.)

I am grateful to Oxfam’s Duncan Green for his fair and thoughtful review of my paper about improving aid, Beyond Planning: Markets and Networks for Better Aid.

I’m glad that Duncan and Chris, his Oxfam colleague,  endorse a key argument of the paper, which is that the development industry will improve through evolutionary change rather than grand design; and that a driver of this change will be better mechanisms feedback from the citizens of developing countries about what is working. The paper points out that this kind of evolutionary change comes from variation and selection – and that the aid business does not have enough of either to ensure evolution towards more effective aid.

Duncan and Chris  have reservations about the word “beneficiary” to describe the people in developing countries whom aid is intended to support.  I think that is a good point, and I’d be happy to use a different word if we can find a suitable alternative (I don’t think that “primary stakeholder” or “rights holder” takes the trick, since neither is sufficiently specific about who we mean).

I don’t want to put words in Duncan’s mouth, but I detect from his review that he is more sceptical than me about the value of markets. He dismisses without much fanfare the  the idea of giving more choice to the, er, “intended beneficiaries” (aka primary stakeholders and rights-holders):

Where I think he is wrong is a largely market based philosophy for creating incentives based on New Public Management theories of expanding choice more than voice. … This in turn requires some quite fundamental organisational change with in aid agencies, as well as establishing more citizen to citizen links possibly using new social media.’

That is an unfair characterisation of my view: I am in favour of choice AND voice.  A large part of the paper, especially when talking about networks, is precisely about how citizens can have more voice, and I talk explicitly about citizens links through new social media.  But there are huge problems to overcome in achieving this, because the “intended beneficiaries” are geographically and politically remote from decision-makers in aid agencies, which means their voice is dimly heard, if at all.

While I agree with Duncan on the need to ensure that people have voice, I find it surprising that he (in common with many people who regard themselves as progressive) is so reluctant to give choice where possible as well.   Duncan’s (excellent) book is called From Poverty To Power – and I believe that giving people direct control of resources and allowing them to choose what services they want, and from whom, can be one of the most important ways of empowering people.  Duncan calls this a “technocratic/new labour enthusiasm for using market mechanisms” – but the idea of giving the poor more direct control of resources goes back long before New Labour:  Oxfam’s honorary President, Amartya Sen, got a Nobel prize for his 1982 book, Poverty and Famines: An Essay on Entitlement and Deprivation, which argued that it would be better to give people money than food in a famine.

I have not swallowed the New Public Management story hook, line and sinker, but I do believe that there have been positive experiences (for example, from the publication of league tables, and the distinction between purchaser and provider).  While I think we should learn from new public management, my paper describes in some detail the shortcomings of a market-only approach, especially as it relates to foreign assistance.  I hoped my paper would be an elegant synthesis of some of the best (and proven) tools of this school of thought with lessons from other approaches, especially the use of complementary mechanisms of networks, voice, regulation and planning.

The aid industry has almost entirely evaded the reform of public services over the last decade.   There is no measurement of results; no distinction between purchaser and provider; no customer choice.  Presumably the lack of reform is partly because the shortcomings of the industry are felt by people with no political power or voice in the political systems of donor countries. The incumbent service providers are politically powerful, well organised, and deeply conservative about any change that affects their interests.  The aid system has, over time, drawn to it people who are sceptical about the value of markets and choice, saddling developing countries instead with five year plans and long coordination meetings.  No politician in a donor country is enthusiastic to take on these vested interests, in order to improve services for people they will never meet and who have no vote in the election.

Michael Clemens from the Center for Global Development talks about immigration – which he describes as “The Biggest Idea in Development that No One Really Tried“.  In this TED-talk style video, he addresses criticisms of open borders such as the idea that open immigration would impoverish rich countries (it wouldn’t), and that it is politically impossible (so too, once, was the abolition of slavery).
 

Michael’s approach is an enviable combination of analytical rigour and strong ethicaal principles.  This 25 minute video is a powerful argument for why we can, and should, remove government restrictions on where people can live and work.

My article on OpenDemocracy today discusses whether aid works.

