The failures of the western financial models

The worst outcome of the current financial crisis would be a return to the status quo ante that produced the pathologies, anomalies and contradictions that are its root causes.

I believe that the Western model of financial capitalism - a convex combination of relationships-based financial capitalism and transactions-based financial capitalism - has, in its most recent manifestations (those developed since the great liberalisations of the 1980s), managed to enhance the worst features of these two ideal-types and to suppress the best. This period has been characterised by a steady increase in the relative dominance of the transactions-based financial capitalism model in the overall financial arrangements of the world, most spectacularly in the US, the UK, and such smaller countries like New Zealand and Iceland, somewhat less in most of continental Europe and elsewhere. (more…)

This blog is a comment on Martin Wolf’s Column in the Financial Times of Friday April 4, 2008, “Four falsehoods on immigration”.

Martin and I have crossed swords before on the issue of immigration. Our disagreement is fundamental and based on different ethical premises. Martin believes that existing residents of a country have a right to control who enters their country. The House of Lords select Committee shares this view, as is clear from their Report, The Economic Impact of Immigration, which asserts that the criterion to be used to assess the costs and benefits of immigration for the UK is the impact on the existing resident population.

I reject that view. The wellbeing of the existing resident population is no more, and no less, relevant than the wellbeing of any potential immigrant to the UK, wherever in the world he or she may be. I recognise private property rights. My home is my castle and I can deny entry into it to anybody at any time. I don’t recognise national property rights. A country is not like a private home. A country is an open club.

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The coming and going of Good Friday and the imminence of Easter has prompted some musings about sanctity. Sanctity is the quality or state of being holy or sacred. I run into a lot of sanctity when engaged in political debate with serious-minded people. For free-market economists there is the sanctity of contracts and of property rights. For right-to-lifers there is the sanctity of life. We hear of the sacred bond of matrimony. We all know of the Holy Land. Holy cities are a dime a dozen: for Muslims it includes Mecca, Medina and Jerusalem. For Christians and Jews, Jerusalem. For Hindus Varanasi - Benares – Kaasi. There are holy rivers, from the river Jordan to the Ganges. Roman Catholics used to have holy water (I don’t know whether they still do). There are, God forbid, holy wars. There are reputed to be holy men and women, although I have never encountered any. There are sacred oaths and sacred honour.

Permit me this spontaneous outburst of self-righteousness, delivered from a simplistic protestant perspective: a pox, pest and plague on all those who claim holiness, sacredness or sanctity for any cause, anyone, any being or anything other than the One God. All other claims to sanctity and holiness are blasphemous. Nothing is sacred, except the One God. (more…)

You have to hand it to Dr. Rowan Williams, Archbishop of Canterbury: he knows how to start a good debate. Even when he gets an issue 100 percent wrong, as he does in his February 7 lecture   and interview  on Sharia law, he at least addresses issues that matter and should engage our intellect, morality and emotions. 

In what follows, I will at times refer to British or UK law where this does not give rise to ambiguity, although I am aware that there are distinct systems of English Law, Scottish Law and Northern Irish Law, not to mention the laws of the various Channel Islands, of the Isle of Man and indeed EU law. 

Dr. Williams makes, and at time mixes up, two quite different points. The first is that different British communities (he appears to be referring only to communities based on a religious faith, rather than on, say, the support of a football team) can and should have their own legal procedures, practices, institutions and even ‘courts’, whose judgements would be enforceable through the British court system. The second is that Sharia law may contain legal principles or practices that are intrinsically worthwhile and could/should be incorporated into British law. 

I will take these two points in turn. Although Sharia law does not distinguish between civil law and criminal law, most issues involving Sharia courts and other religious courts in the UK have involved civil law matters. It would seem pretty self-evident that having community-specific criminal law and criminal courts would be an abomination of the first order. There have been stories in the media that there are ethnic-community-based or religion-based criminal ‘courts’ in the UK, and that some of these operate with the consent of the police. A Somali ‘court’ of this kind, operating in London, was the most frequently mentioned example. These may well be urban myths. If they are not, they would constitute examples of vigilantism that are utterly beyond the pale. I will focus on civil law in most of what follows.

