BLOG WARS!!!!; or, T-Simps Smackdown Watch

Jonathon Hazell

‘T-Simps’, the nom de plume of a Cambridge undergraduate called Thomas Simpson, has a go at the paper Felix Nugee and I wrote and presented the day before yesterday on what we call ‘helicopter money’. I encourage you to skim over it if you haven’t already, before returning to luxuriate participate in its demolition discussion. Snark aside, it’s a great piece, and raises a lot of salient and controversial points. Highly recommended reading, and no doubt the start of an excellent blog. It’s just quite nice to have some conflict in the Cambridge blogosphere – or indeed to have a Cambridge blogosphere at all.

Without further ado, let’s take a look at Thomas’s arguments.  From the top ….

(1) Negative interest rates can be a thing

Well, duh. Central banks can cut interest rates to negative infinity and beyond if they so choose. They have not and never will, because it would be pointless. This is because when interest rates are negative on any given security (say the bank balances which UK banks hold with the Bank of England), there’s almost no reason not to just withdraw its value into physical cash, which has a strictly better interest rate of zero. I say almost because there are costs to storing all that cash – think Fort Knox, bank vaults etc. Thomas rightly points out that Sweden has introduced negative interest rates. And the ECB might do the same. But no one – or almost no one – seems to think this would be more than marginally effective. Because once the cost of holding bank balances with the BoE at negative interest rates exceeds the costs of holding all that money in physical form, banks will withdraw it all. It’s that simple. In fact this is why when we are at the zero lower bound we call it a ‘liquidity trap’. Central banks are trapped by the fact that they can provide unlimited liquidity (i.e. money) without changing interest rates at all. Outsourcing to Barry Ritholtz on Sweden:

“Governor Stefan Ingves was quick to point out that benefits from negative interest rates did not seem to be observable. He did not get into the costs associated with negative interest rates, but he did affirm that it was unlikely that Sweden would use them again.”

The zero lower bound on interest rates is most definitely a problem.[1] And this is why we need to reform. Or as Gotham City’s Caped Crusader once put it:

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2)        It’s not about the state of financial intermediaries. It’s about expectations of future nominal income

I’m confused about this point on a number of levels. Firstly, we have absolutely no problem with nominal GDP level targeting (NGDPLT). In fact, I think (and Felix agrees) that NGDPLT would be a wonderful initiative. It is, however, a different argument – one that we’d fully support, but well outside the scope of our proposal (I seem to remember Felix making this point in our seminar). Most of the people who support NGDPLT (e.g. Michael WoodfordDavid Beckworth [2]) are very keen on seeing the two policies as complements, as are we.

But that notwithstanding, it is simply not true to claim that you could fix a broken financial system solely by stabilising future expectations of nominal income, which is I think the main line of Thomas’ and others’ arguments. It requires a world that is fundamentally at odds with what happened during the financial crisis. It is a world in which banks were willing to borrow from other banks, because they were not afraid that whatever collateral they received might be worthless in a few days time. It is a world in which banks were willing to lend to other banks because they were not worried about the prospect of them going bust. It is a world in which hot money didn’t take flight from the banking system and leave them without funds to lend at all. It is not the world we’ve been living in for the last five years. Instead, it is a world with a financial system that chose to stop lending because of future expectations, and was not forced to stop lending because of current financial panic. When Northern Rock had depositors queuing outside its cash machines in 2007, when RBS was scrabbling around to fund itself after buying the basket case that was ABN Amro in 2008, whatever the Bank of England might have done to the future economy was irrelevant – they simply did not have the balance sheets in place to lend out to the real economy. And so Felix and I remain sure that the financial system was sufficiently bust over the crisis that, we need other ways to target the real economy, which don’t rely on merely stabilising nominal income expectations and trusting to the health of the banking sector.

3)        Can QE or forward guidance cause bubbles?

Admittedly I’m not entirely convinced of this point myself, and lots of evidence points against the UK currently being in a bubble. But I’m certainly concerned about the possibility – and who wouldn’t be? We know from the last five years that the small tail risk chance of a bubble is worth weighing, because the consequences are so catastrophic. But Thomas claims to be confused about it, so I’ll try and point him in the right direction. The gist of the battleground here is this: when QE and forward guidance happens, what happens to long-term interest rates? And if long-term interest rates fall, why would that cause a bubble?

This next bit is quite tedious, but it’s Thomas’ argument as best I can make it. There’s supposedly an effect that says interest rates should go down. Some people call this the ‘liquidity effect’. The idea here is that QE or forward guidance lowers the path of future short-term interest rates, and this makes long rates fall. There are also a couple of effects that putatively act in the opposite direction. These are called the ‘inflation’ and ‘income’ effects. These reflect the fact that in the long run, if the economy picks up because of the stimulus, inflation and growth should rise, so the central bank will eventually raise interest rates.