Some supporters of aid have made what seem to me to be extravagant claims that aid should aim to bring about economic and social transformation of developing countries, so accelerating economic growth and industrialisation.  But this is a very high bar to set.  Aid may well help to increase the probability of economic take-off but there are lots of other conditions that need to be in place for the transition to an industrialised market economy to happen, and aid is not a sufficient condition (nor, probably, a necessary condition) for it to occur.   Even if aid does play an important contributory role, it would be statistically very hard to demonstrate a link between aid and economic growth.

Although the effect of aid on economic growth is uncertain, there can be no doubt that aid makes a huge difference to people’s lives.  Aid provides food, health care, education, clean water, financial services, and modest incomes which transform the lives of the people who receive them.   You can see this both in individual families – like the girl I met in northern Amhara, pictured here, who has health care and education because of aid – and in the overall statistics, which show that there has been a vast improvement in the quality of life on almost every measure other than income.

Aid may not always transform societies, but it does enable people to live much better lives while those transformations are taking place.  And that represents a huge increase in the sum of human welfare.

I believe aid could and should work much better.  Living in a developing country, I see all kinds of waste and inefficiency in the aid system that makes me angry. But it makes me angry because I also see how much difference aid makes when it is used well.  I would like to see aid becoming much more transparent and accountable, so that it becomes subject to evolutionary pressures to improve.

This means, by the way, that I do not subscribe to the view that the aid system should be regarded as temporary.  In the UK we hope that people will be on unemployment benefit temporarily before they are able to get back to work, but we don’t expect the system as a whole to come to an end.  So I think that we should expect that at least for our lifetimes, it will be right and necessary that we transfer income from the richest people in the world to the poorest people in the world.  I do not know which countries will be rich, on average, in fifty years time, and which will be poor; but I expect that the world will still need, and I hope it will still have, a permanent system to help those temporarily in need wherever they happen to be.

Aid would work better in future if we accept that we will need a permanent system to provide temporary help to those who need it, and set about designing a better system to do that.

Read the full article here.

Related reading:

• Phil Vernon at openDemocracy (to which my article was a reply)
• Roger Riddell at openDemocracy
• Ranil at AidThoughts
• Chris Blattman – Could Aid Slow Growth

Martin Wolf in the Financial Times says he is calling for “a debate” about immigration but his article is, in truth, a thinly-veiled diatribe against immigration on the grounds that it harms the economy, the environment and society.

The most important step in his argument is the first one.   Wolf says:

I, for one, have no difficulty with arguing that immigration is a privilege, not a right. Most people agree.

The assertion that “immigration is a privilege not a right” seems to me to be the wrong starting point.  I would begin with an opposite premise that seems to me to be much more basic and compelling:  “The burden of proof rests on those who would restrict human freedom.” If someone wants to move from one part of the planet to another, to live and work and raise their family, then we ought to have a very good reason before we set up a system to stop them.

To construct his argument, Martin Wolf wants us to believe both the following claims:

1. Immigration has a negative impact on the existing population; and
2. We ought to pay more attention to the interests of the existing population than the interests of the migrants.

On the first leg of this argument, Martin Wolf (under the guise of “calling for a debate”) claims that immigration is harmful to the economy, environment and society of the existing population.  As it happens, I don’t agree with any of this, though since that is not the point I want to focus on, I shall restrict myself to pointing to the economic and social success of countries that have been open to large-scale immigration.   But while I think the first leg of the argument is wrong, it is the second leg of the argument that I most want to challenge.

I doubt if anyone would seriously contest the view that even if if immigration causes some harm to the existing population, this harm is in total is far less than the very significant benefits to the migrants themselves.   So the case for restricting the freedom of people to live where they choose can only be made if you accept that we should pay more attention to the interests of the existing population than to the interests of the migrants.

There is no question that it is a widely-held view that we should give more weight to the interests of the existing population.  For example, Wolf says:

My view is that the interests of the existing citizens are of decisive weight, though we should also place some weight, too, on the interests of immigrants.

Perhaps I was born with faulty wiring, but I simply do not understand this view.