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Voting, like jury service, is a civic duty.  Unless you get a warm glow inside from doing your civic duty, it is not individually rational to vote, as the odds that your vote will matter for the outcome are just about zero. So voting should be mandatory, or at least turning up at the ballot box ought to be - the right to tick the box marked: ‘none of the above’ should also be guaranteed.  Unfortunately, only a few enlightened countries like Belgium still have mandatory voting.  The result of leaving it to individual discretion is too often a pathetic turnout rate.  Twenty percent or less of the eligible population in some European Parliament elections.  Fifty percent or less in US presidential elections.  Such poor turnouts undermine the legitimacy of whoever gets elected and of the political system that puts up with it.

So I will vote, or at least turn up to vote, in the coming US presidential elections.  Will it be any of the above?

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Mental illness can be a terrible affliction. It can drive those suffering from it to despair – even to suicide. I can also drive those affected by it, as loved ones of the afflicted person or as carers for yo, to despair – even to suicide. Because it can be such a terrible disease, it is important that it does not get trivialised by over-egging the problem. Because it can be such as terrible affliction, it is important that the treatment offered be the best one available, and that that such treatment be available regardless of ability to pay. The notion that a quick, cheap and easy fix is available is, well, madness.

Mental illness can be hidden or faked
Many varieties of mental illness, especially depression and manic-depressive illness are not easily diagnosed, even by professionals. This means that it is often possible for those truly ill to hide their condition, if it is advantageous to do so for professional, reputational or other reasons, such as being engaged in an adoption process. It is also possible for persons who are not mentally ill to fake it. There is enough information readily available on the web for anyone with an IQ in triple digits to put together an appropriate package of symptoms that will suitably impress a GP, psychiatrist, psychiatric social worker, psychologist, analyst or other therapist. Lower back pain is the only other medical condition that can be faked as easily.

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The brief answer is `yes’.

I will illustrate the point with the example of Mike Huckabee, the candidate for the Republication presidential nomination who came first in the Iowa caucuses. There are many other examples of obnoxious and dangerous fundamentalism, much but not all of it religious, that I could have put in the stocks, but for now Mike Huckabee will do. Before entering politics, Huckabee was a pastor at two Baptist churches.

Sexist fundamentalism

Mike Huckabee, when he was governor of Arkansas, signed in 1998, alongside 129 other evangelical leaders, a full-page ad in USA Today in support of the new statement of faith adopted in June 1998 by the Southern Baptist convention. This statement declared that "a wife is to submit graciously to the servant leadership of her husband." Thanks to my Calvinist upbringing, I know the source of this statement well. It’s Paul’s letter to the Ephesians 5:22-33. My parents used to read it to us when we were children, to impress us with the need to engage our brains when reading the Bible, and specifically to filter out the all-too-human dross that so often obscures its divine message. What made perfect sense for those recording the Hebrew Scriptures (Old Testament) - the religious traditions, doctrines, dogmas, myths, parables, metaphors, legends and history first of a collection of Middle-Eastern nomadic tribes from around 2100 BCE, and then of one or two small Middle-Eastern kingdoms from about 1050 BCE, and what may have seemed self-evident to the Judeo-Greco-Roman first-century CE authors of the the New Testament, can easily become a bizarre abomination in a different age. The passage is worth quoting in its entirety (I am using the New International Version).

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When then Secretary of State Colin Powell told the UN that Saddam Hussain had chemical and biological weapons of mass destruction, I believed him.  When he said that US and UK intelligence had incontrovertible evidence that Saddam Hussain had an active programme to create nuclear weapons and the means to deliver them to targets I cared about, I believed him.  When then Prime Minister Tony Blair went beyond even what Powell had asserted and told us that Saddam’s chemical weapons could be activated within 45 minutes, I believed him also.

We now know that none of this was true.  What is unclear is whether Powell and Blair were lying or relying on bad intelligence - or both. 

This morning, I read in the papers that US intelligence has, in the words of the Financial Times, "downgraded its assessment of the risks posed by Iran’s nuclear ambitions with a surprise declaration that the country, led by President Mahmoud Ahmadi-Nejad …, halted its nuclear weapons programme in 2003 and may not have restarted it".

If this is true, I should be relieved.  Ahmedi-Nejad is a religious fanatic with strong Millenarian tendencies, who is waiting for the return of the hidden Imam.  He is confronted by George W. Bush, a religious fanatic with strong Millenarian tendencies, who is waiting for the return of Jesus Christ.  That’s the kind of configuration  likely to expedite the end of the world.  News that Iran has taken its foot off the nuclear accelerator would would be welcome indeed.

But can we believe it?  I have reached the point that, when an official spokesman in the US or the UK makes an assertion about a fact or issue that I cannot verify directly myself, I really only consider two possibilities: (1) (s)he is lying; (2) (s)he doesn’t know what (s)he is talking about.  The possibility that the authorities could be both truthful and competent is barely worth considering.

