Tuesday, August 26, 2008

China Propping up the $US

I have discussed the position of China in the world currency system previously. I have made the point that China needs to be challenged to open up the RMB to be being a completely free currency, as this is one of the absolute necessities for rebalancing the world economy. The simple fact of the matter is that, as long as the RMB does not trade freely, the Chinese economy can use the currency to subsidise exports. I do not believe in any forms of currency controls, but even for apologists for such a system I can see little justification on the RMB.

Bearing all of this in mind, I was fascinated to read an article in the Telegraph newspaper, which had the following to say:
'China has resorted to stealth intervention in the currency markets to amass US dollars, using indirect means to hold down the yuan and ease the pain for its struggling exporters as the global slowdown engulfs the economy...'
'Beijing has raised the reserve requirement for banks five times since March, quickening the pace with two half-point rises in late June.This is having major spill-over effects into the currency markets because banks in China have been required over the last year to hold extra reserves in dollars rather than yuan. The latest moves have lifted the mandatory deposit from 15pc to 17.5pc of total lending since March'
There are many motivations that could be given to justify this action, some of which are more forgiving than others. It might be argued by apologists for China that they are doing this to protect the value of the $trillion+ reserves of $US. However, such a move can only delay the day of reckoning for the $US, so I do not believe that this would be why the policy is being enacted. Furthermore, it is just multiplying the problem of increasing the holdings of a currency that is structurally weak, meaning that the problem that it is trying to solve would just be getting more acute. However, I agree with the article that China is using unfair means to subsidise exports.

I have also pointed out in previous posts that China has sustained an implicit policy of allowing wholesale intellectual property theft (a generous interpretation of China's policy can be found in an article here). However, there is more to the story of Chinese economic aggression than currency manipulation and intellectual property theft. Last year, whilst living in China, I came up with a rather startling thought about China and the way in which it is managing trade and the economy. It occurred to me that China was waging and economic war against the US, Japan and Europe. Having come up with the idea, I explained this to some friends who lived in China. As you would expect, they were initially aghast at the idea and were disbelieving. However, after I showed them some recent articles, added to the RMB policy and intellectual property policy, they agreed that there was merit in what I had to say.

At the time I had read several articles in the Economist magazine that, in isolation, were not too worrying. However, taken together they showed a pattern of Chinese government anti-foreign business policy. For example one article showed how the Chinese press were campaigning against Western companies through the use of slanderous stories about Western companies. Such campaigns could only be undertaken in China with at least tacit support of the Chinese government, and they appeared to be coordinated. The campaigns were clearly intended to undermine the perception that Western brands provided quality and safety. In other words, they sought to undermine the potential for foreign economic success within China. In another article it was demonstrated that there were counterfeits being made of cars in China. The extraordinary thing is that the cars were being sold below any reasonable cost of manufacture. This is what the Economist had to say:
'The great mystery about these copycat cars is their price. Chinese counterfeiters obviously save on research and development costs, but they still have to buy steel and other materials at market prices. Most of them make cars in very small volumes, so there are no economies of scale. That they can sell these cars for half the price of the originals suggests that something odd is going on. They either do not know their own costs (a distinct possibility), have revolutionised carmaking (highly unlikely) or are being subsidised in some way. For the time being, no one knows.'
The only conclusion that can be drawn here is that the government has been subsidising the manufacture of these cars. They are actively trying to destroy the foreign car business in China.

Such articles were just a couple of examples from a brief period when the idea of Chinese economic war was dawning upon me. There have been many more since. We can add to these examples the widespread use of commercial espionage, such as an article here which shows conventional industrial espionage, an article here which shows commercial espionage against the US government and here for commercial espionage in Europe.

As for the attacks on foreign owned businesses in China, these are still ongoing. For example, China has introduced new labour laws and, no surprise, they have actively targeted the laws at foreign multi-nationals, despite the fact that foreign companies are generally much better employers in every respect. An article on this can be found here. Another recent example of unfair trade (restricting car imports, and car part imports) can be found here.

On a related subject, in an article a while ago the Telegraph, it was reported that senior Chinese officials were willing to use dollar sales as a way of exerting power over the US. In short, the Chinese have the power to destroy the $US by selling the currency, and therefore have huge economic power over the US. The Chinese government later denied the policy, but those familiar with Chinese culture will know that using such methods of presenting a threat is not unusual.

Each of the stories above, taken in isolation, would not cause undue alarm. However, when considering them all together, then there is a worrying pattern emerging. It should also be remembered that all of the above are just examples. What is very clear is that China, and the Chinese government, are actively pursuing a policy of unfair trade at home and abroad. Quite simply, they are using economics as a tool of power rather than just enrichment.

I have suggested in a previous post that the world trading system needs to get tough with China. I did not have the time to dig up the articles that I had read, which caused me so much concern, so have previously not outlined this point of view. However, on reading the latest attempt by the Chinese government to manipulate trade, it seemed a good point in time to outline this problem. I am at heart a free trade advocate, but I also believe that trade should be free and use reciprocal rules should be binding and enforced. It is very clear that China intends to rise economically by any means, fair or foul. The crazy part is that the foul is unnecessary, and one then becomes very suspicious of the underlying motives for such methods.

It is very worrying indeed.

Note: At the end of this post there is an always appreciated comment from a regular commentator on the blog, 'Lemming'. I just thought I would respond. He correctly identifies that I have said that there is no 'conspiracy' in a previous post, but the following post suggests otherwise. However, as Lemming correctly identifies, what I am referring to is that there is no conspiracy amongst bankers and the government of the UK, and Western governments. The point of this post is that China may actually really be conspiring. I hope that the intended meaning is clear in the first post, and believe that there is therefore no inherent conflict of opinion / contradiction in the two posts.
It is nice to know that people are paying such close attention to what I have written, which is very heartening, in particular as I had forgotten the details of the original post myself.

Note 2: A quick response to an anonymous comment (see below). If the Chinese government were to seek to destroy the US currency, it is difficult to guess where the US dollar would land. Let's just say at 50% of today's value against a basket of the major currencies, for the sake of argument. Some of the consequences would be as follows:

1. In so doing, the US currency would cease to have reserve status (loss of economic power)
2. There would be hyper inflation in the U.S.
3. The U.S, would not be able to borrow any more money (maybe a good thing)
4. The U.S. economy would collapse
5. The U.S. would be a much poorer country

In reality, the collapse of the U.S. currency would cause chaos, and it is difficult to predict the precise consequences. In a state of chaos it is impossible to say what situation would emerge. However, the one certainty is that the U.S. would be destroyed economically and would emerge from the chaos fatally weakened.

The revaluation would make the adjustment that I have talked about elsewhere in the blog, such that the U.S. would be a much poorer country. This is, in any event, going to happen. However, in this scenario, it would happen in a way in which it would be a dramatic shock. Instead of a gradual adjustment to a new equilibrium, the U.S. economy would plunge. As an analogy think of a person climbing down a ladder compared with falling from a height.

Yes, it would hurt China's exports, and throw the world economy into a tail spin. It would hurt China as well as the U.S. Eventually, the U.S. would recover with export growth, but it would almost certainly never regain the pre-eminent position in the world economy, which would go to China. China would risk social unrest during the adjustment that followed. However, the reward if they were to pull it off would be status as the new economic power.

As for the cost, $600 billion in devaluation of reserves would be a small price to destroy your greatest rival, and assure a pre-eminent position. The foundation of power is economics. If China destroys the U.S. economy, they destroy the power of the U.S.

The threat to sell the dollar I refer to in the blog, is an expression of China's new found power. Whether they are willing to take a gamble on the consequences of use of such power is a point of question. There are major risks to China if they were to carry it out. However, as things stand, the threat has rebalanced world power.

Friday, August 22, 2008

It's Official Now - Recession - but it will be a depression

The headlines today tell of the final acceptance that the UK economy is in trouble. The Times reports the following:
'Britain's economy is teetering on the brink of recession as official figures showed that output ground to a halt between April and the end of June. This is the weakest performance since 1992, the tail-end of the last recession, and will increase pressure on the Bank of England to cut interest rates to prevent a full-blown economic slump.

Official figures released this morning showed that output failed to grow at all in the second quarter, contrary to initial estimates showing that the economy grew by 0.2 per cent between April and June 30.'

The really odd part of this is that the UK economy has likely been in recession for many years, just not by the way that economists have been measuring the economy. Once growth in debt is stripped out of the 'growth' in the UK economy, it is very probable that the UK economy has been shrinking for some time. It is for this reason that I have been predicting the current state of the economy and that there will be a depression, rather than a recession (for first time visitors to the blog you can find the prediction/s - which have been proved almost exactly right so far - and why I made the predictions here). Once the debt pyramid collapses, it is inevitable that it will take the whole economy with it.

Regular readers will also know that I have been predicting a meltdown of both the government financial position (the government is still predicting growth in the economy!), and have also predicted the onset of bank failures in about 3-5 months time. An interesting article has appeared regarding the two U.S. mortgage giants, Fannie and Freddie Mac, in which Warren Buffett suggests that they would go bankrupt without government support. Whilst the story in the UK is that we do not have the same problems as the US sub-prime mess, the reality is that the situation in the UK is very similar, with for example self certification mortgages. Furthermore, the UK housing downturn is likely to be even more severe than the US for the simple reason that the bubble was bigger. As the UK economy turns down ever faster, the losses at the major banks will accelerate. However, I do need some caution here, as repossessions will lag the economy by some margin (notwithstanding the more aggressive stance of lenders that was reported recently), and the repossessions will be one of the triggers for bank collapses.

