Brexit and the Unforecastability of Demand-Side Recessions

Simon Wren-Lewis claims the Brexit slowdown is about to begin because its negative effect on the economy is no longer masked by unusually strong consumption. Hence, GDP is going to take a hit.

The thing is: all the effects the Brexit vote could conceivably have in the short-run pertain to aggregate demand (AD). Since AD is controlled by the BoE, there is no reason to assume that Brexit will have any short-run consequences on GDP – as I already pointed out immediately after the Brexit vote.

One may argue that at the Zero Lower Bound (ZLB) and under strict inflation targeting, the central bank might lose this control. But since monetary policy in the UK is not even at the ZLB, this theoretical possibility does not apply in the case of post-Brexit Britain.

In general, if the central bank is doing its job properly, any slow-down or reduction of GDP caused by demand-shocks is impossible to predict ahead of time.

Why has this basic fact been ignored by so many economists in the case of Brexit?

Well, most of the economists who have been predicting a negative effect of Brexit on GDP in the short-run believe that Brexit will have a negative effect on the long-run supply side of the British economy. Whether the long-run effect of Brexit will be negative or positive is debatable but taking a pessimistic view is certainly not inherently flawed.

Since economists are human and few humans are immune to the passions involved in political arguments, I guess that, being of the conviction that the long-run effects of Brexit will be negative, these economists have been tempted to loosen their intellectual standards and to sex up their arguments by making gloomy predictions about the short-run as well.

That so many economists have been making these predictions may make them seem respectable. It doesn’t make them well-reasoned or correct.


The Economics of Stupidity

Here’s Bryan Caplan:

I’m an IQ realist, all the way.  IQ tests aren’t perfect, but they’re an excellent proxy for what ordinary language calls “intelligence.”  A massive body of research confirms that IQ predicts not just educational success, but career success.  Contrary to critics, IQ tests are not culturally biased; they fairly measure genuine group differences in intelligence.

Yet I’ve got to admit: My fellow IQ realists are, on average, a scary bunch.  People who vocally defend the power of IQ are vastly more likely than normal people to advocate extreme human rights violations.  I’ve heard IQ realists advocate a One-Child Policy for people with low IQs.  I’ve heard IQ realists advocate a No-Child Policy for people with low IQs.  I’ve heard IQ realists advocate forced sterilization for people with low IQs.  I’ve heard IQ realists advocate forcible exile of people with low IQs – fellow citizens, not just immigrants.  I’ve heard IQ realists advocate murdering people with low IQs. 

When I say, “I’ve heard…” I’m not just talking about stuff I’ve read on the Internet.  I’m talking about what IQ realists have told me to my face.  In my experience, if a stranger brings up low IQ in Africa, there’s about a 50/50 chance he casually transitions to forced sterilization or mass murder of hundreds of millions of human beings as an intriguing response.  You can protest that they’re just trolling, but these folks seemed frighteningly sincere to me.

Don’t such policies flow logically from IQ realism?  No way.  If someone says, “I’m more intelligent than other people, so it’s acceptable for me to murder them,” the sensible response isn’t, “Intelligence is a myth.”  The sensible response is, “Are you mad?  That doesn’t justify murder.”  Advocating brutality in the name of your superior intellect is the mark of a super-villain, not a logician.

But don’t low-IQ people produce negative externalities – negative externalities that well-intentioned consequentialists will want to address?  I’m no consequentialist, but the consistent consequentialist position is: Not if the “solution” is worse than the problem!  And if your “solution” involves gross human rights violations, there’s every reason to think it is worse than the problem.  We should be especially wary of self-styled consequentialists who rush toward maximal brutality instead of patiently searching for cheap, humane ways to cope with the social costs of low IQ.

A couple of questions may arise from reading this:

  1. Where the hell does he meet these people? What are the negative externalities low-IQ people supposedly produce?
  2. If there are such negative externalities, what are the “cheap, humane ways” to cope with them.

What are the negative effects of having a low IQ? Well, people with low IQ are, on average, less productive than people with high IQ. That’s definitely a negative effect – but does it also constitute a negative externality? I.e. does it not only negatively affect the person with the low IQ but also third parties?

Under institutions of private property this is not the case.

The only negative effect of low productivity caused by low IQ (or laziness for that matter) is on the salary of the respective person. In a private-property society, salary – the amount for which a person can sell what he or she produces – corresponds closely to the real value of that product to the people who consume it. You get out what you put in. If you put less in, you get less out.

However, besides the sphere of private property there is yet another sphere: politics. And in the political sphere there is no comparable internalisation of the negative effects of stupidity as in the sphere of private property. When a government produces bad laws, everybody bears the costs, not just those who voted the politicians into office. So, in the political sphere low-IQ people can indeed produce a virtually unlimited amount of negative externalities.