I believe we should give equal weight to the rights and interests of every human being. The idea that the interests of people born in our own country should weigh more in our moral calculus than the interests of people born elsewhere is, in my view, indefensible.  To say that we will less attention to the interests of another human  because they happen to have been born far away is organised racism, directly comparable with the pass laws under apartheid.

The United States Declaration of Independence asserts:

We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable Rights, that among these are Life, Liberty and the pursuit of Happiness.

The Declaration of Independence does not limit its assertion of equality to people born within a single country. Nor is the pursuit of happiness bounded by national borders created by man. (This is just as well, as in the period following US independence one third of Europe’s population migrated to the Americas.)

Of course, the view that we should give equal weight to the interests of all human beings is unlikely to get very far in political systems designed to represent the interests of the citizens within existing borders.  But just because a political system makes it possible to ignore the rights and interests of a group of people who are weakly represented in it does not mean that it is morally right to do so.

My view is that the burden of proof lies with those who would restrict the freedom of people to live anywhere they choose.   This argument would require, at minimum, weighing up the costs and benefits of a restriction to show that we are better off in total if we curtail this freedom.  A case could only be made by placing more weight on the interests of the existing population than on the interests of other people.  I understand that there is a a widely-held view that we should do exactly that, but I nonetheless think it is profoundly wrong.   When we weigh up the argument for a policy to restrict people’s freedom based on the benefits that such a restriction will bring, we should place equal weight on the rights and interests of all people, and not privilege the interests of some people who happen to be like ourselves.  The case for restricting immigration rests on denying the equal humanity of people born abroad.  I hope that, over time, we will come to see this with the same moral outrage as we now view slavery and apartheid.

When I was a teenager, I visited Berlin, and read the grafitti on the Berlin Wall that said “No wall can stand forever”.  Now on the twentieth anniversary of the fall of the Berlin Wall, we look back with horror at the way the wall was used to keep people in.  Perhaps in another twenty years we will look back with equal disgust at the walls we build today to keep people out.

Daniel Kaufmann and Mushtaq Khan talk about corruption in the latest edition of Development Drums.

Though they come from quite different points of view, there is quite a lot of convergence between them. They agree that there is much more corruption in poor countries than in rich countries; that nobody should put too much faith in econometrics to decide whether corruption is a reason that poor countries remain poor; and that you do not fight corruption by fighting corruption.  But whereas Daniel Kaufmann believes that you have to tackle corruption to create the conditions for markets to work and to to create economic growth and prosperity, Mushtaq Khan believes that you should focus on policies to promote growth and that a certain amount of corruption is an inevitable (albeit undesirable) corolloray of the transition to a capitalist economy. I hope you find the discussion between them as interesting as I did.

What strikes me about all this is that this is a topic on which there is a serious gap between mainstream public opinion and the opinion of many (but by no means all) development “experts”.  Most people believe that corruption is a one of the most important reasons why poor countries remain poor; and yet a lot of people working in development seem to be willing to tolerate some corruption as an inevitable fact of life in poor countries.   My view is that this is a topic on which we need to see much more convergence of thinking, based on sound evidence and analysis, and that this is an important step if the development business is to regain and retain the trust of the people paying for development assistance.

Where do I come down?  I guess somewhere in between. Corruption is clearly a very serious problem which robs the poor most of all, and deprives millions of people of access to service and of the opportunity to earn a living.  In some countries, it is a major obstacle to economic growth (I think Nigeria is such a country). But there are many different causes of poverty, and there are some poor countries that have very little corruption (Ethiopia, where I live, is such a country).  And there are striking examples across history of countries that have experienced rapid industrialisation despite having quite high levels of corruption at the time (including Indonesia, Thailand, Korea, Japan) – in many cases, corruption is something that is tackled after the establishment of an industrialised capitalist economy with a strong middle class, not before.

I do think that many people working in development are too complacent about corruption.  The poor, like all of us, have dreams of a better life, and they are not helped by a poverty of aspiration on our part.

There are some countries – such as Nigeria – in which corruption is clearly a major obstacle to investment and growth.  There are other countries – such as Ethiopia – in which there is very little corruption which are nonetheless very poor, so it cannot be the case that eliminating corruption is the main driver of development.  And a lot of industrialized countries had long periods of rapid economic growth despite widespread corruption – which in many cases they sorted out after they became rich, not as a pre-requisite to growth.