More immediate will be the souring of personal debt, which will already be hitting the balance sheets of the banks. Even as I write, there will be mounting panic in many financial institutions as they see a sea of red appearing on their balance sheets. On top of this there is the souring of business debt, as many businesses start to collapse.

In light of the above, I once again strongly recommend that the readers here spread their assets over several financial institutions, with instant Internet access, and be prepared to move your money at the first hint of trouble in any of the banks. When things go wrong, they go wrong quickly, so have transfers from one bank to another set up, so that you do not lose any time and can make immediate transfers.

On a related subject I have been reading about a new film about the US debt crisis, call 'I.O.U.S.A'. Apparently it points out the very bad (horrendous) state of US debt, and is causing quite a stir. When considering this, you may wish to bear in mind that the situation in the UK is far, far worse The US owes $13,773,135,000,000, and the UK owes $11,502,800,000,000 in external debt (this means owed to people outside of the country - original statistics here). You will note the astounding figures. I have not written this in trillions, as I feel this makes the numbers too abstract. You will also note that the level of debt in the UK is nearly as high as the US, but the UK economy is just a fraction of the size of the US economy. I have previously suggested that the UK is actually bankrupt and will be going to the IMF for a bailout at some point in the coming months, and looking at these figures it is plainly apparent why I argue this.

Aside from warning about spreading money over institutions, I have been very cautious about giving advice. However, in light of the fact that I am (depressingly) proven to be correct so far I feel slightly more confident to do so now. I have long predicted that the £GB would fall through the floor, and it is now going through that process. As such I suggest get you assets out of £GB and into other currencies. I hesitate to recommend a particular currency, but the prospects for the £GB are particularly poor, so you are unlikely to do much worse. However, as a general note all the OECD currencies are going to be devalued over the coming couple of years, with the possible exception of the Japanese Yen (note the word possible). An explanation of why can be found here. However, a word of caution - just because I have been right so far does not mean that this means I will continue to be right.

On a more positive note, at least now the reality the severity of the situation is starting to sink in. In particular, I have high hopes for the new film on debt to be a wake up call not only for the U.S. but also for the U.K. Now that it is accepted that the UK economy is not in good shape, there is opportunity for the U.K. to start to commence the process of reform. My only worry at this stage is that nobody is on the horizon willing to take the tough measures that are necessary. I also worry about the fact that the psychology of the people of the U.K. is such that they will not accept/face reality and contemplate such measures. I have outlined some structural measures over three previous posts, in an ongoing project, and so far have covered education, health and the benefits systems.

The simple fact is that the U.K. has been living beyond its means, and only serious structural reform can restore the U.K economy long term. In an age of global competition there is no choice, but the sooner the process of reform starts, the sooner the U.K. will be able to pull itself out of the mess that it has fallen into.

Monday, August 18, 2008

Reforming the Benefits System

In many of my posts I have proposed some radical solutions to some of the structural problems of the UK. You may want to see my posts on education and healthcare. In many ways the following article may appear to be radical, but is only really radical because we have become so used to the current system. However, it is perhaps the most controversial of solutions proposed so far.

The first thing to establish is that the current system is unsustainable in the future that is currently unfolding. The UK can simply not support the 'luxury' of a system that lets people stay idle on benefits. This is to sidestep the debate over 'what kind of society we want to be', because we will simply be unable to afford the current system.

What is the scale of the current problem? I am not going to go into figures here, as the figures for unemployment and how they are calculated is highly contested. All I will say is that it is far, far higher than the headline figure. What I will do, however, is step away from economics (although it is about economic drivers) and enter some muddy and dangerous political waters.

Before starting, a principle has to be established. If you provide economic incentives, and these incentives are perverse, you will get perverse outcomes. The current system provides just such an incentive with perverse outcomes. The problem in question is that of children. Having children in large numbers is currently a way of ensuring that the state gives support. The simple fact is that, if a person has responsibility for children, then they will gain the full financial support of the state, always with a justification that children must not ever suffer. This is a powerful moral argument, and very difficult to deal with. It is a moral force.

As difficult as it may be, the issue must be dealt with. Under the present system there is a perverse incentive to have children as a way of guaranteeing state support. This creates the incentive to have children in order to guarantee security. It is a curious parallel with 'less developed' countries, where having children are also seen as offering security - though with the vital difference that in less developed countries the security is taken from the potential for the future labour of their children. The problem in the UK is that the support that is provided for children of unemployed people is a drain on the state, and therefore a drain on every productive individual and business. The system is one in which children are being born into poverty, and adults are being encouraged into this situation. The more support the state offers for the sake of the children, the more children there will be born into poverty. At some stage the cycle has to be broken leading to the impossible moral dilemma of having to accept that some children must suffer so that others do not. Is there a path through this dilemma?

One thing to consider is that, in order to generate the wealth to support such a system of benefits, the country must be very productive and efficient. However, in order to be productive and efficient, the country must have a sustainable competitive advantage, and that a part of that advantage is an efficient state, and productive workers. Both of these are negated (in part) by a system in which, year on year, the numbers of people claiming benefits slowly increases. Even if the current challenges to the economic success of the 'Rich World' had never taken place, at some point a system of ever more state support 'for the sake of the children' would become unsustainable. In the current situation of intense global competition, the illogic of the system is being exposed more quickly. This does not address the morality of the situation, but does address the fundamental reality. If the current system continues, it will hit a brick wall as there will simply be less money available to support such a system.

At this stage it would be easy to characterise this point of view as heartless. How can anyone propose anything that will see children suffering from poverty? However, this is to ignore the reality that sufficient wealth absolutely must be generated in an economy to sustain such a system, and yet this system is in part a reason why the economy will fail in that task. In sunnier economic times, it was just about possible (just) to have a compromise in which all this was possible, that the economy as a whole could support the unproductive part of the economy. However, times are no longer sunny, and it will therefore be unsustainable.

Here is the real dilemma. If the benefits system continued without the reform of the principle of protecting children, then it would be impossible to create any system where any childless individuals might be subject to bad circumstances without further encouraging people to have children to ensure their own security. Children would simply become an even more important passport to the benefits system. One way or another the principle of benefits to protect children can not survive. If anyone can resolve this dilemma, I would be very interested to hear their thoughts (assuming that you agree with the view that the UK must reform, based upon the idea that we have entered an intensely competitive world).

I will now move on from this subject, and as a reader you have to either accept the economic rationale behind what I have said, or condemn me as a heartless monster (I will at some later stage offer another such situation where I might be so characterised, but for the moment this is the extent of my 'monstrousness'). Also, if you read on, you will see that it is unlikely that many children would ever suffer in the system I propose, though inevitably some would.

Having said this, I believe that overall less children would be born into poverty in the first place under my proposals. With no incentives for living on benefits, less children would be brought up in the benefits system. Furthermore, the system proposed (and this may surprise you) offers more generous benefits in some respects.

Having started with such a controversial point, I will start off the argument for reform with a quote from my essay 'A Funny View of Wealth' as it covers one of the central problems in the current benefit system.
'As mentioned before, all things in the UK are not equal due to the minimum wage, but also because the UK employer needs to compete for labour with the UK benefits system (which is an indirect minimum wage that applies to anyone entitled to social welfare benefits). This system allows an individual to remain economically inactive, or to choose an option of accepting a low paid job for very little real remuneration despite a major increase in the expenditure of their labour. In such cases the value of the labour expended is far below the minimum wage as it needs to be calculated as the weekly pay minus the benefits, to give an actual wage for the work done. The rational person in this situation might reasonably ask whether the loss of their free time to work is worthwhile for what will often be little financial incentive as, in this situation, the UK worker is often working for extremely low wages.'
This situation becomes even more extreme where there is a family involved. Under such circumstance there is the possibility that overall the individual will be working for very little additional income relative to the benefits.

Even more perverse are the benefits provided to those who are in work, benefits to supplement their income. In this situation the government is subsidising the labour of low paying employers. Without raising the wage to a living wage, many people would not be able to support a family and therefore would not take the job (under the current system). This raises the question as to why the government is in the business of offering subsidies for low wages? Whilst a teenager working as a waiter may not need a subsidy, there are many who are subsidised in their employment by the government. How can this make sense? In practical terms, employers who are paying living wages are also indirectly paying the wages of workers of companies that do not pay enough to create a proper incentive for work.

It is all very twisted and convoluted, but I hope that you grasp the basic principle - that perverse incentives are acting upon the market.

So how can this odd system be reformed? No one wants to see people begging on the streets, or children 'going without'. However, in order to retain the levels of employment that avoid this, the economy as a whole needs to be productive and efficient, and that means that the state needs to leave more money in the hands of business and individuals. This is the opposite of the welfare state as we know it.

As for my post on education, there needs to be an element of compromise. A situation in which a person is thrown out of work can not lead them into immediate destitution. It could be argued that they should save for a 'rainy day', a libertarian argument. However, history shows us that those at the bottom of the system often struggle to save enough for such an eventuality. However much people might argue for self reliance, it will always have limits. Those who are poorly educated, and with only a small amount of disposable income will never make such choices. Even in countries with no benefits system, people still do not save if they are at the lower end of income.

The compromise proposed here is that each individual should be given a personal allowance for unemployment. From the moment that a person reaches working age, and has worked for one year, they get an allowance for their entire lifetime, an unemployment account. This allowance is there for them to draw down at any time in which they become unemployed and would be calculated at the annual earnings of the average wage according to predetermined age bands. The allowance would be based upon 365 days of unemployment total, and each day of unemployment would give the individual up to 1/365 of the annual average wage. If they chose to take a portion of that wage, then they would only be debited a proportional amount from their unemployment account.