Truth telling has become a tactical option in political life. You do it when it is convenient - when it serves your purpose, rather than because it is the right and self-evident thing to do.  Competence is no longer expected of our political leaders and hardly hoped for.  The moral, political and economic cost of this erosion of trust and social capital will be with us for a long time, unless of course either the hidden Imam or Jesus Christ make an unexpected (by me) early return.

Consider the following scenario. Scientists determine that, following careful empirical study and the meticulous application of cost-benefit principles grounded in utilitarian ethics, men ought not to be allowed to live beyond the age of 86 and women beyond the age of 88. You can easily see how the utilitarian calculus would lead to this conclusion and policy recommendation. By the time people cross those age thresholds, they tend to be frail, infirm and doddery. Many no longer enjoy life and may even wish they were dead. Some have failed to "shuffle off this mortal coil" only through inertia and lack of commitment, others because of religious convictions that proscribe suicide, yet others because they are too decrepit even to attempt unassisted suicide and because assisting suicide is a criminal offence in most countries.

Because but few of these old folk still make a productive contribution as workers, home makers or child minders, they also impose a serious financial burden on the community. Many no longer pay taxes but are net recipients of government transfers. The medical expenses incurred by and on behalf of the very old tend to be high. In the UK, with its tax-funded NHS, the elderly impose a non-trivial health-tax on the rest of society. In addition to the financial/fiscal burden imposed by the elderly, they impose negative externalities. They drive too cautiously and fail to make due progress; they slow down other pedestrians on busy streets and during the rush to catch a bus, train or tube. Their Zimmer frames clog up passageways and entrance halls. They also are at times not very pleasant to look at, especially when they take out their dentures in a restaurant. Finally they can be highly irritating, because they tend to bang on about the good old days.

A utilitarian paternalistic government would know what to do in this situation. It would rewrite the intergenerational social contract to include mandatory involuntary euthanasia at age 87 for men and at age 89 for women. The week before my 87th birthday, I would receive a note informing me that in a week’s time I have to turn up at my local NHS hospital to be humanely executed by lethal injection. Those who have served in the armed forces could opt instead to be executed by firing squad. The penalty for failing to turn up would (of course) be death.

Professor Julian Le Grand, of the LSE’s Department of Social Policy, would not approve of this classical utilitarian paternalism. His libertarian paternalism (a poisonously oxymoronic expression) would instead prescribe the following government policy. The intergenerational social contract would be still rewritten to include involuntary euthanasia at age 87 for men and at age 89 for women. I would still receive, the week before my 87th birthday, a note informing me that I will be humanely executed in a week’s time by lethal injection. Those who have served in the armed forces could still opt instead to be executed by firing squad. The penalty for failing to turn up, however, would not be death but a fine of £200 (a Life Permit).

The arguments I have used to rationalise a fine or fee for being allowed to go on living, are no different in essence from the arguments used by Professor Julian Le Grand to rationalise his suggestion (offered for discussion and debate) that the sale of cigarettes should be banned except to holders of a Smoker’s Permit. Le Grand’s Smoker’s Permit would cost £200 and would also require the signature of a doctor. Similar proposals have been floated by him for the automatic enrolment of employees by their employer in exercise classes, subject to an opt-out clause (this time without a fine or fee).

Le Grand is advocating ’soft compulsion’, that is, mandating (prescribing or proscribing) certain kinds of behaviour, subject to an opt-out clause. The exercise of the opt-out option can be made costly in a number of ways: by attaching a financial cost to it (£200 for the Smoker’s Permit), by making it time-consuming (the requirement of a doctor’s signature for the Smoker’s Permit), by making it embarrassing (overcoming peer-pressure not to opt out of workplace fitness activities) or by creating the presumption (or at least a suspicion) that future (career) prospects may be adversely affected should you opt out.

Le Grand is not the only highly visible advocate of an enhanced guiding and directing role for the government through ’soft compulsion’. Another LSE notable, Richard Layard, Emeritus Professor of Economics at the LSE, and author of the book Happiness: Lessons from a New Science, published in 2005 and now available as a Penguin book, appears to believe all of the following (the seven proposition are mine; I distilled them as best I could from Layard’s Happiness volume):

1. We know what makes us happy
2. We want to be happy
3. Therefore we ought to do what makes us happy
4. The state knows what makes us happy
5. The state knows how to make us happier
6. The state wants us to be happier
7. Therefore the state ought to take measures that make us happier

A number of strong and to me convincing arguments against propositions 4., 5. and 7. can be found in the useful tract Happiness, Economics and Public Policy by Helen Johns and Paul Ormerod, published by the  Institute of Economic Affairs in 2007. I believe all seven points are either dangerously misleading (or even deceptive), completely wrong or a threat to liberty and to all that makes life worth living.