Of course, due to, e.g., rational ignorance even a democracy consisting exclusively of high-IQ people would overproduce bad laws. However, adding stupidity to the mix certainly exacerbates the problem.

The solution proposed by some IQ realists is apparently to eliminate low-IQ people – either by straight out killing them or through “softer” methods such as a No-Child Policy for people with low IQs.

The thing is: this would not only be morally reprehensible but also (pardon the pun!) stupid: a waste of resources and also not very effective. Not eliminating stupids, but eliminating politics – the only sphere where stupids can, and do, cause significant social costs – is the smart solution.

Just because we are used to law being produced monopolistically by parliament doesn’t mean this is the best or even only possible way.

In a Polycentric Legal System law would be a private good produced on a private market. Different people in the same country could subscribe to different legal codes.

Now, when a low-IQ person buys bad law, this is, in principle, his/her problem. The negative effects of the bad legal code are internalised by the persons subscribing to that law – at least far more so than in a democratic system where I am no less subject to the costs of bad laws than the people voting for them. Of course, this internalisation is not complete because I may have to incur costs to have my good legal code applied in the case of a conflict with somebody subscribing to a bad legal code.

However, market forces can be expected to lead to rapid improvement in the quality of law in general.

In a democracy you buy nothing but promises. You may know how one party ran the country for the past four years, but not how the opposition party might have run it. In a Polycentric Legal System people can compare alternative brands – much like in the case of “normal” products. Information would be imperfect, as it is in making most decisions; people may make mistakes. Stupid people may make more mistakes. But at least alternatives exist; they are there to be looked at. You can talk with neighbors who subscribe to a different legal code and compare costs and benefits.

By turning law over to the private market, making a choice between different legal rules will be much like making a choice between different cars or different Internet providers. So we can expect the same positive effects of competition.

Remember that the sphere of private property is made up of the same people as the sphere of politics but the quality of the products in the former is infinitely better.

Achieving efficient law simply requires changing the way people choose legal rules, not changing the people who make the choice.

The Inexact Science of Economics – and Brexit

Some argue that economics is not a science because it is not able to prove  theories ‘beyond doubt’ the same way as the hard sciences can. Or put another way: most economic theories cannot be disproved in the same way that Popper thought scientific theories could be disproved.

Simon Wren-Lewis objects, defining economics as an inexact science, but science nevertheless. He concedes that in economics no single experiment or regression can kill a theory but points out that economists “[…] have accumulations of evidence that confirm the applicability of some theories and reject the applicability of others. Economists’ views about what models are applicable change as this evidence accumulates.”

I find the term inexact science very fitting and basically agree with Wren-Lewis’ remarks on the topic. But then he ruins it in the last paragraph of the post:

This is why economists views about the (negative – ed) long term impact of Brexit should be treated as knowledge rather than just an opinion. Here knowledge is shorthand for the accumulation of evidence consistent with plausible theory. Sometimes the theories are common sense, like making trade more difficult will reduce trade. Estimates of the size of trade reduction based on evidence are uncertain, but they are better than estimates based on wishful thinking. Empirical gravity equations consistently show that geography still matters a lot in determining how much is traded. Finally there is clear evidence that trade is positively associated with productivity growth. To say that all this has no more worth than some politicians opinion is ultimately to degrade evidence and the science which interprets it.

Not so fast. Economists indeed know that making trade with EU countries more difficult, which Brexit undoubtedly will, will have a negative effect on British incomes. However, the EU is not only a free trade area but also (and arguably more importantly) a political union, producing a large amount of legislation each year.

For example, banking regulation is basically completely defined at the EU level, with national discretion restricted to a couple of unimportant parameters and risk-weights.

That is, Brexit will also have an effect on the laws and regulations under which the UK economy is going to operate. Will this legislative effect of Brexit be positive or negative for British incomes? As I said before, nobody can know for sure.

However, EU legislation certainly has room for improvement (to put it politely) and, in general, smaller political entities tend to be governed better than larger ones. Hence, the legislative effect on British incomes may well be positive. Furthermore, the legislative effect of Brexit might not only be positive but also strong enough to more than offset the negative effect of making trade with EU countries more difficult.

In short, the net effect of Brexit on British incomes may well be positive.

The undue certainty with which many economists have made their predictions on the economic consequences of Brexit is based on ignoring its legislative effect. This effect is, of course, more difficult to measure and to predict than the effect of restrictions to free trade with EU countries. That doesn’t mean it’s not important.

Leave Monetary Policy to the Market !