However, once an individual returned to employment, they would then recommence 'recharging' their unemployment account at a rate of 10% of their salary, paid each month into their unemployment account until they reached the full 365 days level. For the astute, it will already be apparent that what in effect is happening is that the government is offering a subsidised and unsecured loan.

In addition to the loan, another element of the unemployment system would be a process in which the person who becomes unemployed would also be immediately have returned their last three months income taxation. This would be paid in three lump sums over the three months following being made unemployed, and would still be counted as having been paid, despite being returned, if they gain employment in the tax year. This is to aid with the additional expenses of job hunting, and to offer a minor breathing space for higher earners with potentially higher outgoings (notwithstanding that higher earners should be in a position to save, some recognition of their higher net contribution seems fair).

One of the obvious problems with such a system is that some people might use such a loan to have a long holiday, or otherwise misuse the system. In order for a person to be given the unemployment allowance, they would need a letter from their employer that stated clearly that the person was made unemployed, with the employer liable for repayment of the money in the event that they lied in saying they made the person unemployed.

What happens if a person deliberately gets fired so that they can take advantage of the system?

Employers will be given an opportunity to identify cases where they believe an individual deliberately sought to be fired. Such cases would be investigated, and if it was believed that the individual deliberately acted in a way to lose their job, then the benefits would be withheld. It would probably not take many cases before the risks in such an approach became apparent, with the effect of making this kind of behaviour unlikely.

So what happens to those who exceed their allowance of one year of benefits?

Quite simply, they will need to fall back on charity, friends and family. In the traditional usage of the word, they will be destitute.

What about a young person who is having trouble finding their first job?

I have already outlined the education system in my previous post. If a person is unable to find a job then they will have the option of continuing education, provided they can be funded for this. If they can not either find an educational opportunity or work, they will be destitute and reliant on charity, friends and family.

Why include those who earn enough to save?

I start from a principle that everyone who is part of the system should be subject to equal treatment. As more wealthy people will be providing a larger proportion of the subsidy that the loan represents, they should at least be able to benefit from the same system.

Isn't this very harsh?

I am not sure that it is. It still provides a safety net, but also encourages individuals not to claim benefits unless absolutely necessary. Whilst an individual is unemployed, they will be well looked after. However, the cost of such care will be minimised.

The advantages in such a system is that it returns to the original principles of welfare systems, that it offers a safety net, and a good safety net. Being unemployed will not lead to impoverishment unless it is over a very long period of time. Even in a situation of deep recession, a person could extend their benefits over a longer period through not drawing down their full allowance. In fact they will have an incentive to only draw down the minimum, as it will have to be repaid.

Furthermore, with the time limitation, and the requirement to recharge the account, there is always a strong incentive to get back to work as soon as possible. Only the truly feckless would lose out in such a system and hard working people would have a safety net that would not only protect them, but would also protect them well. It would also provide a strong incentive for those that can afford to save for 'rainy days' to do so.

Lastly, it would be a much cheaper system, as the money would nearly always (one way or another) be paid back, with the only cost being the interest for financing the system. In an extreme example, it might even be possible to charge interest on the unemployment benefits paid out, though I am not proposing that here. Unemployment is a miserable enough experience without loading the cost with interest (possibly a rare sentimental point of view).

As with all my solutions, I welcome challenging questions, as such questions might highlight weaknesses I have not seen.

Note: Regular readers will have noted that I have still not continued my discussion on government spending and the Comprehensive Spending Review. I do have a partially finished version in draft, but thought is was time to address another positive solution. I will (eventually) get back to the review.

Note 2 Added 19 August:

I have not mentioned sickness benefit in the above post, and this is a major omission for which I apologise. There are widespread reports of doctors being 'sympathetic' to unemployed people and putting them on sickness benefits. As such, these benefits would only be granted when a person has seen a doctor appointed by the benefits system. They would also be required to attend the doctor at regular intervals, dependent on their condition, to confirm that they are still too sick to work.

For some conditions, there would be a maximum period of time for them to be allowed to claim, such as depression or injuries such that a person can not undertake manual work. Whilst there are some conditions that genuinely preclude work (which should be treated sympathetically) there are many types of work that can be undertaken by people who have less serious conditions, such as back trouble, where the person can retrain and find new work.

For those that are in a position where their sickness is short term, the benefits should be identical to the unemployment benefits system. For those who have sickness that is likely to be long term (greater than three years), the level of payment will need to be lower. Whilst this may appear as a 'punishment' for illness, it is actually just a recognition of the likelihood that the money provided will be unlikely to be paid back. As such, the cost to the state will be much higher and, in real terms, the benefit received will be higher (as they will not just be benefiting from an interest free loan, but will be benefiting from real cash sums). In addition, in some cases, there may be a need for grants for equipment which will be a further cost for supporting the long term sick.

As for the amount of payments it is difficult to give a formula here, as it depends on what level of payment would be needed to provide an acceptable life in different economic circumstances, and the family situation of the individual (in this case, having children should matter). As a ballpark, up to 2/3 of the national average wage would probably be reasonable. In order to afford such costs, the eligibility for sickness benefits would have to be rigorous, but that is the point of having independent assessment and clear delineation of what sickness genuinely precludes working. In a system that only awards the benefits from those genuinely precluded from work, the level of benefit can be higher than at present and still cost less overall.

Note 3 Added 19 August:

Inevitably, one of the problems with the system outlined will be the transition. One year on from implementation there would be a rash of horror stories in which families fell into destitution. There is no real solution to this. It is one of the reasons why genuine reform is so difficult. There are many people living on benefits who probably simply would not believe that the state would abandon them to their own devices. For such people, there is no solution except destitution to make them realise that they do need to contribute, and not just take. As a result there will be some heartbreaking stories one year on, and this would lead to campaigns, headlines, and a media circus. As with many reforms, it would require courageous politicians to implement the reforms. That is a matter beyond the scope of this post.

Saturday, August 16, 2008

The US Dollar

My post on UK unemployment has received a couple of replies. In one the commentator suggested that the rise of the US dollar was a good thing, and suggested that the US economy was therefore on the right tracks. Another commentator replied to this post with the following:
'Isn't the value of the dollar (and the index you mention) just a relative measure, so it's entirely possible that all non-Chinese economies are collapsing together, with just a bit of jostling to see who can collapse fastest?'
In light of these posts, it might be worth just discussing the recent recovery of the $US. In particular, how is it that it is recovering? A dollar recovery does not fit the script that I have been writing over the last few months.

As it is, the second comment is on the right track. All of the currencies of the rich world economies will almost certainly decline against the currencies of the emerging economies, and the reason for this long term trend is given here. However, with regards to the RMB it is a managed floating exchange rate, such that it can not automatically respond to market conditions. This is a big spanner in the workings of the currency system, and continues to be a partial block to the rebalancing of the world economy.

This is obviously just a very broad context and does not explain the recent rise of the dollar. My own suspicion is that the rise in the dollar is nothing to do with fundamentals but just the result of habit. In times of uncertainty, which I think would be a good summary of the current economic climate, people automatically look to the dollar as a safe haven. The trouble is that the dollar is now no such thing, and is still highly vulnerable. It's a bit like the business saying of 'nobody has ever been sacked for buying IBM', but in this case of the dollar it is flying in the face of reason. The simple question to ask is 'what has changed in the state of the US economy in the last few weeks to justify this appreciation?' As soon as you ask the question the only answer is that there has been no major change. As such, sentiment rather than reason is driving the dollar higher.

The real problem here is that the revaluation of the dollar upwards is just storing up even more trouble for the US economy. The US economy needs to be rebalancing towards export led growth, and this will delay progress towards this end. It is only through the relative impoverishment of the US that is represented by a weaker dollar that the US can regain a competitive position.

As such, the dollar may rally for a while, but in the end it can only last for so long before economic reality trounces market sentiment. At some point there needs to be an economic justification for a stronger dollar, and force of habit is a poor justification.

Comments from MattinShanghai:

I have had a couple of interesting comments from a person who presumably lives in China. I am particularly pleased to have a comment coming out of China, as it is only through seeing China 'on the ground' that the reality of that country's economic development is apparent (with Shanghai as a quite startling example).

One point of note was a link to an article/essay that Matt posted. The article can be found here. It offers a very challenging perspective on Japan, and is worth reading. I keep on meaning to address the subject of Japan, but it is on an ever expanding 'to do' list, so will have to wait a while longer.

For his other comment, I will not try to paraphrase it, but it gives an outline of a historical perspective on my post on Synthetic Economics. As such I would recommend a quick read of the comment. Matt refers to one author and his writing can be found here (I am downloading it now, so can not comment on it yet). However, it sounds like the author has an interesting perspective.

Recession Prediction

I have just been looking through the Sunday papers, and it is interesting to note that the British Chamber of Commerce is now saying that the UK is heading for a recession (article in the Times):
'THE British Chambers of Commerce (BCC) will this week become the first leading business group to predict a recession in Britain.

Its quarterly economic forecast, to be published tomorrow, is expected to say that Britain is heading into a “technical” recession of two or more quarters of declining gross domestic product over the next six to nine months.

It will say that a deep recession, of the kind last experienced by Britain in the early 1990s, remains unlikely, but that the risks to the economy have grown significantly over the past quarter and unemployment is set to climb by up to 300,000.'

