Peace will come to earth when the people
have more to do with each other
and governments less.

Via Survival of the unfittest: why the worst infrastructure gets built—and what we can do about it:

[...] Taken together, the UK and US studies both account well for existing data on cost underestimation and benefit overestimation. Both studies falsify the notion that in situations with high political and organizational pressure the underestimation of costs and overestimation of benefits is caused by non-intentional technical error or optimism bias. Both studies support the view that in such situations promoters and forecasters intentionally use the following formula in order to secure approval and funding for their projects:

underestimated costs + overestimated benefits = funding

Using this formula, and thus ‘showing the project at its best’ as one interviewee said above, results in an inverted Darwinism, i.e the survival of the unfittest. It is not the best projects that get implemented, but the projects that look best on paper. And the projects that look best on paper are the projects with the largest cost underestimates and benefit overestimates, other things being equal. But the larger the cost underestimate on paper, the greater the cost overrun in practice. And the larger the overestimate of benefits, the greater the benefit shortfall. Therefore the projects that have been made to look best on paper in this manner become the worst, or unfittest, projects in reality, in the sense that they are the very projects that will encounter most problems during construction and operations in terms of the largest cost overruns, benefit shortfalls, and risks of non-viability. They have been designed like that, as disasters waiting to happen.

The paper goes on to say, “Professional and occasionally even criminal penalties should be enforced for managers and forecasters who consistently and foreseeably produce deceptive forecasts”. Wise words yet we shall have to hope the HS2 project and all the other infrastructure projects planned by the Government are unique in not suffering from the endemic flaws described in the paper.

I’ll leave interested parties to read the paper for themselves but I will add this: while the Government has cloaked itself in the legacy of the great British railway pioneers, they were entrepreneurs risking private capital in commercial projects. The same cannot be said of HS2.

That matters and it matters for all the reasons we have historically defended free societies from the encroach of planning.

Last night, I caught up with Martin Wolf’s November programmes for Radio 4 Analysis, which you can find here. He offered a predictable blend of commentators calling for more money printing, world central banking and greater global governance. It prompted me to look out Monetary Theory and the Trade Cycle (1933).

Hayek wrote (emphasis mine):

It is a curious fact that the general disinclination to explain the past boom by monetary factors has been quickly replaced by an even greater readiness to hold the present working of our monetary organization exclusively responsible for our present plight. And the same stabilizers who believed that nothing was wrong with the boom and that it might last indefinitely because prices did not rise, now believe that everything could be set right again if only we would use the weapons of monetary policy to prevent prices from falling.The same superficial view,which sees no other harmful effect of a credit expansion but the rise of the price level, now believes that our only difficulty is a fall in the price level, caused by credit contraction.

All eerily familiar. And:

We must not forget that, for the last six or eight years, monetary policy all over the world has followed the advice of the stabilizers. It is high time that their influence, which has already done harm enough, should be overthrown.

The truths set out by Hayek in that crucial essay – and in Prices and Production in the same PDF – are ever more relevant today. Yet, despite the evidence of the intervening 80 years, the Keynesians, and indeed the Monetarists, continue to peddle their interventionist policies and monetary statism. Their intellectual bankruptcy is plain but still institutions are regarded as august which hawk their poor ideas about money and bank credit.

The economic truths which Hayek set out in the 1930s are much neglected. It is high time that they were widely read by economists and businessmen and that the impoverishing ideas of Keynes which are now doing so much damage are laid to rest.

After so much economic turmoil, the traditional wish for a prosperous new year can be given with considerable vigour.

The 2010 Legatum Prosperity Index (PDF) – “the world’s only global assessment of wealth and wellbeing” – showed that entrepreneurship and opportunity are the primary keys to prosperity, that they correlate more closely to a nation’s overall prosperity than any other factor.

In particular, Legatum found that:

• Prosperity is found in entrepreneurial democracies that have strong social fabrics.
• Prosperity is a blend of wealth and happiness, but not as one might think.
• Global prosperity is changing in unexpected ways.

In 2010, the UK was 13th overall, behind Norway, Denmark, Finland, Australia, New Zealand, Sweden, Canada, Switzerland, Netherlands, the United States, Ireland and Iceland.

In 2011, we find ourselves again in 13th place behind the same countries but still ahead of, perhaps surprisingly, France, Germany and Austria. Taking the economy in isolation, we are well ahead of Ireland and Iceland at 21st, compared to 35th and 71st respectively. It looks like our overall rating is brought down by safety & security (23rd), the economy (21st) education (19th) and health (17th).

On entrepreneurship & opportunity, we are 4th in the world, according to Legatum, just above the USA.

It is true we face huge problems, not least of which are our financial institutions and Labour’s legacy of overspending, but we remain prosperous by international standards and, by the ranking which correlates most closely to overall prosperity, we are very well positioned.

For all our difficulties, there are reasons to be optimistic about prosperity in the UK in 2012 and beyond.

You can find and download the 2011 Legatum Prosperity Index rankings here.

Yesterday in Parliament, I chaired an event with Gordon Kerr, launching his report The Law of Opposites, which is covered in the Guardian today:

Banks use accounting loopholes to inflate their profits and bolster staff bonuses, according to a report published on Wednesday that calls for changes to the international accounting rules.

According to the paper by the Adam Smith Institute, banks are able to use complex financial products such as credit default swaps to report profits that they might not otherwise be able to.

via Banks use accounting loopholes to inflate profits and bolster bonuses | The Guardian. In related news, The Telegraph reports Watchdog’s verdict could put Sir Fred Goodwin in the dock.