Proposition 1. is true only if happiness is defined either as self-reported happiness (the verbal or written characterisation of their mood/state of mind/feelings by persons responding to questions in an interview or filling in some kind of questionnaire) or as a physiological or electro-chemical response to certain events or stimuli. None of this need bear any relationship to everyday notions of happiness. Using a value- and emotion-laden word like ‘happiness’ to label behaviour, actions, reported feelings and physiological or electro-chemical responses that bear little or no relation to the everyday concept, is misleading.

Proposition 2. is the happiness literature’s equivalent of ‘revealed preference’ in neoclassical consumer choice theory. People choose what they choose, because they prefer what they choose; and the proof that they prefer what they choose is that they choose it. It is a tautology. We want to be happy because if we wanted to be something other than happy, the happy we appear not to want to be cannot really be happiness.

Proposition 3. is a normative statement or value judgement that I reject utterly, regardless of whether Propositions 1. and 2. are correct. Many ethical system, some based on religious principles, others without divine underpinnings, would reject the pursuit of personal happiness as the main goal a person ought to pursue. The Christian tradition I belong to commands me to seek the Kingdom of God and to love my neighbour as myself. From this perspective, the pursuit of personal happiness is immoral, self-obsessed infantilism. Whatever one’s views on ethics, Proposition 3 isn’t science.

Proposition 4. is correct only if we define happiness in one of the peculiar ways prevalent in the pseudo-science of happiness; it also requires that the state and the government that manages it, has taken on board the views of Layard, Le Grand and their ilk. I hope this is not the case, even in the UK, on any wide scale. The worrying trends towards teaching pseudo-happiness in English schools will in all likelihood turn out to be yet another fad that does not outlast the incumbent administration. 

Proposition 5. is wrong, even if Proposition 4. were correct. The state/government knows at most only the ‘partial equilibrium’ direct determinants of ‘happiness’ (or even more likely just of few of the empirical correlates). No one and no institution, including the state, understands the dynamic general equilibrium effects even of those policies whose direct impact effects on ‘happiness’ are at least partially understood. Interaction effects, feedback effects (negative and positive), lagged effects, effects working through expectations and anticipations – no one has a clue.

Proposition 6  is wrong even if Proposition 5 were correct. Even if the government or some other state institution were to know how to raise our level of self-reported happiness, or how to lower hypertension, or indeed how to modulate the electro-chemical reactions in the cerebral cortex (or any other part of the brain) so as to give us a warm feeling or pleasant buzz inside, it would not follow that the government would want to pursue policies aimed at doing any of these things. 

The notion that governments are benevolent and competent makes for bad political economy. Governments are temporary coalitions of partly self-interested, partly altruistic, partly ideological, partly noble and partly evil people who happen to have got hold of the levers of control of the state. Each government represents the good, the bad and the ugly. It does some good and some harm. The primary objective of the governments I have observed is to hang on to power. If that requires making people happy (by any definition), the government may try to do so; its ability to achieve the objective should, of course, not be overestimated.. If it requires making people feel powerless, fearful, resentful and divided, then the government will instead pursue that objective. 

Proposition 7 is a normative statement about what the state ought to do. I strongly disagree with it. The defining property of the state is that it has the monopoly of the legitimate use of force in a society. The state can coerce, prescribe and proscribe behaviour; it can tax and it can declare some of its liabilities to be legal tender. It should only do those things that require this power of coercion. 

The fundamental responsibility of the government is to create institutions, laws and regulations that allow people the maximum freedom to make their own choices. This requires the funding of key public goods, such as defense, law and order, public administration, public health and the education of children. It will also require the public provision of those public goods and services that cannot be provided effectively through private or cooperative arrangements. Governments also have the duty, on behalf of the community and jointly with other private and cooperative institutions, to help those who cannot help themselves: the poor, the weak and the infirm; those too young to qualify as competent citizens; the mentally ill; the mentally handicapped; and those too old and frail to look after themselves any longer. 