On the positive side, at least they are recognising that the situation is bad, but their optimism over the length and severity is completely unjustified. I have looked at their website, and assume the source is the quarterly survey, which is only available with a subscription, so am unable to see how they reasoned their prediction. However, whatever their reasoning, at least the conclusion is positive in that they are pressing the Bank of England to ease interest rates. This is desperately needed in a sinking economy and will help the UK to adjust to the economic imbalances through weakening the £GB.

A good example of the non-argument for raising interest rates is given by Simon Heffer in the Telegraph. He calls for higher interest rates to fight inflation, but as is typical of such commentary, fails to explain (and presumably understand) by what process raising interest rates will prevent inflation. He says:

'A rise in rates, which I believe is necessary to drive the last ravages of inflation out of the system, would be the final humiliation not just for Mr Brown, but for the system of economic management that he has made his own.'
'I know a rise in interest rates will cause more houses to be repossessed, more businesses to fold and more bankruptcies.

Sadly, that is what the economy needs in order to turn itself round. You can't have sustainable "growth" on the back of an economy where people and enterprises are living beyond their means. You can have it only where they are living within their means.'

He may not have noticed, but this is already happening. Regardless of the interest rate, this process is already in train, so how is accelerating it going to help? He suggests that it is better to have the pain now than later. However, an interest rate rise will have the effect of being a prop for the £GB (though will just slow the fall), and this is will only have a negative effect. I give the example of Heffer, because his line of thinking is not isolated. Underlying such thinking is a lack of acceptance of both the severity of the current situation, and the changed reality of the world economy. Britain, along with the rest of the rich world, are going through a crisis, and and this lack of recognition of the crisis is one of the great dangers in the current situation.

Wednesday, August 13, 2008

UK Unemployment

I have long been predicting an accelerating increase in the levels of unemployment, going back to November of last year, and more recently said this:
However, also expect the rate of rise in unemployment to increase more quickly in the coming months (original post here)
In my original essay (November) I pointed out that it was likely that the position on unemployment would be ameliorated by Central European workers returning home, but that this would not be enough to stop the rise in unemployment, a point reiterated in my later post.

Today the newspapers are announcing that 'UK Unemployment Jumps Most in 16 Years'. This headline, under normal circumstances would be a cause for worry. However, bearing in mind that the predicted return of the Central Europeans is taking place, the extremity of the situation is even worse than the headline appears. As ever, the statistics on the Central Europeans are lacking but anecdote suggests that they are returning home in large number - a trend likely to be accelerated by the fall in the £GB, as their wages will be worth relatively less.

What this means in real terms is that unemployment is going up, but levels of employment are going down faster. This is indicative of the dire straits into which the UK economy has plunged. However, the consequences are going to be far deeper than imagined. One of the main sources of revenue for the government is the tax receipts from income taxation (I include National Insurance as Income Tax, as that is what it really is), at just under half of all revenue. We can do some back of cigarette calculations as follows:

Let's say that the total tax take (all taxes) on an average worker being laid off, or returning home to central Europe, is a conservative average of £8000 per annum. If we take a conservative guess at 200,000 Central Europeans having returned home in the last six months or so, that gives us a figure of lost revenue for the government of £1,600,000,000 per annum. These job losses will not show up as unemployment, but in a drop in employment. Furthermore, as the economy turns down, the number returning home will certainly be increasing. We should also consider that many of these workers are young, single and healthy, such that their net contribution to the economy was extremely high. As such their relative net contribution was likely raising the average net contribution per worker on average, such that their departure will bring down the average net contribution. As such the impact of their departure will be greater than for example, the magical disappearance of an average UK worker will be.

To this, we need to add the increase in unemployment among UK workers, which do show up in the unemployment figures. As these workers will be claiming benefits their impact will be even greater than the return home of Central Europeans (If you read the above carefully, you will see that I am not contradicting myself). Not only do they stop contributing to government revenue, but they also become an additional cost for the government. In the case of July alone, the figures show an additional 20,000 workers becoming unemployed, and the figures suggest that the rate of rise is increasing fast, with July's figures exceeding forecasts.

In short, the situation for the governments finances are dire. I have not even mentioned the falling tax take from VAT, Corporation Tax and so forth. Basically, every type of revenue is plummeting.

What I have also not mentioned is another impact of the Central Europeans return home. Many of the workers will have saved a significant amount of money, as that was why they were working here in the first place (money to return home with). As such, each of those central European workers will be returning home with a significant lump of cash, and we might guess that the average savings per Central European worker at £3000-5000 per annum. If we were to guess at the average length of stay in the UK as two years, that would give a lump sum of money withdrawn from the UK economy of about £8000. This is the equivaent to the import of a small car. This is a big lump of money to be withdrawn from the UK economy, and will have even greater impact than might initially be thought, due to the multiplier effect. The multiplier effect means that the loss of this cash to the UK economy means that this represents a considerable loss of economic activity in the economy as a whole. This loss of activity will also translate into a further loss of revenue for the government.

The rise in unemployment and the drop in employment are just starting to accelerate significantly. I actually suspect that there will be a substantial number of people who are actually unemployed but not yet claiming benefits yet. I can imagine (and it is no more than that) that there will be large numbers of people who will be living on redundancy money and/or credit for a couple of months in the hope that 'something will turn up'. I can also imagine these people appearing on the unemployment roll in the next month or two. For this reason the rate of unemployment increase will lag the drop in employment by a 2-3 months. As such, the unemployment figures of today may not fully reveal the drop in employment of UK workers. Again, there is a high likelihood that the the situation is even more dire than the headline numbers suggest.

I do not think I am alone in realising the severity of the situation. I note that the Bank of England is increasingly gloomy, and is starting to accept that the economy is in real trouble. However, even with their newly discovered pessimism, they are still not recognising how bad things will get. The UK economy is sinking like a stone.

I keep on mentioning it, but the rise in unemployment is going to start the second credit crisis. If we look at the headline figures of 20,000 increase in unemployment in July, you can see the harbinger of this crisis. Defaults on mortgages have been steadily rising over the last six months, and that rise lags unemployment rises. If we think of those 20,000 people, many will have mortgages and significant personal credit exposure, and will start falling behind in payments in a very short while. With the majority of UK households heavily indebted, each rise in unemployment will see mounting losses for the banks. With no ability to recover their money through repossession of housing (as the value of the house will increasingly be worth less than the debt), each default will represent a huge loss. These losses will now be starting to hit the banks hard and, even as I write, there are probably panicked meetings being held in all of the major retail lending institutions.

As I keep on saying, the situation is getting to get much worse yet.....

UK Inflation and house price support - What is going on?

I will interrupt my commentary on UK government spending as there has been a string of news that is worth consideration.

There is a lot of excitement in the press at the moment about inflation in the UK (see here and here and here). I have already detailed elsewhere about why I am puzzled that our largest living expense (housing) is excluded from inflation. However, even if it was accepted that the inflation figures made any sense in the real world, why would the current inflation be any prompt for interest rises?

Interest rises are supposed to rein back inflation when an economy is at (or near) capacity, and where there are upward price pressures as a result. In other words, raising interest rates is there to restrain economic activity through a reduction in the money supply.

See the following quote from the Guardian (link above):
'The Bank has said global trends beyond the control of its nine-strong monetary policy committee have been responsible for the rise in inflation and has left the cost of borrowing at 5% since April after three quarter-point cuts in the preceding five months.'
On this rare occasion I am an 100% in agreement on the cause of inflation. It is not generated from within the UK, but is the result of wider global forces. In fact, were it not for such forces, it is very likely that (even on the inadequate measures used), that inflation would be falling in the UK with the economy contracting. Excepting government workers, who in the current climate will be risking high wage demands...
The Bank has warned that if it sees evidence that wage inflation is rising, it may be inclined to raise rates. (in the Telegraph report linked to above)
...and how on earth is the economy going to reach capacity? Shops are already reported to be slashing prices...businesses are already shutting down, unemployment is rising.....

The same Telegraph report suggests that the Bank of England is considering the contraction in the economy 'next year' as part of its consideration. However, this should be the only consideration, excepting government worker's pay.

This brings me to a central problem with the stance on interest rates and inflation.
What exactly is holding or raising interest rates supposed to do in the face of recession and global forces? I am genuinely puzzled, as I can only think of one mechanism that this might impact, and that is the value of the £GB. If interest rates are raised, this may have an upward effect on the £GB as it will attract money into the economy, such as 'Carry Trade' money. Now if the £ rises, this will have the effect of reducing the cost of imported goods, including foods. As such this mechanism will (to some degree) lower inflation in the economy (though I would think not by a great deal, as the £ can only be supported this way to some extent).

However, as the UK service industry goes into recession, the only hope of recovery is manufacturing, and export manufacturing at that. In such a situation, the rise in the £ will be fatal. Also, it will negatively impact the balance of payments, as imports will surge, it will damage tourism, and so forth. Furthermore, raising interest rates will increase the cost of business overall, and further lever down an economy rapidly heading into free fall due to strains on consumers, and the fall in house prices. It will accelerate these processes.

All of this just to try to overcome food price inflation that does not even originate in the UK? Furthermore, one of the inflationary factors has been oil, and the price is dropping. When we consider the reason for fighting inflation with interest rates, this makes no sense whatsoever. As such it is only possible to conclude that this is either an unthinking knee jerk reaction (macho economics? Being seen to be 'tough' on inflation?), or it is politically inspired. For the latter, it is hard to see what can be gained.

In summary, I am genuinely puzzled as to how the thinking on interest rates is playing out, even if we consider the inadequate measures that are used in calculation.