Now I have no idea which of these effects dominate. I have no idea whether any of them are correct. They could both all be powerful or all be weak. We could have totally the wrong model of the economy and financial markets and how monetary policy works (and the evidence seems to be pretty clear that we do). This Scott Sumner bloke who Thomas brings up doesn’t have a clue either. And armchair theorising won’t get you there. You have to actually look at interest rates to figure out what’s going on. I took the precaution of actually doing this:

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So the bulk of QE took place in the October 2011 to July 2012 phase – right next to that nice big cliff in the middle. We had a bit in November 2009, just before the slightly smaller valley to the left. The rest took place in the flattish 2009-2010 phase. But you might say that just eyeballing interest rates isn’t particularly persuasive. Fortunately some very smart people have already done much more careful analysis. Paul Tucker, BoE deputy governor is probably the best the UK has on this front. And he like others finds that unconventional monetary policy has acted to lower long-term interest rates. Which, you know, accords well with just about every piece of serious econometric work on the subject.

So why is this a problem? The issue is that when long term interest rates fall, financial intermediaries who need to make some kind of fixed return on their investments (think pension funds who need to provide steady returns to people drawing down pensions) take on riskier propositions that pay a higher yield. In the parlance, they ‘reach for yield’. And this could create problems further down the road when either (a) these risks all blow up in their face or (b) they all unwind the risky investments when interest rates normalise. In fact there’s a very good case to be made (and Jeremy Stein of the Fed makes it) that this was in large part a reason behind the erratic movements in interest rates over the summer. Now I hasten to add that we don’t have a very good idea of whether or not this ‘reach for yield’ thing matters at all. But one lesson we’ve learnt about finance over the last five years is that trying to poke institutions into overleveraging themselves is something that we should do our best to avoid if we can.

For the record, Thomas’ point about targeting foreign currency is an excellent one. But I digress ….

3) Income inequality

Not even sure how to argue this point. We have a choice between (a) a way of stimulating the recovery by raising the incomes of the few and hoping they trickle down; or (b) raising the incomes of the many. The latter is preferable on this basis. Period. Sure, QE may have raised asset prices because it raises current and future profits. But this is basically the point Felix and I made – poor people don’t own assets so they don’t benefit from this.

Whew. Almost there. I need to sleep.

4) Will helicopter money work at all?

This is a very important point – and one we communicated very badly in the paper and also when we presented it, as Thomas rightly points out. The point made is this; we hope that by design helicopter money would function like a temporary tax cut. So what if consumers simply saved the money or paid down debts, instead of using it to boost spending? We have two answers to that. Firstly, recoveries after financial crises are generally slow because consumers are paying down debts – or ‘repairing balance sheets’ in the jargon. One of the better aspects of helicopter money is that if consumers chose to use it to get rid of these debts, it would accelerate the process of balance sheet repair, and speed the UK along the path towards recovery. That aside, though, if consumers are busy saving or paying down debts with their helicopter-dropped money, the idiot-proof solution is to simply give them even more money. Which is the crux of our explanation.

I guess that’s pretty much everything. A series of very important criticisms from Thomas, but ones which Felix and I think our policy is broadly robust to. People who have made it this far in either of our posts may have also realised that the debate is something of a proxy argument over what Thomas calls ‘market monetarism’. I happen to take a much glummer view of that particular school of thought than he does (having once been a devout myself), but this is an argument for future blogging wars.


[1] There are some racier proposals to introduce negative interest rates on money itself, especially by Miles Kimball and Willem Buiter. This is a different thing entirely.

[2] Respectively, the man famous for working out all of the interesting ideas of the obscure school of thought known as ‘market monetarism’ about a decade before it existed; and the most financially literate and arguably most incisive of the aforementioned market monetarists.

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Helicopter Money – a Proposal for Macroeconomic Reform

On Monday at 6PM, Felix Nugee and Jonathon Hazell are presenting their paper on ‘helicopter money’, proposing to reform macroeconomic policy. We have discussants Ryan Avent of the Economist and their Free Exchange blog, and Martin Weale of the Monetary Policy Committee. Felix and Jonathon blog about why we need their proposal, below. 

Update: The draft copy of the paper can now be found here https://wilberforcesocietyblog.files.wordpress.com/2014/01/helicopter-money.pdf

In 2008, we saw a massive financial crisis in the UK, and then a steep fall in spending across the economy. The result was a deep recession and a sluggish recovery at best. The combined action of the Bank of England and the Treasury wasn’t enough to change this. We put together a paper for TWS to try and answer two questions – what prevented the government response from being stronger; and, bearing in mind these issues, what an optimal stimulus policy would look like. The UK economy is finally growing again, and maybe further stimulus is finally no longer needed.  But beyond this we want to look at how to prevent Britain’s worst economic performance in a century from happening again:

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It’s not all that unlikely that we could face the same problems in the future. Therefore we need a set of institutional reforms, to put in a framework to deal with any repeat of the last five years. This is ultimately the goal of our paper, designing a proposal called ‘helicopter money’. We propose to give the Bank of England the power to make lump sum cash payments to British households during a slump, so that consumers would go out and spend the money, boosting demand and ending recessions. The Bank would figuratively drop bundles of cash from a helicopter, so that people would use them to buy goods and services.