Here is a new paper by Channing Arndt, Sam Jones, and Finn Tarp on whether aid leads to economic growth. The econometrics are done carefully, and it finds that aid inflows of about 10 per cent of GDP lead to an increase in economic growth of about 1 percentage point. (Reassuringly, this is also broadly consistent with a common sense calculation of the sort of effect that aid ought to have.)   They also find evidence of bigger, more positive effects of aid, consistent with positive effects of aid on productivity.

I’m not a fan of these aid-growth regressions, because they are technically difficult to do well (see David Roodman’s article on the problems.)  But they are important for one reason: they are a more systematic way of doing the popular “folk regression” offered by authors such as Dambisa Moyo and Bill Easterly.  When Moyo and Easterly point out that countries that have had high levels of aid have also suffered from slow growth, they are implicitly pronouncing on whether there is a statistical relationship between aid and growth.  But of course you would expect to see a lot of aid going to poor countries (rather as ambulances tend to be present at the scene of road accidents)  so these simplistic comparisons do not tell us very much about the effect of aid on growth. The more careful question to ask is whether, other things being equal, aid leads to higher or lower growth, and that is what this kind of statistical analysis investigates.  It is good to have confirmation that the folk regressions are wrong and that aid does, as best we can tell, lead to economic growth.

There are a few other interesting things about this paper:

• the paper uses the same data as the infamous and oft-cited Rajan and Subramanian paper which claimed that there was no effect on growth (which I criticised at the time here) and finds that, if the regressions are done more carefully, those findings were not correct;
• the effect of development aid on growth is probably understated by this analysis because it includes all aid (unlike the paper by Clemens, Radelet, and Bhavnani, which subtracts humanitarian aid and other aid which is not intended to lead to economic development and finds – as you would anticipate – much larger effects of aid on growth from the subset of aid that is actually intended to promote development);
• there is no sign of diminishing returns to aid in this analysis. (This is an unusual finding – generally studies have needed to include a diminishing returns term to generate a statistically significant relationship between aid and growth).
• the study uses donor-specific fixed effects (the only study to do so, as far as I am aware). I’m looking forward to looking at these in detail, as the estimates will give us an insight into which donors are the most effective.

(h/t Chandan)

Update: David Roodman, whom I regard as an authority on these matters, thinks that I am wrong and Bill Easterly is right.

Not according to Michael Clemens at the Center for Global Development.  Read his “Think Again” piece in Foreign Policy.

Here’s a sample:

This common idea that skilled emigration amounts to “stealing” requires a cartoonish set of assumptions about developing countries. First, it requires us to assume that developing countries possess a finite stock of skilled workers, a stock depleted by one for every departure. In fact, people respond to the incentives created by migration: Enormous numbers of skilled workers from developing countries have been induced to acquire their skills by the opportunity of high earnings abroad. This is why the Philippines, which sends more nurses abroad than any other developing country, still has more nurses per capita at home than Britain does.

My new working paper, Beyond Planning: Markets and Networks for Better Aid is on the Center for Global Development website in the innovations in aid series.

In the paper I argue that more planning and coordiation among donors will not overcome the political constraints that prevent better aid.  The aid system is in a political equilibrium which we need to try to change; we won’t solve aid’s problems by trying to move away from the equilibrium.  This means making more use of market and network mechanisms to change incentives within the aid system. We need to stop thinking of grand new designs of the aid system and start putting in place mechanisms that force evolution in the right direction.

I’ve listed a set of measures, from the commonplace (untying aid, for example) to the unusual (tradable missions permits, or a tax on proliferation pollution) to illustrate the ideas.

I’ll be discussing the paper at the Overseas Development Institute (ODI) on Friday, and on a forthcoming episode of Development Drums.

I’m looking forward to comments and feedback.

George Osborne told the Conservative Party Conference eight times:

we are all in this together.

This is a powerful message.

When 15 million people  face starvation in East Africa this Christmas, let us say:

we are all in this together.

