The great leap backward

The importation of socialism into the Third World, even in the relatively non-violent form of Congress-Party Fabian-Gandhism, unintentionally stifled growth, enriched large industrialists, and kept the people poor.  Malthusian theories hatched in the West were put into practice by India and especially China, resulting in millions of missing girls.  The capitalist-sponsored Green Revolution of dwarf hybrids was opposed by green politicians the world around, but has made places like India self-sufficient in grains. 

State power in many parts of sub-Saharan Africa has been used to tax the majority of farmers in aid of the president’s cousins and a minority of urban bureaucrats.  State power in many parts of Latin America has prevented land reform and sponsored disappearances.  State ownership of oil in Nigeria and Mexico and Iraq was used to support the party in power, benefiting the people not at all.  Arab men have been kept poor, not bettered, by using state power to deny education and driver’s licenses to Arab women. 

The seizure of governments by the clergy has corrupted religions and ruined economies.  The seizure of governments by the military has corrupted armies and ruined economies.

Deirdre McCloskey

Percentage of the New Zealand population on a welfare benefit since 1970

Issue 13 2014

But a different story in the USA

Graph comparing the ln(percent) from FY1997 - FY2007 of California and District of Columbia child-only, TANF and state population

Richard Epstein on the true nature of labour markets

via Back to Basics for New Zealand Labour Markets

The real beauty of this free-market price system is that it brings about its own kind of sustainability

This is not so much sustainability in the use of particular resources — for particular goods fall in and out of favour according to supply and demand factors — but sustainability of high economic growth and high standards of living in the economically developed, capitalist economies.

Take, as an example, the transition in the market for interior illumination: tallow candles were replaced by whale-oil lamps, which were replaced by kerosene lamps, which were replaced by incandescent bulbs powered by electricity.

There was no social or political pressure needed to accomplish this evolution; there was no “peak whale oil” movement, no kerosene conservationists, no sustainability crusade of yore. All it took was a functional price system, combined with the ever-present entrepreneurial drive for profits under a competitive, free-market order.

Tyler A. Watts

Examples of Spurious Relationships

Observed Spurious Relationship Reason for Relationship (the Third Variable)
Amount of ice cream sold and deaths by drownings (Moore, 1993) Season: Ice cream sales and drownings tend to be high during the warm months of the year
Ministers’ salaries and price of vodka Area (i.e., urban or rural): In urban areas, prices and salaries tend to be higher.
Shoe size and reading performance for elementary school children Age: Older children have larger shoe sizes and read better.
Number of doctors in region and number of people dying from disease Population density: In highly dense areas, there are more doctors and more people die.
Number of doctors in region and number of people dying from disease Population density: In highly dense areas, there are more police officers and more crimes.
Number of police officers and number of crimes (Glass & Hopkins, 1996) Population density: In highly dense areas, there are more homicides and more churches.
Number of homicides and number of churches Time: Both variables were increasing over time
Number of storks sighted and the population of Oldenburg, Germany, over a six-year period (Box, Hunter, & Hunter, 1978) Time: Both were increasing during the 1970s.
Number of public libraries and the amount of drug use Time: Both tend to increase over time.
Teachers’ salaries and the price of liquor (Moore and McCabe, 1993) Time: Both tend to increase over time.
Tea drinking and lung cancer Smoking: Tea drinkers have a lower risk only because they smoke less

Halpern (2003) identified correlations that are often used to erroneously infer causality: illusory correlations, spurious correlations, and accidental correlations.


Illusory correlations are based on an individual’s preconceived notions or beliefs which lead one to look for associations between variables that confirm those.

Accidental correlations have no logical connection between them.

Finally, spurious correlations are correlations between two variables that are actually caused by a third variable.

Jacob Viner and the ambiguous welfare effects of preferential trade agreements

The world trade system is a growing assortment of discriminatory trade agreements known as the ‘spaghetti bowl’ for reasons that the diagram of regional trade agreements (RTAs) in the Western Hemisphere makes clear.

Preferential trade agreements are the correct name for the political spin masters call free trade agreements or regional trade agreements.

  • A preferential trade agreement is a trading bloc that gives preferential access to certain products from the participating countries. This is done by reducing or abolishing tariffs and other trade restrictions for the members of the trade bloc.
  • A customs union is a type of trade bloc which is composed of a free trade area with a common external tariff.

Everything you need to know about trade blocs, preferential trading agreements, and customs union is in a book written by Jacob Viner in 1951. His book The Customs Union Issue introduced the distinction between the trade-creating and the trade-diverting effects of customs unions:

Trade diversion occurs if the common tariff around a customs union and the absence of tariffs within the union lead one of the members to purchase products from another member rather than from a “cheaper” producer in the outside world.