Governments can try to correct market failures and failures of other non-government allocative mechanisms, as long as government failure is not likely to make things worse. The main causes of market failure are externalities (including informational asymmetries) and market power. Both regulation and taxation or subsidies can be used to address the causes of market failure. 

Externalities are any effect of the actions of one or more persons on the well-being (utility) of third parties. I prefer restricting the government’s role in addressing externalities to those instances where an action has a material (significant) adverse effects on the rights of others. Such material rights externalities would exclude, for instance, someone taking offence and getting upset at something I write or say, no matter how much this lowers their subjectively experienced wellbeing or comfort level. This is because, in my book, there is no right not to be offended. 

As I accord the government no automatic role in correcting externalities that are not rights externalities, it will not come as a surprise that I also oppose the government having any role in boosting people’s ‘happiness’ (in any and all senses of the word) when there are no rights externalities involved. Even if the government were to know what is good for me, it is not the government’s business to see to it that I (or someone else) undertakes the actions required to bring about that good. If my actions harm me (smoking tobacco, excessive alcohol consumption, smoking cannabis for non-medical reasons, using heroin for reasons other than pain relief) there is only a role for government if my actions also infringe on other peoples’ rights.

In the case of smoking, the health effects of secondary smoke inhalation are a prima-facie case for banning smoking in enclosed public spaces. If the only externality from smoking had been the fact that it causes the air to stink and to become irritating to some people’s eyes, this would not be sufficient grounds for the government to ban smoking in enclosed public spaces, although private clubs could do what they want. Putting further obstacles in the way of mentally competent adults who wish to smoke – things like Le Grand’s Smoker’s Permit cum doctor’s signature – is harassment and an assault on freedom. Excessive alcohol consumption is not a problem requiring government action if all it does is to cause my liver to rot. If I drive under the influence, or become drunk and disorderly in public, there are laws to deal with this. 

The wearing of seat belts by adults is another area where governments have no obvious role, other than an informational one (see below). Clearly, insurance companies may require seat belts to be fitted in cars they insure. Air lines have the right to refuse passengers who do not wish to tighten their seat belts. Mandating seat belts for children is also legitimate. Mandating the wearing of seat belts by competent adults is an unwarranted interference with individual sovereignty. 

The only legitimate role for the government in areas of private decision making where there are no rights externalities involved are (1) the provision of information and (2) framing. Information is an awkward commodity. Ex-ante the discovery of information can be costly. Ex-post, information is non-rival in use and should be disseminated as widely as possible. Governments therefore have a role in funding the provision of relevant information on health issues (even those without a public health dimension), seat belts, hygiene (which may also have a public health dimension) and food and product safety. Mandating the provision of information on the ingredients/materials in food, household products and drugs by the producer or seller can also make sense, with due allowance for the cost of providing different kinds of information. Therefore, pace Julian Le Grand, no ban on salt in processed foods, but clear labelling and information about the health risk of too much salt. 

Framing or presenting logically equivalent choices in different ways is a tool for influencing choices that relies on the violation of one or more of the conventional postulates of rational decision theory – often the independence of irrelevant alternatives. Framing matters if you feel different when I describe the bottle as half empty or half full. Framing is central to the opting in – opting out debates concerning trade union membership and participation in ‘second pillar’ company pension schemes by workers. When the ‘default’ is that workers are enrolled in the company pension scheme unless they actively opt out, 80% of the work force stays with the scheme. When the default is that workers are not enrolled but are free to opt in, only 20% of the workforce signs up. 

If mere framing, that is, mental window-dressing which does not have any effect on outcomes and payoffs in different states of nature, has a powerful effect on behaviour, the role of government becomes interesting. If we believe that there are areas of private choice for which the government knows what is good for us better than we do ourselves - if not all of the time then at least at those times when we actually decide to opt in or out of the company pension scheme – then we should grant the government the right to insist on a particular kind of framing of the choices in private pension schemes. If we don’t trust the competence of the governments and its experts, we should deny the government the right to frame choices in private arrangements. 

It is clear from Le Grand’s Smoking Permit example, that he does not trust the ‘soft compulsion’ of moving from opting in to opting out when it comes to many kinds of private choices. The cognitive distortions exploited by framing will in many cases have to reinforced with other incentives to get the outcomes preferred by Le Grand. Fines, taxes, mandatory waiting periods, time wasted in obtaining permits etc. are all part of the toolkit of the new Paternalists.