When twenty thousand children die tomorrow from easily preventable and treatable diseases, purely because they don’t have enough money to buy drugs that cost cents to produce but for which we charge rich world prices, let us say:

we are all in this together.

When the developing world demands proper compensation for their part of the atmosphere, which we have filled up with carbon emissions far beyond our share, resulting in the risk of destruction to entire nations, let us say:

we are all in this together.

When the people of the Niger Delta demand a share of the wealth lying beneath their ground, and an end to the environmental destruction caused by our oil companies so that we can drive our cars and cool our houses, let us say:

we are all in this together.

When we complain about corruption in the developing world, forgetting that all the money that pays for those bribes comes from us, and then choose not to prosecute our own companies that pay the bribes, let us say:

we are all in this together.

When we continue to be one of the largest manufacturers and exporters of arms in the world, fuelling conflict all around the world, but are more concerned about a hundred jobs on the Isle of Wight, let us say:

we are all in this together.

When people are forced to leave their homes, their family and their country because they lack freedom or face persecution, or because they cannot find work that pays them enough to support their family, and they look for a new beginning in rich countries, and we decide how we will treat asylum seekers and immigrants, let us say:

we are all in this together.

When the world’s poor demand fair payment for their coffee, cocoa, and minerals, and for their labour which provides us with the cheap clothes and electronics which we take for granted, let us say:

we are all in this together.

When the world economy recovers, companies of the rich world begin to prosper, when bankers get their bonuses again and the rich start to become richer, and we decide how to share the proceeds of that growth within and between nations, let us say:

we are all in this together.

I was on the BBC World Business Report yesterday, talking about proposals for a Tobin Tax (a tax on financial market transactions with the revenues allocated to poverty reduction).  David Hillman from Stamp Out Poverty discussed the issue with me.  I said I could not see the logic of linking measures to reduce capital market volatility with financing aid.

The World Business Report podcast is here.  The discussion about the Tobin Tax was in the edition for October 7th, 2009 – it will be there for a few days.  Alternatively you can download just the relevant part of the programme here.

The presenter, Mike Johnson, introduces the discussion by saying that James Tobin (a Nobel prize winning economist) proposed the tax as a way to finance efforts to combat poverty and disease. That isn’t true: James Tobin proposed the tax as a possible way to reduce speculative transactions.  The idea of linking the tax to development spending is a subsequent embellishment by campaigners against global poverty.  James Tobin said in an interview in Der Spiegel in 2001:

Ich habe nicht das Geringste gemein mit diesen Anti-Globalisierungs-Revoluzzern.

(My translation: “I have nothing at all in common with these anti-globalisation revolutionaries.”)

There are bad reasons and good reasons for supporting the use of innovative finance for development. Unfortunately, some development advocates seem williing to back any proposal that they think might raise more money for development, instead of focusing on mechanisms that will improve the way that money is used.

When is innovative finance good?

Innovative finance can improve the effectiveness of aid spending. There are at least four ways this can work.

First, innovative finance can improve intertemporal optimisation.  Aid budgets are often given from year to the next, which makes it difficult to spend the money at the best time.   For some spending, it makes sense to spend today to save money tomorrow (for example, spending money to eliminate smallpox reduced the need for health care spending later on).   It is not always sensible to bring forward spending – particularly if you believe that there are diminishing returns to some kinds of aid spending. The International Finance Facility for Immunisation is a good example of how spending tomorrow’s aid today can be sensible, because future generations benefit from the increase in herd immunity in today’s beneficiaries.

Second, innovative finance can create a commitment technology.   There are many benefits to being able to make commitments – which is why in normal life we have mechanisms such as contracts and warranties.   We need commitments to deal with dynamic inconsistency and to allocate risks.  But constraints on aid agencies make it very hard for them to make commitments about aid.  A good example of an effective forward commitment is the Advance Market Commitment, which guarantees manufacturers a more lucrative price if they develop and produce a new medical product for developing countries.  Forward commitments enable governments to invest in reforms which have costs over several years, or firms to invest in new products for developing countries.