As the Adam Smith Institute blogs:

The Adam Smith Institute report is structured around six shortcomings in the rules governing bank profit and capital reporting, which must be addressed:

• Uncertain future cashflows can be recognised as certain by purchasing a credit default swap (CDS) or similar “protection”, even though the supplier of the protection is likely to default if the insured event occurs;
• Profits can be recognised from the increased value of assets, or decreased value of liabilities, on the basis of a market price, even though the totality of revalued assets or liabilities could not be sold at that price;
• Profits can be recognised from the increased value of assets, or decreased value of liabilities, even when the revaluation of assets is estimated, not by market prices, but by a model built by bank employees. This is the so-called mark-to-model approach to valuation;
• The net present value of uncertain future cashflows can be recognised as profits even when they are estimated using implausibly optimistic forecasts. (This is a variation of the mark-to-model problem listed above);
• The EU’s IFRS accounting system, voluntarily adopted by UK and Irish banks at the banking company level, is inconsistent with UK law;
• Banks need not make provision for expected losses when calculating their profit.

The implications of all this are profound, not just for the solvency of banks, but for the justice of taxpayer bailouts and bank bonuses. I’m sure we have not heard the last of the flaws in IFRS and the problems it causes.

I spoke last night in the general debate on the economy, saying*:

As I rise to speak I am reminded of a quotation from an economist who was a fierce critic of Keynes, a chap called Henry Hazlitt, who said:

“Today is already the tomorrow which the bad economist yesterday urged us to ignore.”

We have heard today some moving accounts of individual and collective suffering in different regions of the country and among different sections of the public. We should be asking ourselves why, oh why, have we been delivered into this misery, which looks as if it will extend over years. Much of the conversation we have heard has been along the lines of aggregates, coarse economic aggregates, and has tended to stray away from individual choices and consequences. We have talked about markets in the abstract, and it is a pity that we seem to have forgotten that markets are a social phenomenon, and that they are about people co-operating. When we talk about markets, we tend to imagine overpaid people, high-frequency trading and those who add nothing to society.

I am reminded of something a constituent said to me recently after hearing a Minister’s speech. He asked, “Why is it that everything always seems to get harder for the working man, whoever is in power?” Indeed, in my constituency unemployment is up by 6.3% among the over-50s, up by 9.5% among those aged 25 to 49 and, scandalously, up by 23% among the young. We have heard that child poverty increased by 200,000 under the previous Government and that it is likely to increase by up to 100,000 under this Government. In the 21st century, that should not be our economic position.

Why are we in this debt crisis? I have just checked the M4 money supply figures—I am sorry to return to aggregates, but needs must. When Labour came to power the money supply was about £700 billion and it is now about £2.1 trillion, so it has tripled over the past 14 years. Unfortunately, most economists talk about money flowing into the economy as if it were water poured into a tank that found its own level immediately, but what if it is like treacle or honey? What if it builds up in piles when poured into the economy and takes a while to spread out? What if that money was loaned into existence in response to individual choices led by the excessively low interest rates pushed by the central bank? What if it was loaned into existence in particular sectors, such as the housing sector, where prices have more than doubled over the same period, and what if it was the financial sector that received the benefit of that new money first? Would that not explain why financiers and bankers are so much wealthier than everyone else, and why economic activity and wealth has been reorientated towards the south-east?

Unfortunately, the idea that money takes some time to move around the economy is lost on most economists, which I very much regret. Why did most economists not see the crisis coming? I put it to the House that it is because their theories of credit are mistaken. They make fundamental errors. Unfortunately I do not have time to go into that, but the fundamental point is that credit is a choice to consume more now and less later. It is about the exchange of present goods for future goods, and co-ordinating the economy through time, and I am afraid that the current intellectual mainstream in economics has dropped us into this desperate mess.

Opposition Members criticise the Thatcher and Reagan years. I think that there was much to applaud in those years, but unfortunately their intellectual underpinning was monetarism, which, like Keynesianism, is infected with those dreadful mistakes. People in the Occupy movement, and our constituents, are right to question the justice of our economic processes. The hon. Member for Penistone and Stocksbridge (Angela Smith) said earlier that the system cannot endure, and I am inclined to agree. I agree that the current debt-based and—I am afraid to say—statist system cannot endure. However, if this system is not to endure, which way should it fall? [Humanity] tried the statist direction in the past and it led to misery and murder. I stand for free markets and free co-operation, but I say this to the House: if this is capitalism, I am not a capitalist.

* (I have made a small correction to the quote and a clarification in [], both of which I have requested from Hansard)

Related reading can be found here:

• Hazlitt, Economics in One Lesson (buy, PDF), chapters 1, 6 and 23 in particular.
• Mises, Human Action (buy, online), especially chapter 20 “Interest, Credit Expansion, and the Trade Cycle”
• Hulsmann, The Ethics of Money Production (buy, PDF).

The Bank of England’s money supply measure M4, which I referred to, may be found here. I used M4 in this context because it is the conventional mainstream measure, but I prefer Kaleidic Economics’ MA for reasons explained on that site (Notes and Coins is too narrow and M4 too broad). MA tells a clear story of where jobs and growth came from and where they went – money supply growth created the illusion of prosperity, broke the banking system and collapsed, taking the illusion with it:

Year on year change in Kaleidic Economics' MA - click for source

Update: Video here. My delivery picked up after about the first minute.