A true libertarian wants the state out of his life and out of his business. The camel’s nose unavoidably is back into the tent when one recognises the legitimacy of collective coercive action given the reality of rights externalities – when my actions impinge on your rights. There is, however, a huge difference between those who try to keep as much of the camel out of the tent as possible and those who are trying to push every inch of the beast into the tent. Le Grand and Layard are contributing to a dangerous ideology rationalising ever-increasing and ever more sophisticated attempts to steer, nudge, influence and in the limit completely override individual judgement and choice. One opt-out and fine at a time, it is moving us towards a nightmarish form of central planning not even attempted by the former Soviet Union – the micro-management of individual consumption, life-style and human capital management choices.

This ideology is fundamentally totalitarian, although the uniform of the familiar military dictator has been replaced by the tweed jacket and business suit of the expert and the technocrat, and the secret policeman has given way to the psychiatrist and behavioural therapist.

It is totalitarian because the state refuses to leave the private sphere alone.  Actions that have no external effects, and which therefore a-fortiori have no external rights effects, are nevertheless deemed legitimate concerns of the state.  Private actions can be nudged, influenced and incentivised by the state using any of the tools and instruments it possesses, for no reason other than that the state believes this to be in our ‘true’ interest. 

Well, thanks but no thanks.  I prefer making my own mistakes to having someone else, be it the state or another entity or individual, make the ‘right’ choices for me.

The London School of Economics and Political Science has moved a long way from the days when it counted among its economists such champions of liberty as Lionel Robbins and Friedrich von Hayek, to the present-day prominence of two champions of the intrusive, micro-managing, overweaning, overbearing state – Richard Layard and Julian Le Grand. Let’s just hope these things move in cycles.

I would like to make a deal with the Right Rev Peter Selby, Bishop of Worcester from 1997 to 2007. I promise not to make public statements about the merits of the Trinitarian doctrine (a form of higher theological mathematics asserting that 3 = 1).  In return I would like the Bishop not to write any more nonsense about credit and debt. In today’s Credo column on the Faith page of the Times of London (It’s time to stop giving credit to our culture of debt", The Times, Saturday October 13, 2007, p. 83) the Bishop produces a number of canards about debt.  Unencumbered by logic or facts, the Bishop makes a slew of assertions that are, at best, unproven and at worst plain wrong.

Assertion 1: The Jubilee 2000 campaign, advocating debt relief for the poorest nations of the world, "was a remarkable achievement". Case unproven. The Bishop makes the common mistake of confusing poor countries and poor people. The debt relief in question is the forgiving of debt owed by the governments of the poorest nations. It is quite possible, and in a many cases indeed likely, that the vast majority of the citizens of these poorest nations may have been made worse off by the cancellation of part or all of the debt owed by their governments. Most of the poorest countries have appalling governments - repressive, corrupt, incompetent and inefficient. Unlike the vast majority of the population, the rulers of the poorest countries often are rich – their wealth stolen from the people. Debt forgiveness consolidates the hold of these disastrous governments on power and postpones the day that they can be held to account. When trying to help the poor ‘do no harm’ should be an overriding concern. Jubilee 2000 violated the ‘do no harm’ maxim.    

Assertion 2: The need to get across “a systemic analysis of the nature of runaway debt, its roots in the creation of money by lending and borrowing, and the potential dangers for the world of both domestic and international debt.” Here the Bishop makes a factual statement about runaway debt. Where is (was) this runaway debt? The UK The US Everywhere in the world? Clearly, one can point to specific instances of excessive borrowing. Some households in the US and the UK have undoubtedly engaged in this. Elsewhere there is too little debt and borrowing. In the People’s Republic of China, for instance, it would probably be welfare-enhancing for the government to raise spending on education, health and environmental investment, and to finance at least part of this by borrowing, thus absorbing the excessive saving of Chinese households and public enterprises. Apart from his factual errors, the Bishop also confuses money creation with credit and borrowing. One can have lending and borrowing without money creation and money creation without lending or borrowing. The Bishop is confused about what money is, how it is created and what it does. He is in good company. Most people haven’t got a clue about the meaning and modalities of money. But fortunately, most monetary ignoramuses don’t display their ignorance by writing about it in the Times.   