Our proposal is not quite new. In one form or another, top commentators at the Financial Times, the Daily Telegraph and the Economist have all mooted the idea. A few leading policymakers, in particular Lord Adair Turner are enthusiastic. However, to our knowledge there is not yet a piece of work that takes the wealth of important, rapidly-evolving academic ideas relating to helicopter money, and brings them together into an accessible proposal which more people can understand. Nor, we feel, is there a work that fully sketches out the political economy of helicopter money – only in this way can we understand what the optimal institutional design is, an issue which many discussants puzzle over or pass by. If we want a genuinely forward-looking reform to deal with future crises, this last step is necessary.

Failure of the alternatives

Of course to figure out why we need reform, the first step must be to discover why the status quo isn’t working. Before 2007, central banks steered the aggregate economy through varying the short-term interest rate, thereby affecting consumption, investment, and future growth and inflation expectations. The Bank of England was a “Flexible Inflation Targeter”, a role it performed very successfully – growth was high, unemployment and inflation low, from the 1990s to the eve of the financial crisis. However, when interest rates reach their zero lower bound (ZLB), theory and common sense indicate that the power of monetary policy to stimulate is constrained. This is because central banks cannot cut interest rates below zero, stopping their ability to add stimulus through that channel. This is the famous ‘liquidity trap’ phenomenon, where interest rate policy is powerless, like ‘pushing on a string’. A good demonstration of how problematic this is comes from recent work by economists Cynthia Wu and Dora Xia. They try to calculate what the MPC would have cut rates to, had the ZLB on interest rates not been an issue. The results aren’t pretty:

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The ‘shadow rate’ estimates the level of rate cuts then would be preferred by the MPC in the absence of the ZLB 

Clearly, then, the ZLB is a major problem – and stops standard monetary policy from eliminating the kinds of problems we’ve seen in recent years. So where do we turn when trying to fight recessions? Fiscal policy – cutting taxes or raising government expenditure to boost spending – is the other obvious option. But it is also quite problematic. We cover several reasons in the paper, but above all the problem is politicisation. Ideologically driven decisions to alter the size of the state can be flown under the flag of fiscal policy. Take the Bush era tax cuts – passed after the collapsing of the dotcom bubble ostensibly as a recession-fighting measure and pilloried by economists, they have now mostly been made permanent and totally restructured the American tax burden. Closer to home, the obvious example is austerity. This is not the place to retread the argument, but to our minds (and that of the OBR), austerity has been a total disaster for growth.  And David Cameron himself admits to using austerity to shape the British state for the long run:

“We are sticking to the task [of austerity]. But that doesn’t just mean making difficult decisions on public spending. It also means something more profound. It means building a leaner, more efficient state. We need to do more with less. Not just now, but permanently.”

Obviously when these sorts of explicitly political decisions have such a high cost, we can’t rely on politicians and fiscal policy to dig us out of any future economic mess.

What about unconventional monetary policy? The response by the Bank of England to the ZLB was to develop Quantitative Easing (QE) and forward guidance. The jury is out on how effective these have been – we try to take a look the costs and benefits in our paper. All we would say in this post is that the impact has almost certainty been small, and the costs far from trivial. But tellingly, almost no one argues that the sort unconventional monetary policy used by the Bank constitutes an ideal framework for the long run.

Helicopter Money

So clearly we need some new macroeconomic tools. Enter our proposal, helicopter money. Abstractly, a sum of money, chosen by the Bank to provide the right amount of stimulus, is dropped by helicopter to every household in the country.  In reality, of course, the Bank would simply credit every household with the given amount. In very simple terms, helicopter money is like a big lump sum tax cut by the government, financed by money instead of bonds – in each case, the policy move is a cash rebate to households. Clearly, then, it would be a powerful way of boosting overall spending in the economy, and stopping recessions. The post is running long, and we don’t want to give away exactly why we like it so much as a policy. But in our paper and seminar, we defend the idea that this is a roughly optimal way to prevent recessions. Come along to find out why!

Inglorious Isolation

Greg Burke

“When will Labour learn that you cannot build Jerusalem in Brussels?”

The words of Margaret Thatcher echo louder than ever as that other ancient city of Athens crumbles and many warn that Europe will drag the City of London down with it too. As UKIP’s popularity and EU integration gain momentum, it is time to ask whether a British exit would bring independence or isolation; regain our sovereignty or lose our power; place national pride above prosperity.

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Getting Out

According to the Eurosceptic argument, the debt crisis has accelerated progress towards fiscal and political union. Fiscal union would require common banking supervision and greater regulation, stifling the City; it would also transform Westminster into a sort of regional parliament for Brussels. Europe would no longer consist of countries on one continent, but states of one nation.