Having expressed puzzlement at the potential political motivation for interest rates, there is one are of the economy which is plainly a matter of political convenience, and that is help for the housing market. A Times article reports that the government is going to extend further support for the market as follows:
'The scheme allows banks to swap mortgage-backed bonds issued before the end of 2007 for much more tradeable Treasury bills that can then be used to raise funds in the markets.'
In short, the government is going to take on a pile of low grade debt, and swap it for high grade debt (though the government is claiming that the debt exchanged is all high grade - sound familiar?). Furthermore Darling is
'considering a more controversial multibillion-pound plan for the Government itself to guarantee temporarily high-quality mortgage-backed securities. This could help to create investor demand for the government-backed bonds, assisting lenders to sell on their loans and so increase the supply of finance for lending.'
All this on top of the Stamp Duty holiday. All in all, this smacks of desperation. The fundamental question to ask here is as follows:

On what basis do they think that the current house prices should be supported? In other words, are the current house prices the right price, too high or too low. If they are making these proposals they must have a reason as follows:
  1. If they think prices are too high, then they are doing this to delay the day when prices fall.
  2. If they think the prices are 'just right' then they are supporting prices to protect the right price. However, how would they be able to demonstrate that the price is 'right' now?
  3. If they think that prices are too low, then the same question as above. How do they work out that they are too low? Do they have some magic formula to justify this. If not, then why not?
As is evident in the points above, there are some serious problems with each of these scenarios. The first is that the government has made a decision on what the correct house might be, but they have offered no evidence of how they could make such a calculation. As for trying to hold or boost prices artificially, how can this be sustainable in the long term? How can they keep prices from eventually correcting to a different level? The only thing such measures can do is delay any price adjustment. This raises the final question - at what cost?

The truth is that such measures will not do anything significant. Nothing is going to make the banks lend in the way they were in past years. In order to support the market, they need to continue with their dangerous practices of high income multiples for lending, self certification etc. The banks must do this if prices are to rise or stabilise, as the boom in housing was in part the result of an increase in the finance supply (see a funny view of wealth - the section on housing for a fuller discussion of this).

I am guessing, and it is only a guess, that Darling knows that the banks will not use the finance for new lending, but it will be used to shore up their battered balance sheets. In other words, with the exception of stamp duty, the measures look remarkably like the government trying to prop up the banking system. It looks like he realises that there is another credit crisis on the way, and is trying to forestall it.

Alternatively, he may just be incompetent, and responding to expediency in order to prop up the economy short term at the price of greater havoc later.

A quick post, and I will return to government spending soon. As a note, this is a quick review, as much more explanation could be given for why this is very odd behaviour.

Update Made on 14 August:

Just a quick note to mention that it seems that the BoE is not going to play ball on the idiocy that Darling is contemplating. Mervyn King says the following:

“We don’t guarantee lending to other forms of borrowing. There is no reason why in the long run you need any guarantee of lending to the mortgage market.”
Taken from the Times here....

Friday, August 8, 2008

UK Comprehensive Spending Review - Post 1

I have just been having a look at the UK government Comprehensive spending review which can be found here (for the brave only). Whilst reading through the report, I found endless points where I thought 'I should write about that'. I therefore decided to post as I perused. My original intention was to analyse where government money is being spent, but there were so many points in the general text that demanded attention that I have been distracted from my original purpose. As such, the review of spending in the specific will have to wait for another time.

I will try to ruthlessly edit myself, as there is far too much content worthy of comment. As such I will just note particular points that grab my interest, and comment very briefly. I would like to take the time to dissect this review but, as ever, time is not on my side.

A starting point- this is 'box 2.2' on inflation and pay (p26):
The UK economy is experiencing both an unprecedented period of growth and its longest period of sustained low and stable inflation since the 1960s. Low inflation has provided the platform for record employment levels, higher investment, productivity and economic growth. [.....]

In contrast to periods of higher inflation in previous decades, the credibility of the UK’s monetary policy framework has kept inflation expectations anchored and earnings growth has remained subdued.
The first problem with this wonderful section is that the government is taking credit for the low inflation. It seems that, when inflation is low, then it is down to the government, but when inflation is high, it is down to external forces. The reality, as I have made clear in past posts is that inflation and wage restraint has been the direct result of a massive number of new workers entering the world economy. That the government claims credit during the good times, and refuses blame during the bad is just dishonest.

I am tempted to comment on the 'Golden Rule' and other such nonsense in the report, but am not sure I can add anything to the discussions that have been provided elsewhere. As such I will not waste time on the farce, except to say that the Golden Rule is a sleight of hand, and makes no sense on any level whatsoever.

There is one point that emerges in discussion of the 'Golden Rule that demands attention. This is the endless use of the word 'investment', where the government actually means spending. I have argued elsewhere that the idea of government borrowing to 'invest' is unsupportable, but in many places in this report, the word investment is actually a direct synonym for spending, and can not even make (albeit flimsy) claims to be investment. Why has the media allowed this word to be used in this way? It is one of the great mysteries.....

Just to illustrate the point:
investing in Britain’s future, with total public spending over the CSR07 period
rising from £589 billion in 2007-08 to £678 billion in 2010-11 – an average increase
of 2.1 per cent a year in real terms consistent with the fiscal rules – enabling
further investment in the Government’s priorities of education, health, transport,
the Olympics, security and housing. Within these plans the continued strength of
the UK’s public finances have enabled an addition of £2 billion to the plans set at
Budget 2007 to take forward vital capital investment in public services;
Apparently, investing includes paying for a person to deal with your tax return, or to pay for a frigate, or to pay a nurse, or a social worker, or to... I could go on. The point is that all of this is apparently 'investment'. And the return on buying a frigate is how much? What is the return on the Olympics?

The curious part is that, at other points in the review there is an acknowledgement that this is spending. But how many people read that far? e.g.
spending on the National Health Service is nearly 90 per cent higher in real
Moving to a different point entirely, apparently the UK is in a good position for the long term.
2.46 The most recent assessment, published in the 2006 Long-term public finance report, shows that the UK fiscal position is sustainable over the long term. The UK is in a strong position relative to other developed countries to face the challenges of an ageing society. A further discussion of long-term fiscal sustainability is included in Annex B.(p30)
This statement would be amusing if it were not serious. The UK long term fiscal situation is dire. The UK has an unfunded pension system, an ageing population, and ever growing health care costs (that are likely to increase ever faster with an ageing population and ever more expensive treatments). No doubt the government will suggest that the UK is in a better position on pensions than, for example, some European countries, but that is like comparing a man with broken arms and legs with a man with a broken back. If we also consider that this long term is one of sustained economic growth, then the scale of the erroneous thinking becomes clear. This is a big subject, and I will return to it in the future, including some proposals for reform.

I will now quote a paragraph, and will not even comment on it. I will let you be the judge of the merits of what has been said:
third, value for money for the taxpayer – ensuring that world-class public
services are not just pursued through increased spending alone, but by
targeting resources on the most effective policies, reforming delivery to raise
productivity and increase efficiency wherever possible – thereby ensuring
sustainable levels of public spending which entrench macroeconomic
stability and maintain the UK’s competitive position in the global economy. (p31)
It is a bit later that we come to a rather frightening section as follows:
3.3 These increases in spending have been made possible by the stable and sustainable economic growth described in the last chapter, with falling debt interest payments and low unemployment releasing resources for key priorities, as illustrated by Chart 3.1. (p36)
I say scary because they then show a chart that gives growth in expenditure from 97-98 predicted out to 2010-11. Included in this projection is that the servicing of government debt will fall by approximately 1.5%. This is positively Orwellian. The truth is that debt is increasing, and this chart is based upon a continuous high growth rate in the economy. Instead, the economy is sinking fast. Furthermore, as the economy sinks, along with the £GB, borrowing is going to get much more expensive, if anyone is going to lend at all (excepting the IMF).

The other obvious point is the talk of stable and sustainable growth. Bearing in mind the state of the economy at the moment, the idiocy of the statement is already evident.

The report later starts to talk about improvements in front line services (they switched back to 'investment' again here rather than spending). I give an example as follows:
deaths from cancer have fallen by 14 per cent, and from heart disease by 31
per cent. In total, over 200,000 lives have been saved since 1996 as a result of
reductions to mortality rates from cancer and circulatory diseases among
people aged under 75; (p37)
At this point, it might be mentioned that cancer was one of the targets that were measured by government. I quote below something that I wrote on another occasion on the Balanced Scorecard (BSC), which directly addresses the problems of targets (sorry for the change of font).

There are some inherent risks in any measurement system. Neely, in the performance Prism, [1] describes an incident in an airport business. A senior executive in the airport noticed a baggage handler running with a bag towards a carousel. When he enquired about why the man was running it became apparent that the baggage handlers were measured on the time that it took from an aircraft landing to the time that the first bag went on the carousel. As soon as the start button was pushed, the time was recorded. Clearly, the intention was not to have handlers running with and individual bag, but was intended to ensure speedy disembarkation of luggage.

The point in the example is that measurement systems cause distortion in the behaviour of those being measured. This is one of the greatest risks in the BSC system, despite Kaplan and Norton’s warnings against the dangers. Taking an example from the real world it is possible to discern examples of measurements distorting behaviour. One famous example was apparent in the last UK election. Doctors were set targets for appointment booking times, and the system created a distortion such that appointments were delayed in order to ensure that a booking target was met.

At this point, I will leave this post, as real life is demanding my attention. However, I will return to this subject in the future, time allowing. In the meantime, I strongly suggest that you take a look at the report (I am afraid 286 pages of it). However, if you look at nothing else, look at where government money comes from and goes to. It can be found at the start of the report. As you look at the charts, just ask yourself:

'Where is this money actually going?'