Assertion 3. “It is obvious that if you allow financial institutions to make huge profits by lending large multiples of the deposits they hold, you are allowing them to create money”. This is complete gobbledegook. For those who care, there are many operational definitions of money, ranging from narrow money (coin and currency plus commercial bank deposits with the central bank) to broader monetary aggregates, typically the sum of coin and currency in circulation, plus some subset of the deposits of certain deposit-taking institutions, plus some of the close substitutes for these deposits. ‘Creating money’ – an unfortunate and imprecise phrase that appears to attribute divine powers to the ‘money creating’ institutions – does not require financial institutions to make huge profits; neither do financial institutions that make huge profits necessarily create money.  If financial institutions lend huge multiples of the deposits they hold, they must be financing that lending out of non-deposit resources (the wholesale markets, for instance, as Northern Rock did). This may have been reckless, but has nothing to do with money creation.    

Assertion 4. “This failure of understanding has led to the use of debt as an instrument not just for uncontrolled personal consumption but also for building hospitals, schools and even prisons. The disciplines of living within your means, of allowing public functions to be provided by democratically accountable institutions, and of not using tomorrow’s resources today are forgotten as the young are trained in indebtedness as a condition of obtaining their tertiary education”. This is complete nonsense. The institutions and financial instruments that permit borrowing and debt (the cumulative total of all past net borrowing), represent a wonderful manifestation of human ingenuity – the Bishop might even call it a gift from God; I certainly would.
Without borrowing and debt, each household, each firm and each government could only invest what it saves itself. That would lead to gross inefficiency and a colossal waste of resources. The financial means for financing investment are not necessarily distributed in the same way as the capacity to come up with productive and profitable investment projects. Without debt and borrowing, each family, enterprise and government would have to be financially self-sufficient. The creation of enterprises on a scale larger than cottage industries would have been extremely difficult. Material standards of living would be at the level of India and China before the 1980s.    Consider the state of UK infrastructure (social overhead capital). Transportation infrastructure is sub-standard and clapped-out. Many hospitals are a disgrace; many primary and secondary schools are in need of further capital investment; there is prison overcrowding.
Clearly, there is a strong case for large-scale catch-up investment in infrastructure. To finance all of this temporary investment boom with a balanced budget would be inefficient, as it would require large temporary increases in average and marginal tax rates. It would also be unfair, because the benefits from the improved infrastructure will benefit future generations as well as current ones. These future beneficiaries should contribute towards the cost of the investment.    There is another reason why borrowing by governments may be fair. Government borrowing tends to shift the burden of financing the government from the old to the young and from current to future generations. If the pattern of the past 225 years persists, future generations are likely to be better off than us. Shifting the tax burden to future generations that are likely to be better off than ourselves, is something even the Bishop might not object to.     The same holds for student loans to finance tertiary education. It is efficient and can be made fair. The returns to investing in a tertiary education accrue overwhelmingly to the student in the form of higher future income and greater job satisfaction. It is only fair that those who benefit should pay. Taxing the average Briton to subsidize the tertiary education of persons who, after completing their tertiary education, may well be richer than the average Briton, is unfair. Clearly, the risk of failing to complete the tertiary education programme or of failing to achieve a higher income for some other reason should not be a deterrent to enter tertiary education for students from poor backgrounds. That’s why repayment of the student loans should only begin once the income of the former student is above some appropriate threshold level. Requiring students to pay for their own tertiary education, if necessary by borrowing, is both efficient and fair if income-contingent debt service is built into the programme.       
Finally, as regards “…not using tomorrow’s resources today..”, the only way to shift physical resources from tomorrow to today is by reducing investment and, in the limit, consuming capital. Investing in tertiary education, likely all investment, shifts resources from today to tomorrow, regardless of how it is financed. A closed economic system has to reduce current consumption (and possibly also early future consumption) temporarily in order to increase investment today and thus achieve higher future consumption in the longer run. By borrowing, it may be possible, in an open economic system, to avoid any absolute decline in consumption, today and tomorrow, provided the return on the investment is sufficient. Borrowing and then repaying principal and interest is a wonderful mechanism for achieving a more even, smooth consumption profile over the life cycle.

Assertion 5.  “Most serious of all, we fail to notice where the resources are coming from: all the talk in the world about climate change and the depletion of the resources of the planet will be fruitless if we do not limit our appetite for eating up tomorrow’s bread and burning tomorrow’s oil today.” The Bishop may well be correct that were are depleting exhaustible natural resources too fast. However, excessive resource depletion and destruction of the environment have nothing to do with the culture of credit and debt. The former Soviet Union had very little credit and debt. Its financial system consisted of a single monobank that provided virtually no consumer credit. Its government debt was low. Other communist countries, like Romania, paid off all their public debt (at great cost to the population alive at the time). Yet despite being as far removed from the culture of credit and debt as one could get, the communist countries depleted scarce natural resources and vandalised the environment on a scale never seen before or since (except for China today). 