Their plan is to secure an amicable divorce, given our relationship with Europe has mostly been a marriage of economic convenience, and uses Norway as its template. Norway is a member of the single market and exports 75% of its goods and services to the European Union. Norwegian oil, like British services, is highly valuable to EU countries. Therefore it is in Europe’s interest to maintain free trade with Britain.

But whatever negotiating power Norway can bring to bear comes too little too late, as all the early preparation of laws governing these sectors is concluded amongst EU countries alone. This essentially means that Norway is forced to follow EU laws without having any influence on their formation. There is also a time lag before these laws are implemented in Norway, giving EU firms a head start over their Norwegian competition. Furthermore, the British situation is different. Regulation for services is much more complex than for oil, Norway’s main export to the EU, potentially leading to an upsurge of legal arguments against UK standards. Thus by leaving Europe we cannot leave red tape behind, and the red tape will not be of our choosing.

The City is so dominant because it is seen as the financial centre of Europe. Many economists warn that the 160 European banks currently located in London would be put under pressure by their national governments to relocate. Banks of all nationalities are also likely to move their foreign exchange desks to mainland Europe, draining Her Majesty’s tax revenues. What about trade with the rest of the world? Eurosceptics argue that businesses which do not trade with the EU would no longer be pointlessly bound by EU rules. They also say that Norway has carte blanche to negotiate bilateral trade deals with the likes of China and Indonesia. However, there is no mutually exclusive choice between EU and world trade. In fact, a solid export base in Europe will bring in the revenue needed for many manufacturers to expand their horizons to more distant markets. More importantly, Britain’s negotiating position as an economy worth $2.5 trillion with 60 million consumers is little compared to the EU, which boasts an annual GDP of $16.5 trillion and 500 million consumers. As a case in point, the US-EU Free Trade Agreement is forecast to bring an additional £380 to each household in Britain, but President Obama has warned that Britain would have to renegotiate a bi-lateral deal if it were to leave. A Brexit would also exclude us from potential EU talks with Japan and India in the future, and this strength in numbers is also useful to get a better deal from multi-nationals, the EU roamer tariff for mobile phones being a recent example.

So if Britain were to pull up the drawbridge and use the Channel as a moat, it would be still be the subject of EU laws but no longer the sovereign, and poorer both in services and manufacturing.

Staying In

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If Britain does decide to stay, we must look at how it will define its place in a future of fiscal, banking and, perhaps in the long run, political union.

The case for fiscal union is this: because the Eurozone consists of very different economies with the same currency, if one country goes into recession the ECB will not be able to lower interest rates to spur spending and investment. However, a larger central budget could transfer money to suffering economies, smoothing out any downturn they may suffer. Governments pay into the budget in the good times and take out from the budget in the bad times. It is planned to break the vicious connection between banking debt and government debt, where governments like Spain currently have to borrow from banks to pay off their debts. This means that they are still in debt, just to different lenders. Some argue that fiscal union creates the issue of moral hazard, where the governments of weaker economies behave recklessly knowing that they will be bailed out by the stronger economies. However, this is where the Fiscal Compact comes in, committing national governments to live within their means and punishing them if they exceed a certain debt level without taking counter-measures. The Fiscal Compact, alongside the massive deterrent of the debt crisis, serves to reduce the risk of another recession.

Britain has not signed up to the Fiscal Compact and is not a member of the Eurozone, but we may have to contribute more to the EU budget to fund fiscal union. This may well be in our national interest, shielding both the Eurozone countries from another dramatic downturn and the United Kingdom from the stifling side effects to our growth. But even if governments borrow within their means having signed up to the Fiscal Compact, the banks may still plunge the EU into recession. Hence the last step is to establish a banking union. So far, the G20 has already agreed on a leverage ratio of 6% for 8 SIFI banks and 5% for their bank holding companies. At the EU level, a cap on bonuses has been set at 100% of salary, but many banks have simply raised wages in response. The most important elements of banking union are outlined below:

1)      As of mid-2014, the ECB will work with national authorities to enforce a single set of rules on Eurozone banks whose assets exceed €30 billion.

2)      A single deposit insurance scheme to be introduced to prevent bank runs.

3)      A single bank resolution mechanism for winding down failed banks

The first of these prompted concerns that the Eurozone, acting as a unanimous block, would effectively impose legislation on those member states which have not chosen to join single banking supervision. However the Chancellor has negotiated a double majority voting system, where any banking law would need a majority in both the Eurozone and non-Eurozone blocks to pass. He also secured Britain against any future discrimination where the ECB might have set capital rules to put London at a competitive disadvantage. This measure gives Britain further scope to negotiate its relationship with Europe, as Germany has stipulated that it will only accept the new supervisor on the condition of treaty change.