The classic example of this is the entry of Britain into the European Common market in 1973. It started sourcing dairy and wool imports from within the common market rather than from New Zealand as was the case for the past hundred years.

Assume the most efficient producer of lamb in the world is New Zealand.  Before joining a customs union the UK will place an identical tariff on lamb imported from any country, this is shown on the diagram below. Before the customs union, French lamb is more expensive than New Zealand lamb once the tariff was paid. There are no imports from France. After joining the EU the tariff on French lamb will be removed.


The formation of the customs union between Britain and France reduces the price  of lamb imports from PNZ+t to PFrance.  Trade diversion now takes place as consumption switches from the low cost New Zealand farmers to the higher cost French lamb. Lower cost imports from outside the customs union have been replaced by high cost imports from within the customs union.

The  welfare analysis  analysis is tricky  because consumer prices fall, but some of the tariff revenue is now converted into higher import prices  because the lamb is sourced with the inefficient French farmers. This is shown in the multiple graphs below where some government tariff revenue is lost  and is instead converted into payments to the higher-cost French farmers.


Source: http://revisionguru.coisionguru/economics-2/economics-a2-unit-4/european-union/trade-creation-and-trade-diversion/

On the diagram below it is possible to highlight the gains and losses in welfare:

  • There has been an increase in consumer surplus of areas 1 + 2 + 3 + 4.
  • There has been a reduction in the producer surplus of UK lamb producers of area 1.
  • There will be a loss of government tariff revenue of 3 + 5.



The will be a net loss in UK welfare if 2 + 4 < 5.  It is possible that trade diversion will lead to an increase in UK welfare if 2 + 4 > 5. All in all this situation is full of ambiguity rather than the glories of straight out free trade were a country simply abolish the tariffs and buy from the cheapest supplier. As Paul Krugman explains:

If economists ruled the world, there would be no need for a World Trade Organization. The economist’s case for free trade is essentially a unilateral case – that is, it says that a country serves its own interests by pursuing free trade regardless of what other countries may do.

Or as Frederic Bastiat put it, it makes no more sense to be protectionist because other countries have tariffs than it would to block up our harbours because other countries have rocky coasts. So if our theories really held sway, there would be no need for trade treaties: global free trade would emerge spontaneously from the unrestricted pursuit of national interest.

Trade creation occurs if the abolition of tariffs between members of the customs union leads a member country to purchase products from another member country rather than producing it at higher cost itself.

Whether the trade creation of seats that trade to version requires very careful calculations such as those above .  Whether there is a net loss or net gain will depend upon how the elasticity of domestic demand and the size of the initial tariff.

It doesn’t take much trade diversion to offset any trade creation. The trade diversion must be to a supplier within the trade bloc that is not much more expensive than the global cheapest price.


Viner noted that the greater the similarity of the production mixes of the member countries, the greater the scope for trade creation relative to trade diversion; the more different the production mixes, the greater the scope for trade diversion!

Viner recognized that countries forming a customs union would in fact not be likely to permit the extensive relocation and reorganization of industry required to realize the potential benefits from the finer division of labour. This led him to regard customs unions as:

“unlikely to prove a practicable and suitable remedy for today’s economic ills” but rather “a psychological barrier to the realization of the more desirable but less desired objectives of … the balanced multilateral reduction of trade barriers on a non-discriminatory basis”

The expansion of trade after the signing of preferential trading agreements such as the common market and the many that followed including those signed by New Zealand, Australia and NAFTA are consistent with both trade creation and trade diversion.

The quality of arguments mounted against preferential trade agreements are surprisingly poor.There are good economic arguments against them based on the trade diversion cancelling out the trade creation.

By introducing discriminatory treatment into the trading system, the  proliferation of preferential trade agreements promote costly trade diversion, interfere with the efficient operation of global business and allow great powers to extract unjustified concessions from weaker countries. These concessions can be  in areas such as intellectual property rights, the purchasing pharmaceuticals by government agencies and social clauses on issues such as environmental and labour standards. Krugman again:

Fortunately or unfortunately, however, the world is not ruled by economists. The compelling economic case for unilateral free trade carries hardly any weight among people who really matter.

If we nonetheless have a fairly liberal world trading system, it is only because countries have been persuaded to open their markets in return for comparable market-opening on the part of their trading partners.

Never mind that the “concessions” trade negotiators are so proud of wresting from other nations are almost always actions these nations should have taken in their own interest anyway; in practice countries seem willing to do themselves good only if others promise to do the same.

The last time a world trade agreement was negotiated Clinton was President, cell phones were as heavy as a brick and no one had heard of email.