Assertion 6. “The communities of faith – Jewish, Christian and Islamic - have a proud history of criticising the institutions of credit and debt”. Fortunately, that is not true now and never has been. There is a tradition in the Abrahamic faiths of periodic limited debt forgiveness. In the Old Testament, this takes the form of the Sabbatical year and the Jubilee year. A creditor could, following a borrower’s inability to service his debt, take possession of the debtor’s land and cultivate it in order to be paid. Sometimes the debtor had to sell his own and his family’s labour to the creditor - a form of slavery known as bondage.  Every 7th year was a sabbatical year in which the debt would be erased. The sabbatical also applied to the land itself, which was to be left fallow every 7th year. Every 7th Sabbatical, that is, every 49 years, was a Jubilee year. Debtors were released from both debt and bondage, and the land was restored to the debtor. The Sabbatical and Jubilee tradition limited the extent and duration of indebtedness. It did not do away with the institutions of debt, bondage (or other forms of slavery), or declare them ungodly.
There is also, in the Abrahamic tradition (and in even older traditions on the Indian subcontinent), a prohibition of interest, or usury – making money just by lending money. Today, only the literalist, fundamentalist followers of Judaism, Christianity and Islam consider the charging of interest to be sinful and ungodly per se. The best-financed and most vocal forms of Islam today come from the oil- and gas-rich theocracies of the Middle East (often taking the fundamentalist and literalist Wahabbite form of Islam found in and exported from Saudi Arabia). Today, therefore, the prohibition of interest (riba) is only an economically significant issue for Islamic finance. Sharia permits financial contracts, including securities, that involve the sharing of profit and loss. A stream of payments must be associated with an underlying real asset with risky returns or with an underlying risky productive activity. Collateral is also allowed.  From an economic point of view, interest (strictly the nominal interest factor), is just an intertemporal relative price - the price today of borrowing money. Prohibiting interest, or setting caps on interest rates to avoid ‘excessive’ interest rates is a constraint on exchange that limits intertemporal trade and therefore will tend to be inefficient and welfare-decreasing. It is true that in an economy where there also many other distortions in credit markets and insurance markets, and where the scope for targeted redistribution is limited by informational and administrative constraints, caps on interest rates can sometimes be rationalised as a second-best policy.
However, I have yet to encounter a problem to which the prohibition of interest is the solution. The prohibition of interest, a constraint on voluntary exchange and on the right to determine the terms of a contract freely, makes no economic sense. Religious fundamentalism and literalism, in economic and financial affairs as in all others, is obscurantism, based on a perverse mixture of fear and muddled thinking. Fortunately, the more enlightened Christianity that has evolved since Thomas Aquinas condemned usury, recognises the social value of the institutions of debt and credit and the welfare-enhancing potential of borrowing and lending.

The Bishop is more than 700 years behind his church. The explosion of wealth, much of it held in financial form, among oil- and gas-exporting nations, many of which adhere, at least notionally, to fundamentalist-literalist forms of Islam, has led to an explosion of financial engineering aimed at circumventing the Quranic ban on riba. Considerable ingenuity and vast amounts of resources are devoted to the construction of financial products that are economically equivalent to interest-bearing loans or interest-bearing bonds, but theologically equivalent to permissible Islamic risk-sharing instruments. The process of certifying financial products as Sharia-compliant is time-consuming and costly; those with the religious authority to provide the desired certification (typically Islamic scholar-jurists) often don’t understand finance. Financial experts tend not to be well-versed in Sharia law and its application to financial structures. Those with the power of certification can extract significant rents from the issuers and buyers of Sharia-compliant problems. From an economic point of view, it is costly theological window-dressing, in the sense that no Sharia-compliant product I have ever studied passed the interest rate ‘

duck test’: if it looks like interest, compounds like interest, imposes on both parties to the contract obligations equivalent to those associated with interest, and – the bottom-line test – provides the parties to the contract with equivalent contingent payment streams, then it is interest, even if it is stamped “profit sharing”. Take a car loan as an example. Under Islamic banking a conventional car loan is reproduced by the bank buying the car from the dealer, selling the vehicle at a higher-than-market price to the buyer of the car (with the buyer often paying in instalments), and with the bank retaining ownership of the vehicle until the car (i.e. the loan) is paid in full. This is functionally equivalent to a car loan with interest where the car is the collateral for the loan.