Third, innovative finance can change incentives both for donors and recipients.  For example, funding schemes that link payments to results may reduce the incentives of donors to micromanage the way aid is used.  If payments to organisations are linked to demand (eg through a virtual voucher scheme) they may improve their services for beneficiaries.

Fourth, innovative finance can improve the allocation of risk.  Insurance pools may diversify risk, and permit rapid increases in funding in the case of disasters.  We can pool medicines, for example, so that they are available to whoever needs them first.  Stabilization funds with automatic disbursement criteria can ensure that finance is rapidly available, without strings, where and when it is needed.

In each of these four cases, well-designed innovative finance can increase the productivity of aid spending.  As aid becomes demonstrably more effective, so in the long run we can make the case for greater investment.

When is innovative finance not good?

While there are excellent reasons to identify innovative ways to give aid, the need to increase funding is not one of them.  I am in favour of a large increase in aid, but not in favour of achieving it by distorting rational decision-making on taxation and spending.   Many development advocates support schemes to tax financial transactions (a so called “Tobin Tax”) or airline tickets, or a new global lottery (a tax on the poor), if these are used to pay for increased foreign assistance.    I understand the desire to get aid any way we can, but I don’t respect this kind of opportunism.

We should determine the structure and level of taxes on the basis of evidence about the most effective (or least damaging) ways of raising the revenues we need; and we should decide the level of spending on the public’s various priorities based on how we will do the greatest good.  Linking a particular kind of spending to a particular revenue  cannot improve choices about spending or tax, and may unnecessarily constrain them.

Conclusion

Some particularly misguided proposals involving introducing taxes on goods or services we would not normally considering taxing (such as investment in information technology).  By linking these proposal to the (rightly appealing) goal of increasing aid spending, we are in danger of being seduced into doing the wrong things for the right reasons.

Innovative finance holds rich possibilities for accelerating poverty reduction by making aid money work better.  If we can find ways to relax the institutional constraints on spending money at the right time, or increase our ability to make rational commitments, we can make aid money work harder.  In time, this may mean that taxpayers and donors are willing to spend more.  But we should not invent mechanisms whose main effect is to bypass our existing processes for making sensible decisions about tax and spending.

All foreign aid is, in the end, used to pay for imports.

In a few moments we’ll discuss why this is true and why it matters. But let me offer two apologies.

To those for whom this is a statement of the bleedin’ obvious, sorry for wasting your time.  Please feel free to skip down to the reasons why this important.

And to those for whom this is a shocking revelation, I am sorry to puncture the bubble. This reality is not the result of a conspiracy between aid agencies and commercial interests but an unavoidable consequence of the fact that aid is provided from abroad.

In what sense is all aid used to pay for imports?

Suppose a rich country gives $100 million in aid to a poor country.   The recipient may be a person or organisation, or the government. Sometimes the aid is given as money, sometimes as goods and services (such as food aid, or technical expertise).  If the aid arrives as imported goods and services, then the aid has been used, by definition, to pay for imports.

But suppose the aid comes not as goods and services but as foreign currency.  The only value of that foreign currency is that it can be used to buy imports from abroad.

Of course the recipient might do something else with the foreign currency, like sell it or save it.  But in the end the foreign currency has to be used to pay for imports, or it is worthless.

Suppose you send $100 to an NGO in Nairobi.  That NGO might want to use your donation to pay its rent. The NGO has to sell the $100 and get Kenyan shillings to pay its rent.  The people who buy the $100 want the dollars at least as much they wanted the equivalent amount of Kenyan shillings. Why? So that they can buy something from abroad, either today or in the future (or sell the dollars on to someone who will).  Instead of using their Kenyans shillings to buy something locally, somebody at the end of the chain must be selling their shillings and using the $100 to buy something from overseas.  So the impact of your donation on the NGO has been that it can pay the rent (which of course is not an import); and the net impact on Kenya as a whole is that imports have gone up by $100.  The additional imports are of value to someone in Kenya, and because you originally gave the claim on those additional resources to an NGO, the NGO was able to use the value of those additional imports pay its rent.