This is a subject I will certainly cover in the future. My apologies for an incomplete post, but I can either read the report or write a full post. In order to comment, I need to read the original, which does not leave much time for comment. As such, a compromise. I would wait, but it seems that I have a growing regular readership, so like to add fresh content whenever I can.

[1] The Performance Prism, Neely A. et al, 2002, Pearson Education, 1st Edition, UK

Wednesday, August 6, 2008

Why do Economists get it so Wrong?

Note: For some reason I am getting large numbers of people coming in directly to this page, which suggest that it has been a worthwhile post and is generating considerable interest. However, it is an unusual entry point to this blog, and the post assumes that you are one of the regular readers. As such, I would ask for your forbearance, as it assumes an element of knowledge of previous posts (having the effect of creating a strong interest in what is explained). As such I have not made it as easy as I might have. However, if you do stick with the post, it does stand alone, and may prove to be a revelation about the functioning of the today's economy, and why the UK and the West are in trouble . Alternatively, you may wish to start with the rather neat summary provided by a commentator at the end of the blog ( just scroll down) before returning to the main entry. You may also want to take a look at the post 'The Cigarette Lighter Problem' for a (perhaps unusual) context on the problem that the West faces, and this will help in clarifying why I am suggesting the UK (and the West) is in such deep trouble.

Original post starts here....

Today, I will make a rather belated (apologies for this) reply to a comment from a few days ago in response to my post 'Can the Economics of the Past be used to Predict the Future?' The comment was as follows:
'However, I still keep hearing 'experts' being quite complacent about the situation. On The World This Weekend at lunchtime Vicky Redwood, economist at Capital Economics, said that the reluctance of banks to lend to each other meant we might have a "technical recession" but hopefully not as bad as the early 1990s. (I asked around, and in my circle, nobody could remember the recession in the early 90s!). Another expert seemed to be suggesting that the problem is a "contagion" spreading through the economy, which makes it sound less than a fundamental problem.

As I understand it, both of these analyses are very shallow (only looking at the symptoms, not the causes), and these experts tacitly admitted that they are having difficulty making accurate forecasts. It made me wonder whether it ever occurs to them to step back and look at the 'bigger picture'. I suspect not.'
I did not see the interview, so I am unable to comment on the specifics of what was said. However, I think that this comment captures one of the problems of current economic thought. The world economy has changed significantly since the early 1990s. I have given an explanation for why this is the case in my post 'The Root of the Problem'. My argument is that there has been the development of a situation in which there is a massive over-supply of labour in the world economy, and that this makes the critical difference to the way in which the world economy is operating.

It may be worth reiterating how this provides a problem. Imagine that there are three factories that use commodity x, and the factories use a total of 100 workers (workers have a particular meaning outlined at the end). Each worker uses 1 unit of commodity per week in order to produce up to 100 units of product z. There is demand for 98 units of product z. There are 3 commodity companies who together can extract up to 105 units of the commodity per week. As such there is an oversupply of the commodity and a very small oversupply of labour, and this helps keep prices down.

Then something changes. It starts with one or two extra workers becoming available, and a new small factory is built to utilise their labour. Each of the new workers can supply half a unit of product z, but only adds a quarter of a unit of demand for product z. Initially, this is not a problem. They make very little impact upon the supply and demand, though their ability to produce more without greatly adding to demand holds down the price of product z.

However, because they can make the product z without demanding so much of product z in return means that this prevents the three original factories from raising their pay to their workers. As time goes on, the one or two extra workers start to increase in number, and as time goes by, they start becoming better at production so that they can produce just under 1 unit per week per unit of labour.

This is all fine, but suddenly there is a little too much of the product being made. The price of the product starts to drop, and with the drop demand overall increases, as more people can afford more of product z (including the workers in the new factory). The three original factories start to struggle, as they have too much labour. The price has fallen with the increase in supply, but their workers demand too much of product z in return for their labour, in comparison with the new factory. They realise that they must lay off workers, until such time as demand for product z increases to the point where prices will rise enough to give their labour what they demand.

As fast as the original companies lay off workers, new workers are appearing at the new factory. As each new worker is added, there is a new pressure on the price as the lost production capacity is replaced with labour that demands less of the product in return. Meanwhile the overall demand for the commodity is rising, along with demand for product z, as more workers can afford to buy it. The commodity extraction company notices that demand is rising and starts extracting more, but each week only add a fraction of a unit of the commodity to supply, such that supply in comparison to demand is slowly falling.

Furthermore, as it is apparent that a new factory offers the ability to produce the product more cheaply than the original factories, a trend of building ever more new small factories starts. Add to this that the new factories have improved on the amount of product z that each new factory produces per worker, and that the amount of the product z that the new workers are demanding for the labour is increasing slowly, and the situation sees a further escalation in demand.

The question here is; what happens next?

We have an ever increasing number of units of product z being produced as the original factories laying off of staff lags increases in supply (they are responding to the market signals), and we have an ever increasing supply of labour that wants comparatively less of product z per person, and we have an overall increase in supply of, and demand for, product z in comparison to the increase in supply of the commodity.

I was tempted to do this as a formula, but would rather let you use a heuristic/estimation approach (in part because I do not have the time, in part because it is clearer if you think about it).

We have several problems in this scenario. The first is that, as workers are laid off, there should be a decrease in demand for product z. In the real world this is not the case and the question is how this can be so? The other problem is that, where commodities are not keeping up with demand, what happens when commodity supply can no longer meet demand?

The second problem is relatively easy. With only so much increase in supply of the commodity, there will be a situation in which there will one day be excess capacity of labour in relation to the supply of the commodity, in particular in a situation where more and more workers are being added. This is the situation today. In this situation, only the factories that can manufacture product z with the least demand from the workers for product z will be able to to be supplied with the commodity. There is only so much of the commodity to go around, and only the most efficient factories will survive.

The other problem is that with only so much of the commodity, for a while, there will be an increase in the cost of the commodity, and therefore the price of product z will increase, thereby lowering demand, as the product becomes more expensive. In part this is offset by the increase in labour keeping demands for return for labour low, and the greater productivity of the new labour, but eventually the increase in the price of the commodity outstrips these factors.

Now, in a perfect economic world, what should have happened is that, as the new factory opened and commenced production, the workers in the original factories should have reduced their demand for so much of product z in return for their labour. Instead, they continued to demand the same amount of product z, and this led to their factories progressively shutting down. As this happened, there should have been a drop in the demand for product z, but this did not happen. Here is the mystery of the world economy. How is it that demand continued from the original factory workers? It does not make sense.

We are now in a position where one of the original factories has shut down completely, the remaining two are much smaller, and there are a mass of new factories. Available labour has now outstripped the capacity of the commodity. The price of product z has started to rise dramatically, and demand is therefore falling back. Sill the mystery remains of how it is that demand did not adjust with the closing of the original factory and the lay off of so many workers from the original factories.

It is here that we come to the 'economic miracle' of the last ten or so years. The new factories could produce product z without so much demand for workers for their labour of product z. This gave them a greater surplus per worker, and they then invested this surplus. Furthermore, as the commodity producers enjoyed ever greater demand, they made ever greater profit, and also invested this.

We now need to step away from this simplistic explanation, as it can not explain what happened next. This investment is the surplus generated from the emerging economies such as China, and the profits of the commodity producers. They invested this money into the governments of the West, and the Western consumers, thereby delaying the day when demand for product z would drop. It is only now that the supply of commodity is inadequate for the supply of available labour, that the problem has come to light. Demand should have fallen back a long time ago, but was propped up by bad investment of the surpluses that were created. Without a commensurate increase in supply of commodities, the growth could not continue. and without a lowering in demands from labour in the West, they were going to lose the competition for the allocation of the commodities.

We now have a mess. The west is in debt, prices are rising, demand is falling. The amount of commodity is only 120 units per week, but the number of workers is 140 and still growing. Someone somewhere is going to lose out. The amount of commodity per worker has fallen, and is falling further, despite the amount of commodities overall increasing. As such, the world as whole is richer. What has changed is that, whilst the world as whole is richer, the original workers must accept that the distribution of the commodities has changed.

When the original factories were in the West, they were using nearly all of the commodities, and were therefore the primary beneficiaries of the commodities. When the emerging economies entered the market, then the amount of commodities per worker was redistributed, such that some of that share was being transferred away from the West. Had commodities kept up with demand, then eventually (albeit with some painful adjustment along the way) everyone in the West could have remained wealthy, and the rest of the world become wealthier. However, in order for this to be the case, then there needed to be an increase in supply of commodities such that every single worker has the same amount of commodity per worker as we had in the beginning in the original scenario.

In other words, the only way that everyone could have won was to have exactly the same level of commodity extraction and production per worker as at the start of the change in the world economy.

The reason why economists have got it so wrong is that they have ignored the fundamental problem in the world economy. You can only grow the world economy if you have the raw materials to provide the means for growth. If not, then the raw materials will simply be redistributed. Redistribution means winners and losers.

It really is that simple.

Note: If anyone would like to do a scenario with all the numbers to illustrate the point, then this will be welcomed! Just add it as a comment, and I will publish it (it may also reveal some faults with my scenario?)