For the second step, the Eurozone has not yet come close to pooling its resources. Germany is strongly opposed to the measure, believing its taxpayers will shoulder a great deal of the burden. The scheme might instead be funded by the Financial Transactions Tax, which would raise €57 billion a year according to EU Commission estimates (minus €10 billion without Britain). This places a tax of 0.1% on the exchange of shares and bonds and 0.01% across derivative contracts, affecting all transactions with Eurozone banks. The Eurozone countries have agreed to press ahead with this in spite of legal challenges.

The third step has met much opposition, most notably again from Germany, arguing that national authorities should decide which banks to liquidate and that the Commission would be torn between its duty to shut down banks and to enforce state aid. A painstaking economic solution must be worked out before political union can even get underway and it is unlikely that countries will change their defining approaches to the EU without significant concessions.

So with such substantial change, there is bound to be considerable disagreement, room for negotiation and necessity to compromise. Britain’s hand is strengthened by the threat of its exit, which would deprive the EU of 14.8% of its economy, €14.7 billion contribution to its annual budget, drain time and effort in protracted negotiations and undermine market confidence in the EU. So what should Britain seek from these negotiations?

We should first insert a pro-growth protocol into a new treaty which forges a real single market in services and cuts back on unnecessary regulation. The EU’s biggest long-term task is to improve competitiveness and this is an area where Britain can play a strong and active role. Secondly, we could work for a British veto over financial regulation, like the one France possesses for agriculture. Our share of the wholesale financial industry in Europe is 36% compared to France’s share of 20% in agriculture.

There will need to be concessions in return. Although the Government has ruled out a Financial Transaction Tax unless implemented globally, it might not be as harmful to the City as they think. The UK introduced a similar but much heavier task over 25 years ago: the Stamp Duty Reserve of 0.5% on the transaction of all shares listed on the London Stock Exchange, regardless of the traders’ nationality. This means that companies cannot escape the tax by leaving the UK. Moreover, the costs of mass re-location, not to mention the clarity of the European legal system, means that big companies will still issue bonds/shares and hedge their transactions in London. If the UK were to join the Eurozone’s FTT, the US would face no competitive disadvantage and could raise significant revenue by introducing the tax itself. The tax could be shared between the Treasury and Brussels, gaining significant bargaining power over Treaty Change without contributing more to the EU banking budget and increasing national revenue. Moreover, A Eurobarometer poll found that 65% of Britons interviewed were in favour of the tax. Politically, this could boost the pro-EU cause, showing that the EU is acting in the interests of the British public and ensuring that the financial sector would pay its share towards any future bailout.

Disraeli and Cameron: Splendour or Isolation?

Disraeli and Cameron: Splendour or Isolation?

So the Europe of the future provides opportunities and challenges. In the 19th century, the policy of ‘Splendid Isolation’ was characterised by a focus on British territories overseas, as free trade was the engine of the Empire in an era of increasing international competition. Whereas at that time isolation from Europe meant engagement with the world, today Europe is Britain’s major market. Today it is not Napoleon or European war ravaging the continent, but the debt crisis. Greater unification does alter our place in Europe, but it strengthens Europe’s place in the world. Perhaps Brussels is not the new Jerusalem, but if we seize the chance to change our relationship with the continent, Britain will build itself a better future.

Originally posted on Forward Forum 

Prison Reform

TWS has an event on prison reform tomorrow, presenting a paper by Josephine Delves and Robert Norfolk-Whittaker. Read on for a taste of tomorrow’s paper. 

Foreword

The idea for this paper came from my experience of working on a rehabilitation project in Springhill Prison, Buckinghamshire in 2011-12. During that time I gained an insight into the difficulties that offenders face when they are released from prison, and was surprised at the limited support available to those recently released.

I saw at first hand some of the coalition government’s policies at work, and had the opportunity to engage with offenders at the critical juncture, just after they are released from prison. My experience showed me that current and past government policy aimed at reducing reoffending has not worked. Unfortunately, on a national level the evidence points to the same conclusion.

The authors of this paper have lived through an era in which stigma and hostility towards offenders is not only commonplace, but pervades public discourse on crime and punishment. During the last 20 years, political rhetoric on law and order has been dominated by the mantra ‘tough on crime’. However, since the peak in crime during the 1990s, the crime rate within England and Wales has halved. ‘Tough on crime’ rhetoric is no longer as relevant as it once was. This presents us with an opportunity for dialogue and discussion about the direction we are heading in, and the vision we have for the criminal justice system as a whole.

Our experiences working in the third sector, on rehabilitation programmes and in human rights, have led us to question the punitive approach. Although crime rates have dropped, the reoffending rate within England and Wales stands at almost 50%. This shows that in spite of punitive measures, prison is not deterring offenders from recommitting crime. The Conservative Party recognised the need to redress the balance in favour of a rehabilitative approach in their 2008 policy paper, ‘Prisons with a Purpose’. However, the policies enacted under the coalition government have not lived up to this promise.