The same argument applies to aid given as budget support to governments. We may expect that the recipient government will use the money to employ teachers and nurses, or to build roads.  None of that may be imported.  How does giving foreign currency to a government help it to employ teachers?  The answer is that we have given them something of value – a claim on imports – which they can trade in the economy to get the money they need to enable them to pay teachers.  But since the thing of value we have given them is a claim on imports, the government can only use it if somebody somewhere in that economy wants the imports enough to give up some local currency in return.  The aid is in the form of additional imports, even if the ultimate importer is not the original beneficiary of the aid.

It maybe that someone will save the foreign currency – perhaps the Central Bank will use it to increase its reserves, or a firm might keep some dollars in a safe. But these savings have value because the money can be used,  by someone somewhere, at some time in the future, to pay for an import.

This should all be uncontroversial – it is, after all, just another way of describing the national accounts identity.  Aid is a capital inflow; and an increase in capital inflows must be matched by an equal and opposite current account deficit.   So when aid goes up, either imports must increase, or if imports stay the same, exports needed to pay for imports must go down.

Why does it matter that all aid ends up as imports?

Here are some consequences

• Aid to developing countries is a fiscal stimulus for rich countries.
  If the cause of the economic crisis was that rich countries were consuming too much relative to how much they were producing, the only possible way out of that is for rich countries to increase production faster than they increase consumption, and that means increasing exports.  Increasing aid does that.
• The question of how much aid “ends up” in a developing country is a red herring.
  All aid “ends up” as goods and services imported from abroad.  The right question is whether they are the most valuable goods and services, and who benefits from them.
• Effective aid must inevitably increase the current account deficit of recipient countries.
  Hare-brained schemes to “sterilize” the effect on the balance of payments could only work by preventing the aid from being used.  A worsened current account is the accounting counterpart of increased aid.  Unless you are a paid-up mercantilist, you’ll know that getting more imports for nothing, or not having to export as much for the same amount of imports, is a good thing.  (Of course, if the aid is used for things that increase the country’s productivity, that might increase exports and so improve the current account, but that is a second-round effect which might or might not offset the direct effect.)
• The only significant difference between budget support that some donors give today, and the old balance of payments support they used to give, is the nature of the political dialogue that accompanies it.
  In the old days, donors were happy to be told that the money would be used for imports (what else could it be used for?).  Today, by calling it budget support, donors feel able to get more engaged in how the government allocates its overall resources.   It is weird that auditors seem to think this is a riskier business, when the economics is the same.

Peter Mandelson has not thought this through:

First, taking something for nothing, without permission, and with no compensation for the person who created and owns it, is wrong. Simple as that.

With respect, it is not as simple as that.

The reason this looks plausible is the use of the word “taking”.   If I take something from you, that implies that I now have it and you no longer do.  If it was yours to start with, that would be unfair (or, in Mr Mandelson’s word, “wrong”).  But the challenge for making good policy about intellectual property is that the goods in question are non rival – meaning that one person’s consumption does not come at the expense of another person’s consumption of the same good.  If I make a copy of a song and listen to it on my MP3 player, that in no way reduces your ability to listen to it.   So I have not “taken” it from you.  We can both listen to it.  The marginal cost to society of my listening to the song is zero.

Mr Mandelson may have meant by “take” the idea that if I neglect to pay you for something, you lose out.  But this isn’t necessarily wrong.  As Chris Dillow points out, if I give a lift to a friend, I deprive a taxi company of revenue.  The taxi company might not be very happy about that. They might lobby the Business Minister over cocktails on a yacht, requesting that taxi companies be given a monopoly on giving rides in the area they serve.  (After all, they have spent a lot of money on cars and offices.)  The Business Minister should tell them to get stuffed.   There is no basic right to make money on your investments, and being deprived of potential revenue is not the same thing as a cost.

As I explained in more detail here, the economics of non-rival goods is quite different from the other kinds of goods.   Intellectual property rights are a social construct to create temporary monopolies which, unlike other forms of property, worsen rather than increase static allocative efficiency.  For non-rival goods, allocative efficiency requires that the price is zero, but dynamic efficiency may require some sort of remuneration for the creators of the products.  A society may choose to restrict access to a product as a way to create financial incentives for innovation. This may be worth doing if the welfare gains from the incentives to innovate exceed the welfare costs of reducing access to the products.  But that trade-off does not automatically and necessarily come down in favour of having intellectual property rights, nor is the creation of intellectual property rights the only or the necessarily the best way to create incentives to innovate.