On EconLog, Scott Sumner leads us to a mind-blowing January 31st, 2009 article from The Economist. Here’s an excerpt from that article:

THE European Central Bank (ECB) believes it deserves a break. In a flurry of activity it took its benchmark interest rate from 4.25% in early October to 2% by mid-January. Its president, Jean-Claude Trichet, has hinted that interest rates will be kept at 2% when the bank meets on February 5th, though it may act again in March. But the euro-area economy is deep in recession and inflation is falling rapidly. Why delay?

The rationale for holding off seems a bit muddled. One worry is that once interest rates fall too far, it will be hard to lift them again. Low rates make risky assets look cheap, so policymakers may hold off from raising them for too long, for fear of derailing a recovery based on rising asset values. But this is more a plea for wiser policymakers than a case against reducing rates.

Another reason for caution, voiced by Mr Trichet, is to avert a “liquidity trap”. This ambiguous bit of jargon usually refers to situations, such as when interest rates fall to zero, where orthodox monetary policy can no longer affect demand.

Trying to avert the liquidity trap by not loosening monetary policy is the most hilarious thing I’ve heard in a long time – and Scott Sumner is accordingly outraged:

That’s an EC101 level error. If the Economist magazine is right, and this was the motive, then the Great Recession in Europe was partly caused by an almost unbelievable level of ECB incompetence. Lowering rates to zero with easy money does not make a liquidity trap more likely, it makes it less likely. A liquidity trap is often assumed to occur when the actual market interest rate is stuck at zero. Actually, it’s a situation where the Wicksellian equilibrium interest rate is zero or below. What Mr. Trichet doesn’t seem to have understood is that lowering the policy rate of interest with an expansionary monetary policy actually tends to raise the Wicksellian equilibrium rate, making a liquidity trap less likely. This is just basic EC101.

The article in The Economist illustrates again why monetary policy shouldn’t be left to central bankers and why Market Monetarists call for Futures Targeting, where the central bank pegs the price of futures on NGDP, inflation or whatever else constitutes the monetary policy target. This way, the market, not central bankers, would set both the level of the monetary base and short-term interest rates. Monetary policy would be endogenous and fully market based.

Milton Friedman once said that money is much too serious a matter to be left to the central bankers.


The conduct of monetary policy by the ECB during the Great Recession should convince even the last sceptics that handing over monetary policy from central bankers to the market is the sensible thing to do.

The must-read book for libertarians, socialists, conservatives, progressives as well as the politically confused

Finally, a book showing the way to strike at the root of bad government is out.


In Seasteading: How Floating Nations Will Restore the Environment, Enrich the Poor, Cure the Sick, and Liberate Humanity from Politicians Joe Quirk and Patri Friedman set out how creating permanent, autonomous communities on the ocean will create a vibrant start-up government sector – a Silicon Valley of the Sea – with many small groups experimenting with innovative ideas as they compete to serve their citizens’ needs better.

Disrupting the Largest Industry in the World

When viewed as an industry, governance is the largest in the world, representing about 30 percent of global GDP. And today, this industry exhibits a serious lack of competition. There are extremely high barriers to market entry because putting a new idea into practice means having to win either an election, a war or a revolution.

As a result, products (the bundle of rules and public goods provided by governments) are low-quality, prices (taxes) are high and customers (citizens) are generally unsatisfied.

The creation of ocean platforms constitutes a much lower barrier to entry for forming a new government than winning an election or a revolution – or a war. And with technology advancing, the barriers of entry to the market of governance will decline year by year.

A Silicon Valley of the Sea, where those who wish to experiment with building new societies can demonstrate their ideas in practice would apply the scientific principle of trial and error to governance.

Science Fiction Fact

The technology to create floating cities is basically already there. Take, for example, the Portunus Project, a plan to build six floating mega ports surrounding the United States, each four hundred acres in size and located twenty to forty miles offshore.

The Dutch architectural firm Waterstudio, on the other hand, has designed a floating stadium that could travel the world hosting the Olympic Games.

In 2014, India began installing a solar power plant on a 1.27-million-square-meter floating platform and by 2025, Shimizu Corporation, a Japanese construction giant, plans to have self-sufficient, carbon-negative botanical skyscrapers floating in Tokyo Bay.

A Technology rather than an Ideology

Seasteading is a technology for anybody to try their vision of society. Seasteaders are from all political spectrums – and some simply identify as politically confused. They share the conviction that experiments are the source of all progress and that humanity needs more experiments in governance. They have realised that arguing about politics is a waste of time and that trial and error is the way to go.

I recently argued that the most important book for every libertarian to read was The Machinery of Freedom by David Friedman. Seasteading by Joe Quirk and Patri Friedman, on the other hand, is a must-read for anybody who believes that not all political systems are equally good. Seasteading, not arguing, is the way to find out what works best.