The best way to prevent reoffending is of course to prevent offending in the first place, through addressing the root societal causes of crime. However, focusing upon those who have already fallen on the wrong side of the law, in this paper we will argue for a shift in attitudes, away from punishment and retribution towards reconciliation and rehabilitation. There are glimmers of hope in the numerous pilots and projects run throughout the country that offer support to offenders re-entering the community and have a genuine impact upon rates of recidivism. Through this paper we hope to show where government policy is currently going wrong, highlight successful initiatives and to make suggestions that build upon these and other positive examples so as to create a Criminal Justice System that helps people to turn their lives around.

Robert Norfolk-Whittaker

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Executive Summary

Background

The prison population currently stands at around 84,000. This constitutes a 100% increase on the 1993 prison population.

During this time the rate of reoffending has remained stubbornly high, with about 50% of offenders reoffending within a year of release from prison.

The reoffending rate has remained consistent despite a range of initiatives and policies aimed at tackling this problem.

The Cost of Reoffending

Reoffending in England and Wales is estimated to cost the economy £9-13 billion every year.

Reoffending is helping to maintain the high prison population and significantly contributing to the amount of crime.

Each new prison place costs £170,000 to build. The average cost per prisoner per year is around £40,000.

Key Proposals

We propose that the government sponsor a Royal Commission on the CJS, and reoffending in particular, in order to reframe the debate and divorce policy from party politics.

Policy should be directed toward greater levels of support for those leaving prison. This should include:

  • The creation of a national offender support scheme.
  • A renewed emphasis on the social work aspect of probation work.
  • The marketisation of the probation services deserves further consideration before being rolled out nationally. The government should wait for the result of pilot projects and give due weight to consultations.
  • The Prisoners’ Earning Act is counterproductive, it should be repealed.

Josephine Delves and Robert Norfolk-Whittaker

The ECB Rate Cut

The ECB cuts interest rates, and looks like it’s doing something powerful to prevent a deflationary bust in the Eurozone. We try to explain why it’s a weak move, over on Pieria:

“The reasoning is that the rate cut will lower short-term money market interest rates, and therefore shift the cost of funding downwards across the entire yield curve, giving a boost to spending in the Eurozone at a time when it is sorely needed. …. [In fact] it is a way of appearing to deliver major monetary stimulus without doing much at all. It allows the ECB to carry on doing close to the minimum necessary to stimulate the Eurozone, even as it fails on its own terms – the Eurozone is on course to enter a disinflationary bust, with core inflation heading well below its (already highly conservative) mandate of an inflation rate just below 2%.”

Read on here

What to do with a problem called Kim?

Chris Watkins

Here we go again. On September 11th, satellite photos were released showing steam rising from the towers at Yongbyon, one of North Korea’s nuclear research facilities. On the 17th, the country failed to answer or provide evidence that rebutted a special UN human rights report report accusing it of “unspeakable atrocities”. On the 21st Kim Jong Un cancelled plans to allow hundreds of families split between North and South since the Korean War to be reunited at the Diamond Mountain resort in the North. Quite the active ten days for the Kim regime. These are just the latest in a long history of bellicosity and blatant disregard for international law.

YongbyonThe Yongbyong nuclear research facility

This confrontational attitude is made more interesting in contrast to Pyongyang’s recent “charm offensive”, where the country seemed increasingly willing to engage diplomatically. There was noise about restarting 6 party talks with denuclearization on the table, and Seoul had high hopes for the family reunification program. On September 2nd South Korea promised extra aid as a conciliatory gesture on account of improving relations, and on September 16th the joint industrial park at Kaesong was finally reopened following a 4 month hiatus. All of these positive steps have been wiped out in one fell swoop following the recent shift in tone.

Entrance to the Kaesong Industrial ComplexEntrance to the Kaesong Industrial Complex

So, what gives? Why restart a globally condemned nuclear research program, further enrage human rights activists, and stonewall efforts to thaw relations just when the international community is beginning to respond positively to its overtures?

It turns out, in fact, that this is a trend. The North Korean leadership isn’t stupid, it isn’t naive, and it certainly isn’t irrational. For decades senior officials in Pyongyang have walked a diplomatic tightrope as they try to squeeze maximum aid out of friends and foes alike. The strategy is this: provoke for a period, but make sure not to step too far out of line. After all, provocation is a useful tool only if it doesn’t land you in a war with the world’s remaining superpower and its allies. Once the others have gotten themselves worked up over these actions, (the sorts of things that gets North Korea lumped into the so-called “axis of evil”), offer to come to the bargaining table in return for no-strings-attached foreign assistance ensues. Rinse, wash, and repeat.

Aid is absolutely necessary for the regime’s survival. The DPRK’s economy has long ceased to be capable of supporting its own population. Assistance not only prevents vast swathes of the population from starving, but also helps to consolidate political control. Provided without distribution conditions, these supplies of food, fuel, and industrial equipment are allocated according to an individual’s loyalty. Kim Jong Un strengthens his control by rewarding those who are and withholding from those who are not.