This is not a wholesale argument against intellectual property rights.  But it is an argument against the daft claim that intellectual property rights are just the same as rights to rival goods such as physical property.   Property rights for rival goods increase, or at any rate do not diminish, allocative efficiency and hence welfare;  property rights for non-rival goods decrease allocative efficiency, and that is a welfare loss that has to be justified by a welfare gain elsewhere.

We do need to reward and incentivize innovation and creativity appropriately.  But I am struck by the lack of imagination and innovation in the current debate about how we do it.  Intellectual property rights are one approach, but they have important drawbacks.  We should not forget other possible approaches – such as prizes, buy-outs, or public funding – which might secure many of the same benefits without the costs.

It worries me that people who are interested in reducing world poverty leap so readily on the Tobin Tax bandwagon.

There are three questions to answer:

• should we spend more on reducing global poverty?
  (my answer: yes, if we have to)
• should we tax transactions in financial markets?
  (my answer: maybe, though I am not persuaded)
• should we link aid budgets to revenues from such a tax?
  (my answer: definitely not)

My answers are explained below the fold.

I can see why some people are attracted by a combination of extra money for the world’s poor and a poke in the eye for the unacceptable face of capitalism.  But to support the Tobin Tax on these grounds is at best opportunism, and at worst reveals a hostility to the functioning of markets which will, in the end, not serve the poor.

Read the rest of this entry »

Adair Turner, Chair of the Financial Services Authority, says that the FSA should not be expected to curb city bonuses:

Lord Turner, head of the Financial Services Authority, said it was “economic illiteracy” to expect his organisation to be able to dictate to banks what they paid their staff.

He complains that is is beyond the remit of the FSA:

“My message was . . . stop telling the FSA to go beyond its remit and to start imposing limitations on the level of bonuses, which it is neither within our legal power or our practical ability to do,” he said.

Well, up to a point, Lord Copper.

It all depends on why you want to curb city bonuses:

• concerns about social inequality
  If inequality is your motivation, Adair Turner is right. This is for the Government to sort out, not the FSA.
• concerns about the cost to the banks
  If you are worried about the cost of salaries, this is for the shareholders to sort out. Again, since the Government is a big shareholder in a number of the banks, the Government could take steps to address it.
• concerns that bank staff have incentives to take unnecessary risks
  But this is squarely the business of the regulator.  If you think that the bonus culture leads city folk to take risks with our money because the bonuses reward short term payback and do not sufficiently penalise long run losses, then this is something the FSA should sort out.

So it is not economically illiterate to think that the FSA should look at city bonuses, if there are concerns that they might create incentives for risky behaviour that we want to avoid. (I have no idea whether the FSA  the legal powers to do so: but that is a different point.)

My father was a diplomat.  When he left his last post in Africa (as High Commissioner to Nigeria) to become High Commissioner to Australia, he sent a message to the then Foreign Secretary reflecting on a career spent mainly in Africa. (These messages from Ambassadors are known in Foreign-Office-speak as a despatch).

Thanks to the Freedom of Information Act, he has been able to obtain a copy of this despatch, and he has published it online. At the time, it was regarded as controversial and radical.  Circulation within the Foreign Office was limited.

Perhaps my judgement is clouded by filial loyalty, but today it strikes me as forward-looking and far sighted.  He wrote:

Such grotesque disparities in the human condition are an inevitable source of conflict and instability. It is a century since British people ceased to be willing to tolerate massive inequality of wealth and income within their own society.  The time has surely come when we should tackle an even more offensive situation in the global village.

My father made a compelling case in 1991 for doing more to ensure that Africa shares in the benefits of globalisation and rising prosperity. As he predicted, the need has become greater the longer we have neglected the challenge.

I’m proud to follow in his footsteps in demanding change; but dismayed that I have to do so. If only they had listened then we might not have to be making the same case today.