Gary Becker and George Stigler on continuity in economic thinking


this recession had got a lot worse, we would have seen two major changes: much more government intervention in the economy, and a lot more concentration in economics in trying to understand what went wrong.

Assuming I’m right and, fundamentally, the recession is over—a severe recession but maybe not much greater than the 1981 recession, or those in the nineteen-seventies—I think you are not going to see a huge increase in the role of government in the economy.…

Economists will be struggling to understand how this crisis happened and what you can do to head another one off in the future, but it will be nothing like the revolution in the role of government and in thinking that dominated the economics profession for decades after the Great Depression.

If the problems of economic life changed frequently and radically, and lacked a large measure of continuity in their essential nature, there could not be a science of economics.

An essential element of a science is the cumulative growth of knowledge, and that cumulative character could not arise if each generation of economists faced fundamentally new problems calling for entirely new methods of analysis…

[Economics] will continuously be confronted with new circumstances which call for more than a routine application of standard knowledge. Thus the energy crisis of the nineteen-seventies has provided much employment to economists, but it has not called for important changes in economic science…

The responsiveness of economics to environmental problems will naturally be more complete and more prompt, the more urgent the problems of the day. The response will also be more complete, the less developed the relevant body of economic analysis.

The responsiveness of macroeconomics to contemporary events is notorious. Keynes’s conquest in the nineteen-thirties was due to the fact that the neoclassical theory could not account for the persistent unemployment of that decade. A generation later, persistent inflation even with less than full employment was equally decisive in ending Keynes’s supremacy. If and when macroeconomics produces a good theory of the business cycle, its responsiveness to environmental changes will diminish sharply

Attacking people personally is so much easier than doing the hard analysis

James Buchanan and a non-discriminatory democracy?

James Buchanan was a classical liberal who admired the Swedish welfare state because it was based on the principle of generality.
Under Buchanan’s generality norm, governments impose uniform regulation and use flat rate taxes on uniform tax bases to fund an equal-per-head demogrant (or a guaranteed minimum income) to replace all existing government cash transfers. Such a government would account for a large share of GDP. That did not bother him:

It seems to me that far too much of our politics is favourable treatment or unfavourable treatment for particularised groups. If we could somehow introduce into politics the requirement that would be analogous to the rule of law, that is, don’t treat one group differently from another group.

That has a lot of implications. That would not necessarily mean we’d have much smaller politics or government. It would mean there’d be a quite different characteristic of government…

The normative thrust of my current work is to try to push the generalization principle to the maximum extent possible, that is, so you don’t have particularised exemptions. One person gets it, everybody gets it. It cuts in favour of something like a flat tax. It cuts against means testing.

Buchanan has said that all successful welfare states (such as Sweden) apply a generality norm in some form or another.

For Buchanan, the very logic of majority rule implies unequal treatment or discrimination. If left unconstrained, majority coalitions will promote the interests of their own members at the expense of others.

Buchanan proposed a non-discriminatory democracy through the principle of generality:

  1. If extended to any single industry, tariff or quota protection also be extended and on equal terms to all industries.
  2. Tax structures would necessarily become simple, since the same tax rate would have to apply across-the-board on all sources or uses of tax base. Flat rate or proportional taxes on all incomes would broadly meet the generality norm.
  3. On the transfer side of the budget account, payments would have to be made in demogrants, equally available to all persons.

This is equivalent to Rawls’ veil of ignorance: choices must be without knowing where you lie in society so you make choices that are to the benefit of all.

Buchanan argued that if politics generates undesirable results, it is better to examine the rules than to argue about different policies or to elect different representatives. He build on Hayek who called a constitutional amendment that should read:

Congress shall make no law authorizing government to take any discriminatory measures of coercion.

Hayek went on say that, with such an amendment, all of the other rights would be unnecessary. In a non-discriminatory democracy, government choices are limited to those that benefit all.

Europe’s Lost Decade?

U.S. Economic Snapshot

by Zach Bethune, Thomas Cooley, Espen Henriksen, and Peter Rupert

Is Europe about to repeat Japan’s lost decade? Six years after the Great Recession began, the Euro area has shown little sign of sustained growth.  Japan’s so called lost decade began in 1991 after several decades of rapid economic progress and sustained increases in asset prices that were suddenly reversed.  The average growth rate of real GDP per-capita declined from about 3.5% per year in the 1980s to about 0.5% per year in the 1990s and was accompanied by  rapidly decreasing equity and real-estate valuations.  But, when we compare the performance of Japan’s economy with the European economy since the beginning of the Great Recession it is clear that Europe is in far worse shape than Japan ever was.

The following Snapshot-style comparative charts show the paths of key economic variables in Japan after the peak of its equity and real-estate valuations…

View original post 1,045 more words

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