Kim Jong-unKim Jong-un

Up until the early 90’s it was easy to secure enough aid to go around, even without the provocational attitude we see today. Pyongyang skillfully played China and the Soviet Union off of each other; despite their common affinity for Marxist ideology, differing strategic interests and personal acrimony meant that the two countries were never really allies, and came close to war several times. Like two jealous parents aiming to earn the loyalty of an only child, North Korea exploited this animosity to secure aid from both countries in ever-increasing amounts.

Many North Koreans actually look back with fondness on this period during the 1980’s under the rule of the “Great Leader” Kim Il-sung; the Public Distribution System that handed out rations always had enough rice and grain, and people would only go hungry only through disloyalty to the regime, not because it couldn’t afford to feed them.

However, with the collapse of the Soviet Bloc also came the collapse of aid to North Korea. Russia was in disarray, and while China would still help to some extent although their interests had shifted as they initiated their own market reforms. Within a few years the country was destitute, and a horrific famine endured for much of the decade. The only way the country could survive was to extract as much aid from China and others, but without the leverage of its rivalry with the Soviet Union. Ironically, the countries that are the targets of the harshest North Korean propaganda – Japan, South Korea, and America – were in fact the countries whose aid prevented the death of even more North Koreans during this time.

North Korea Flood Aid

Given this background, what should the US and its allies do to best improve the lives of North Korean citizens and promote stability in a rapidly growing region?

According to Andrei Lankov, a specialist in Korean Studies at Kookmin University in Seoul, the best strategy is to expose as many North Koreans to information about the outside world as possible, then simply wait. Most Korean strategists believe regime collapse is inevitable. The only question is how long Kim Jong-un or his successor can hold on. In today’s global reality, even state-sanctioned activities threaten to destabilise the country.

The North’s Kaesong Industrial Complex, which provides 123 South Korean companies access to the cheap labor of 53,000 North Korean workers, illustrates the pressures currently facing Mr. Kim and his advisors. Kaesong has been both a great blessing and curse to Pyongyang. It is a critical source of hard currency; $90 million a year flows into North Korean government coffers in return for its citizens’ labour, and is used to import fuel, food, and military equipment.

However it also exposes workers and their families in the Kaesong region, around 200,000 in total, to South Korean culture and products. Strict regulations are of course in place that carefully regulate what can and cannot be said or shown to workers, but even the factory buildings themselves speak volumes about just how much more advanced the South is.

The wealth of Seoul by nightThe wealth of Seoul by night

This exposure presents a threat on multiple fronts; ordinary North Koreans are becoming more aware of the deficiencies that they have been enduring for decades, but simultaneously see an increases in their standard of living. When survival ceases to be a primary concern, individuals are able to think, to talk, and to organise. This is the stuff of nightmares for the Kim family. A population aware of the world beyond their borders and able to rally itself means almost certain downfall for the regime.

Ordinary citizens are forced to work on large infrastructure projectsOrdinary citizens are forced to work on large infrastructure projects

Already there are signs that even those without the privilege of working at Kaesong know more about the outside world than at any other time, and are increasingly willing to speak out about it. The current generation of youth will be the first in the country’s history that grows up with the universal knowledge that they are being fed a lie by their government. Smuggled movies and music that show life in South Korea; cell phones with which they can call relatives in China; computers that can be used to read and hide Western literature and news. These are all increasingly common ways in which the government is losing control over its population.

This new-found propensity to flaunt the rules doesn’t just stop there, however. There have been several instances of protest in the past decade. In 2009 hundreds of middle-aged women clashed with police after the government attempted to initiate a clamp-down on the local markets which now form the backbone of economic life in the country. The government couldn’t make the restrictions stick.

In 2011 news reports trickled out announcing that for the first time ever, citizens in several major cities joined together in organised protests against the government demanding food and electricity. They were immediately repressed, but when the state authorities tried to identify the organisers, they were met with silence. As far back as the late 90’s, the combination of a huge network of paid informants and the social pressure to oust disloyal neighbors would have surely led authorities to the guilty parties. People are no longer beholden to the state in the way they once were.

The government’s control over its people in North Korea is rapidly diminishing as it fails to balance its need for foreign investment, the personal greed of the country’s elite, and the ease with which modern technology disseminates information. Perhaps the modern world makes it simply impossible to maintain control to the same extent as it was in the past. Either way, it is in nobody’s best interest to react with aggression to North Korea’s latest desperate attempts to grab the attention of the international community and squeeze much-need aid out of interested parties.

Repeated provocations are hard to ignore, especially for those on the receiving end, like the South Koreans, but everyone stands to gain from such a strategy. In fact, encouraging cooperation despite such provocation will help to accelerate the downfall of the regime, and lead to a better life for the true victims of the current situation – the tens of millions of ordinary North Koreans who continue to endure the harshest of realities.

Originally posted on the Forward Forum blog

Modelling Stability after Revolutions

Dom Aits is presenting a seminar tomorrow on political stability after revolutions, applying mathematical methods. Here, he blogs about his work.