A note added to the post later: I mentioned that, as more labour enters the market, and commodity extraction increases, the world will be getting richer. I perhaps did not make one point clear enough. The overall wealth of the world on average has increased, but the likely outcome is that the wealth of the West will, on average, decrease. As such, whilst the world gets richer, a share of that wealth will be redistributed to the emerging economies such as China. In crude terms if we say that each of our Western consumers averaged a usage of 1 commodity unit per week, then the world must produce the same additional amount of that commodity for each new worker for everyone to reach the wealth of the West at the start. Where there is only 0.6 units of commodity per worker, then not everyone can be as rich as the West at the start. The question then arises as to how the new commodity per worker will be shared amongst different workers. More to the point, what happens when ever more labour is pouring into the market?

I should also clarify that a worker is a person with sufficient capital and infrastructure supporting their entry into the world labour market.

Another Note added 8 August: I just thought I would mention that I have been guilty of implying that the key differential between the emerging economies and the West is wages. It is not just wages, but all of the other 'benefits' that come with living in the West that are also part of the differential. These are structural problems. I address this issue in a rather unusual way in my post 'The Cigarette Lighter Problem'.

Sunday, August 3, 2008

As Expected - The UK Economy is Collapsing

For the regular readers of this blog, they will be familiar with some of the predictions made in my essay 'A Funny View of Wealth', and some follow on posts that I have made in which I have discussed other aspects of the economic outlook. It is a while since I have looked at the 'big picture' so a brief review seems to be in order.

The first point to make is that, as predicted, house prices are not just falling but plummeting, and this was very much in line with predictions for this period in time. However, my prediction was, and remains, that they have a long, long way to go down still. In a later post I suggested that my already extremely gloomy predictions were too conservative, and I would suggest that my later more pessimistic outlook is more realistic. I do accept that there may be a very small upward blip at some point, a false recovery, but see the chances of this diminishing with time. However, there are still a few optimists out there, but I would suggest that such optimism is self-delusion.

Another element in the downward spiral that I predicted was that consumer confidence would evaporate, which is now the case, and that this would start to hit the service sector hard and fast. The knock on effect of this would be that many businesses would start laying off workers and that unemployment would start to rise. I mentioned the likelihood of the Central European workers going home or to other parts of Europe as the economy contracted and other labour markets in Europe were opened, and that this would ameliorate the rise in unemployment. As predicted unemployment is rising, the Central European workers are going home in large numbers, and unemployment is not rising as fast as would be expected in a sinking economy. However, also expect the rate of rise in unemployment to increase more quickly in the coming months. Whilst the return of immigrants can dampen the effects, it will not be enough to hold back the tide.

The predicted (and inevitable) rise in personal insolvencies is well under way, and will also accelerate with unemployment, with further stresses on finance caused by inflation in oil and food prices (both of which I did not predict!), as well as higher taxation. Expect a personal loan and credit card debt meltdown in the coming months. It has already commenced in the US, and the UK will soon follow. The banking sector is about to enter the second credit crisis, and banks such as Royal Bank of Scotland are already showing their vulnerability. Expect more runs on banks - Northern Rock was just round one, and round two will be even more ugly. The second round will see mortgage defaults rising with a sinking market providing negative equity, personal debt rapidly turning sour, and business insolvencies all hitting together. The banking system is toxic (spread your risk over several institutions, and make sure that you can move your money fast using online banking).

As expected business insolvency is rising, and as expected it is hitting the service sector first and hard (as well as house builders). Expect these numbers to now accelerate hard and fast, in particular pulling in the retail sector. The whole UK economy, as predicted, will be pulled down with the service sector and this is already taking place. The destruction of businesses is only just starting - prepare for much worse to come. If you are wondering where to put your money, keep out of retail, banking, and anything to do with leisure, excepting those companies that service home leisure. Solid exporters with unique technologies are the safest bets.

As for Sterling, I suggested that this would also start to fall, which it is doing (if you will excuse the metonymy), even against the US dollar, which has been tanking. I stick with my prediction that it has a long way to go yet. As confidence in the UK falls, it will fall off a cliff. I would suggest that there will be a steady decline for another couple of months, and then a steep drop.

As predicted the drop government receipts are making havoc with government finance, and this will get much worse as the economy sinks further. As I have predicted in a previous post, cap in hand to the IMF appears to the the likely scenario in the near future, though not for a while yet. I am really not sure that many people are aware yet of the Tsunami about to hit government finance, but it will be very ugly indeed. To misuse Alistair Darling's phrase, we are uniquely misplaced to weather the economic storm.

In other words, the UK economy is following the path that I predicted. As such, if I have been right before, I have to accept the uncomfortable idea that I will be right about the next phase of the collapse. This is not a pleasant idea. I am afraid the next phase is one of acceleration of the downturn, as each negative reinforces the others. The only remaining question is to ask at which point will other countries lose confidence in the UK economy? This is a matter of sentiment, of feeling, of intuition, of 'groupthink', and therefore hard to predict. It is when the sentiment goes that the banks will start failing, and the IMF becomes the saviour. I think that this is not far off, but am slightly less certain than in my previous predictions that this will be within 6 months. However, this is only a case of slightly less certain.

Not a happy post, and I have a feeling they will become ever more gloomy in the coming months.
Note: When I discussed the Chinese economy I suggested that China may be able to weather the world economic storm, but also suggested that China is on a knife edge on this subject. The early news is suggesting that China may not be that resilient. In my post I pointed to worries about their banking system and construction. It appears that these worries may have been well founded. See here for why. Having said this, I am still not confident to jump one way or another. China has many economic strengths, and may pull through this okay, although it will certainly feel negative effects of the global downturn.

At some time I may talk in detail about the US, if there is interest from readers on this subject.

Friday, August 1, 2008

Rectifying Health Care Costs - No More NHS

I have mentioned that, over time, I would post some ideas on how to make structural reforms to the UK. I have already covered education, and the next big area of government expenditure I want to cover is that of healthcare. The solution I have outlined is radical, which may not surprise regular readers of this blog (who seem to be rapidly increasing in numbers).

The National Health Service in the UK has taken on the status of being untouchable. As such, I write this in the knowledge that such a system as I am proposing will only be considered in extremis. However, extremis is what the UK is now potentially facing, so I will detail a new system on the basis of putting the idea 'out there' in the hope that it might provide inspiration, or at least help people consider that there are other ways of running a health service.

Like any system, the one that I am proposing only makes sense as a complete entity, so I would ask that you stay with the idea to the end. Do not rush to judgement at the early stages, as the system is not what it seems at first. As for my post on education reform, the system offers a market based solution, and aims to remove as much government control from healthcare as possible.

I will not detail the many criticisms of the healthcare system here, except to say that the arguments normally revolve around the bureaucratic nature of the system, cost, efficiency and quality of care. A particular criticism of the moment is the use of top-down targets, which distort priorities and outcomes. My aim is that my proposed system will address all of these issues.

I will start with a shocking statement. The system I am proposing will cost people money for their treatments. However, before recoiling in shock, you should be aware that nobody will be denied treatment.

To best explain the system, I will start with an individual who thinks that they might be ill. We will call the patient Fred. Up until today, Fred has been very healthy, and has therefore never utilised the health system, so he has not even registered with GP (doctor). Unfortunately, Fred has not been feeling well.

His first task is to therefore find a doctor. He goes online and searches for a doctor and finds a directory of all the doctors in his area. The directory lists the details for the doctors along with ratings for each of the doctors. There are two kinds of ratings; rating from patients, and ratings from consultants, both of which are shown as stars. The search also includes the hourly rate that the doctors charge, and whether the doctor is taking on new patients. Fred is a middle income manager, so he chooses a doctor with middle level hourly rates, and a good rating from his patients and consultants. He telephones the doctor's surgery and makes an appointment. In order to confirm his appointment he needs to present his government health card to the surgery, and enter a PIN to confirm his registration.

Having popped into the surgery with his health card, he is now registered with the doctor. A couple of days later he has an appointment with his doctor. The time that he enters the doctor's office is taken through his swiping his health card, and entering his personal PIN. He sits down with his doctor. The doctor conducts an examination of Fred, and concludes that he does have a problem. He is concerned, but not overly concerned. He thinks the best option for treatment is a course of drugs but, if that does not work, he will require some minor surgery.

The doctor prescribes the drugs, and Fred enters his PIN before the doctor can issue the prescription. The doctor updates the notes on the computer in front of him. At the end of the consultation, Fred swipes his card, and enters his PIN again. His time spent with the doctor is recorded. He is then taken to a room, where he is left alone with a computer. The computer asks him to rate the service that the doctor has provided.

At this point, you may be puzzled. What is going on here, and how is this different from private medical care? The difference is explained below.

When Fred chose his Doctor, he selected the doctor in part on the hourly rate that he charged. When Fred registered with the doctor, he accepted the hourly rate as part of the registration. This acceptance was recorded, and he then opened a government health account. In doing so he was making a commitment that up to a maximum of 5% of his income would be deducted each month to pay off his medical bills (achieved through the taxation system). The cost of the visit to the doctor was entered into this account, one of several health accounts. The following month, up to 5% of his income will be taken to pay for the visit. Each subsequent month the same will happen until the account is paid down. Also included in this account is the cost of medicine and diagnostic tests. As such, in this case, Fred will also have the cost of the medicine added to this account. We will call this account, Basic Medicine.

A week later, Fred is feeling no better, so arranges to return to the doctor. As before the same procedure is undertaken with the swipe and the recording, and the cost will be added to the Basic Medicine account. However, this time the doctor knows that he must use a consultant to further examine Fred. He ends the consultation, and Fred is sent to the surgery administration. The doctor has informed the administration of the surgery what kind of consultant is needed, and the administration makes a search on an online market for consultants. They enter Fred's postcode, and the search produces results for the nearest 20 consultants to Fred. Each consultant has two ratings, a doctor's rating and a patient rating, along with an hourly charge and earliest available appointment. The administrator asks Fred to select the consultant that he would like to use. The administrator makes a small flat fee charge for helping Fred use the system.