The crisis unfolding in the Arab world, and in particular in Egypt, shines light on how suddenly imposing a democratic political system on what was previously a dictatorship can have dire consequences. The key to working out why there is such violence after a revolution is set within the beliefs and the expectations that people and organisations hold for the future of their new government.

There is always a cost with a political revolution. The act of revolution itself – to overturn what has come before – can bring personal loss and economic ruin to name a few. But the sacrifice that comes with this is the very characteristic that makes the aftermath of a revolution so unstable.

This seminar aims to explore how important beliefs and expectations are, and how the sacrifice that comes with a revolution warps them. The political system will be analysed from a different angle applying economic ideas to a new context. This new angle uses logic in a very similar vein to that used in economics, and applies mathematical abstraction to uncover different ways at looking at elections, democracy and the behaviour of pressure groups.

What the seminar will ultimately focus on is a policy tool that can be applied to stabilise post-revolutionary states that fundamentally tackles the issue of future expectations and beliefs.

The executive summary is below:

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The most noteworthy aspect of the recent political revolutions in the Arab world is that there is nearly always a failure to suddenly superimpose a democratic style of government based on Western political constitutional foundations onto a set of domestic government institutions. In my paper, I argue that there is a need to consider the notion of a ‘learning equilibrium’ – to recognise that it takes time for institutions and socio-economic agents to adapt their expectations about the new state of governing such that a stable democratic political environment is generated.

The model I develop defines all groups that aim to implement a manifesto (or a set of beliefs) as pressure groups, which I assume are strictly competitive entities by nature. These groups, at a point in time, can either decide to work within the rules and confines in the current ‘state of government’, or aim to change this ‘state’. If a pressure group wants to change the state, it can still work within the confines of the current state of government, and hence does not have to reject it. This is the case when there are elections that allow the peaceful transition between states of government. A pressure group can work to change a state of government without having to reject the current state.

How a pressure group makes the decision to reject a state of government consists of four factors – a minimum-bound utility, a realised utility, an optimal utility, and a Feasible Time Frame.

Pressure groups are considered to be no different to any other economic homogenous agent, and thus utility is the key concept used in this paper. As a starting point, each pressure group has a minimum-bound utility – this is the minimum utility a pressure group will accept in order to conform to a state of government.

I argue that pressure groups gain utility from their expectations of how they will succeed in the future. Critically, there are two types of utility that a pressure group considers. The first, optimal utility, is what the pressure group would gain in an ideal world (in their opinion) when they are faced with realising their own limitations. This is expressed as an optimisation problem in the paper. The second type of utility is realised utility. This is what the pressure group actually gains from the current resources and successes that it has when it considers its future prospects.

Utility is realised over a set of time intervals called Feasible Time Frames. The intuition is similar to how any organisation operates. An organisation tends to have a strategy that is reviewed from time to time to make adjustments (i.e. consider timely reports and project reviews). Between these reviews, there needs to be time for the strategy to be implemented, and hence during this process (unless critical adjustments have to be made) that strategy will remain on the whole intact. I argue that pressure groups follow a similar mechanism and realise utility at the end of these time intervals.

So at the end of a time interval, if realised or optimal utility is lower than the minimum-bound, a pressure group will reject the current state of government.

The purpose of the paper is not to analyse a revolution itself, but to look at the aftermath.

I argue that after a revolution, the minimum-bound utilities of pressure groups increase. This takes into account the sacrifice that comes with the revolution, due to: the physical human loss, the interruption of ‘normal life’, the economic cost etc. In other words, pressure groups want the revolution to be worth something to make up for the cost of participating in it, and so expect more from the new state of government. At the same time, in the aftermath of a revolution, political processes and the functioning of the state (and economy) tend to be stunted (i.e. slow recovery) for a while – so realised and optimal utility are likely to fall. Combine this with pressure groups’ impatience leading to a shortened feasible time frame, and the conditions for a quick rejection of the newly established state of government increase quickly.

The paper ends with a policy contribution to tackle this. I argue that that to create stability, a learning equilibrium needs to be established whereby pressure groups gradually adapt to the new state of government. This can be achieved by removing the pressure groups’ high expectations of the post-revolutionary state of government. Both political demands from the pressure groups and the supply of such concessions from the government need to be mediated. The idea is to create a model with slowly increasing terms of office for subsequent states of government to avoid a new revolution and to suppress violence.

I propose beginning with a one-year term before new elections, and increasing the terms by one year until a four or five year limit is reached. With short terms in office, pressure groups cannot realistically demand huge improvements in the country because they will be forced to realise that this would be impossible given the imposed term of office. Similarly, those running the state cannot offer similar promises either, because the electorate will be less likely to believe that those promises can come to fruition. As terms of office increase in length, pressure groups will eventually mediate their expectations to work within a democratic, election-led political process, and hence the impetus for further revolution is more likely to be suppressed.