Fred decides that a consultant near to home is his priority, and selects a consultant with the best rating, at a roughly middle cost, that is near to him. He enters his PIN, and the contract with the consultant goes through, and the administrator helps Fred book an appointment At this point the administrator forwards the patient record to the selected consultant electronically. There is no centralised IT system for patient records, but all records must be available in a proscribed format (for technical people, an XML schema). As before, the costs of the visit are transferred to Fred's Basic Medicine account and Fred is asked to make a rating on the service of the doctor.

A few days later, Fred goes to see the consultant. Fred swipes his card at the start of the consultation, and enters his PIN. The consultant examines Fred and decides that Fred needs some minor surgery. At the end of the session, he writes up the results of the examination, tests and so forth, and forwards these electronically to Fred's doctor. In addition, he rates the decision of the Doctor to send Fred to see him. In this case, it was a necessary visit, so he rates the doctor highly. In addition, Fred is asked to enter his rating of the consultant in a private space for this purpose.

Once the doctor has seen the record from the consultant another appointment with Fred is made. At this stage, the doctor needs to help Fred to arrange the hospital that will be used for the surgery, and the doctor must be involved in this decision. However, before the appointment, the details of the required surgery, and the patients notes will be sent to the nearest 5 hospitals (or providers of the necessary surgery) to Fred's postcode. Fred's name and location will not be provided at this stage, such that local hospitals are unaware that Fred lives near to them. Each will be requested to give a quotation on the surgery. Included in the quote will be the total cost, the earliest date available, the surgeon available and so forth.

The quotation will be based upon the cost of the procedure itself, the cost of a hospital bed per night. In addition a quote will be given for managing likely complications, and the cost of additional days residency in the hospital. These will be calculated into the costs and will be weighted in the calculation according to likelihood. i.e. if a particular complication is very rare, then the cost of treatment will only be added in as a tiny fraction of the total quoted cost. This is one of the few areas of complexity within the system, and would require monitoring of statistics for the outcome and complications for different kinds of treatments. The aim will be to offer a final quote that includes loading for extended stays, and additional treatments, calculated as a final single figure. However, the actual bill will provided to the government will be based upon the full cost of what actually was undertaken, in accordance with the quote.

In addition to the 5 nearest hospitals Fred's doctor will also have the option of requesting a quote from two other hospitals. If the doctor believes that good treatment for the condition can only be obtained out of the area, then this will allow him to find other options. In addition, the doctor will be allowed to exclude up to one hospital if the doctor believes that their standards are poor. When excluding a hospital, the doctor will be required to give a reason why, so that the provider is made aware of their poor reputation.

The doctor can then select from the three providers of the lowest cost quotations, provided that there is no more than 10% differential between the costs of the cheapest and most expensive. If the differential is greater, then the system will automatically broaden the geographic spread, widening it until such time as 3 quotes are available within the the 10% range (the doctor will not need to actively do this, as the doctor should only finally see the results when 3 quotations meet the criterion). At the end of the process, Fred should be presented with three choices based upon geographic search, and up to two choices of hospitals selected by his doctor.

At this point, Fred has a real choice. Each hospital will have an availability date, and he will also be able to see a rating for the hospital for the procedure made by doctors, a rating made by patients, and the final cost of the procedure. Fred then needs to make a choice of hospital for the procedure. Fred can then select the hospital that best reflects his needs. He will be made aware that 25% of the cost of the procedure, and 100% of the costs of the hospital bed, will be allocated to his government health account. This will be allocated to the Major Procedure account, that will allow for up to 3% of his income to be taken each month to repay the cost of treatment.

We will jump forward in time, and Fred has been treated and (happily) with a successful outcome. Fred will then be asked to rate the treatment and hospital, as will his doctor. The costs of the entire process will all be deposited in his government health account, and over the coming months he will find that he is paying 8% of his total income into repaying the healthcare costs.

So what is the advantages of the system. The first advantage is that the system encourages everyone to consider a combination of quality of care and cost of care. It allows the users a wide choice of care according to their own priorities and needs. Furthermore, whether employed or unemployed, there is 100% availability of healthcare, and few would argue that a burden of a few percent of income for healthcare would be unreasonable, even taken from unemployment benefits or a pension.

However, within this scenario, there are several elements that are still missing. The first of these is Accident and Emergency treatment. This is a situation in which a patient does not have a choice. In this case, the only solution is direct government funding, and fixed fees for the system. In this case up to 2% of income would be used to repay treatment and a fixed fee will be applied for any entry into the A&E system. This will require a third account, the A&E account, making the total that can be taken from a person's income 10%. Due to the nature of the system, the government will need to directly contract with hospitals to provide A&E services.

Who would provide for the hospitals, or how will they operate?

The hospitals can be provided by any means. They could operate as charitable trusts, or as private concerns, or any format that can be imagined. Because of the system of choice, and doctors and patient ratings, only hospitals that provide good quality care cost effectively will survive. For example, if a hospital is providing poor care, then the doctor will reject it from the list of hospitals provided to the patient. If the standards of care given by nurses are poor, or if the hospital is not clean, providing poor quality food, then patients will give it a poor rating, reducing demand for its services.

What check on costs will there be?

One government check on costs will be to have a system close to that of NICE (National Institute for Health and Clinical Excellence). They will have a role of determining what might be funded within the system.

What of children?

The accounts of children will be allocated to their parents and, where the parents are not together the costs will be evenly split between the two parents.

What of preventative medicine?

Each individual within the system will be allowed one free health check per year without cost. Certain preventative checks, determined by NICE, will be offered free of charge to encourage uptake.

What of Medicines?

One of the few benefits of the current system is that the massive purchasing power of the NHS allows for cheap purchase of medicine through central control. As such, central purchasing will be retained in this area - the only centralised control in the system.

Won't this hurt the poor?

One of the benefits of this system is that a maximum of 10% if income will be taken from any individual. Even if the individual is on benefits, this is a very small price to pay. Furthermore, because of the system being capped at a percentage of income, the more wealthy the person, the more likely they are to pay for the treatment they have benefited from. If a person is on low income, and they undergo a major procedure, it may be that they never pay down their account. On the other hand, a high earner will be more likely to pay down their account. In this way, everyone makes a contribution, but it is likely that high earners will, on balance, pay more on average.

What is the role of government?

Government is subsidising healthcare, and collecting the remaining fees.

Should government have any role?

If we were to take a purely libertarian stance, no. However, health care is perhaps the one area where even libertarians might be nervous of a completely free market. Few want to see people lacking treatment, and dying for lack of healthcare.

What of dentistry?

The same system applies, and an additional 2% of income can be used to pay for the costs. However, each dentist can not undertake the work they suggest, but will play a role similar to that of the doctor in selecting treatment. As such, each individual will have a dentist for prescribing treatment, and will use another dentist for enactment of treatment. The system will therefore be the same as the system for selecting hospitals.

What of the rating systems?

One of the keys to a successful market is information and choice. The purpose behind the rating system is information. This is one area that would be under central control, as all users of the system need to have an input into one unified system, so that all ratings can be aggregated. This is a relatively simple system to achieve, and can be cost effectively deployed over the Internet. One of the keys to the system is that each rating needs to be anonymous, and each individual can only rate one event on one occasion (to avoid vindictive ratings).

Who is providing all the IT?

Each medical provider will have complete freedom over the system they use, provided that they can offer the information necessary for the operation of the system securely and with the data in a common format.

How could it be implemented?

The only complication in implementation is ensuring that everyone is prepared to provide data in an appropriate format. For provision of hospitals, the simple solutions is to take the existing hospitals and make them independent charitable trusts. From that point forward the market will then adapt to meet the demands of both patients and doctors. There need be no further intervention.

What if people have to travel for treatment? Won't they complain?

This is a question of explaining the benefits of the system to people. At the outset, there will be problems, complaints, news reports about the 'terrible hardships' this caused x,y, and z person. This is all about explaining that no system can be perfect and asking for patience whilst the system beds in, and patience until the benefits can be felt. The system will certainly improve standards over time, such that having to travel to get decent care will diminish as a problem over time, though will never be eliminated.

You've missed out a lot. What about, say, midwife services?

There are many elements not dealt with in detail. I am only establishing guiding principles here. Apply the principles laid out, and I think you will answer this question yourself.


As for my proposal for education reform I do not suggest that this is a finalised system. It is an idea, a framework, and nothing more. The purpose of the system, just like education, is to create a system that is both cost effective and provides good quality. In an ideal world, there would be no government role, but this offers a compromise between a state funded and private system.

In this system, everyone has their interests aligned towards quality and cost. A doctor can only propose a cost effective hospital, and a patient will need to decide what their priority is - locations, cost, availability over time, and quality of care. In such a system, over time, the healthcare system will shape itself to the needs of patients, but will shape itself in a way that offers cost effective care without sacrificing quality. Most importantly, paying for the care will not cause individuals hardship, as the maximum payment is !0% of income per month, or 12% if dentistry is included.

My reason, as for education reform, for such a system is to alter the structure of the UK, with an aim of making it more effective in the allocation of state expenditure. In this system, the state would still be required to offer subsidy, but that money would be used more efficiently and effectively, and with a vastly reduced bureaucratic cost. Furthermore the quality outcome would be improved for this reduced cost.

As before, comments on the system will be welcome. I hope that, at least, such a system motivates you to question the current centralised system.