Picking Losers

Another calamitous consequence of Callamity's time at Ofgem

There is much talk in energy circles of the "capacity gap" - the shortfall between operating capacity and demand that may arise as a result of the imminent closure (mostly within 6 years) of many of our coal-fired and nuclear power stations.

Competitive markets don't work that way. If there is a good with highly inelastic demand, and supplies of that good are expected with reasonable confidence to run short in the future, investors will step in to produce more of the good. Why wouldn't that be happening (as much as required) within the electricity industry?

Some might like to blame it on a gap between the cost of new plant and the price that customers are willing to pay. But demand is pretty inelastic, remember. You can be fairly confident that an unregulated price would rise to the level that was needed to satisfy demand.

The VILE companies like to blame it on the projected increased capacity of intermittent power (like wind and wave) and the absence of a capacity payment to accompany it. A capacity payment is a charge paid to generators simply for having their capacity available, whether or not it is used. It provided nice bunce for the big two generators in the days of the Pool, and they'd like some more. And it's true that, if we have substantially increased capacity of intermittent power, let alone if we try to use more electricity for heat (with its strong seasonality), then dispatchable generation plant will be called more intermittently to balance supply and demand. If the plant runs fewer hours, it will be unable to recover its costs at current prices. A capacity payment would be one way of dealing with that, but it is a bad one (favoured by the lazy VILEs, who like money for doing nothing). A better way would be to allow peak and balancing prices to increase to allow the generators to recover their costs over the shorter operating hours, and provide an incentive on the demand side for consumers to try to reduce their peak demand (if they were exposed to prices that reflected variation in supply and demand through the day).

But the real reason is that we do not have a liquid traded market for electricity. You cannot get forward prices for electricity beyond about 3 years. For gas, you can go beyond 10 years. And volumes in the traded market are tiny. That means that it is very difficult for an independent generator to build a power-station to fill the gap. He won't have a liquid market to sell into, and he can't mitigate his risk by contracting (or at least seeing and hedging) forward prices.

That leaves it to the VILE companies to fill the gap, and they can use their dominance and reluctance to build sufficient new capacity (on whatever pretext) to pressure the regulator for things they want, like capacity payments, which will further embed their dominance.

So we may have blackouts within 6 years (although this is probably brinksmanship and the gap will be filled in the end). And all because Callamity chose to allow vertical-integration and destroy any prospect of a competitive, liquid traded market. However difficult, and however much they scream, we have to reverse this process, not only for the sake of a competitive energy market, but to reduce the power of the big corporations to steer policy to their advantage. Disintegrate the VILE companies.

Are the Tories spending or saving?

On the front page of today's FT is the headline: "Osborne warns of big spending cuts to come".

But in a speech yesterday, he announced 10 measures that should be implemented in the Budget to "kickstart a green recovery". Just his first measure alone - £6,500 energy-efficiency entitlement voucher for every home in Britain - would cost (given that there are around 25 million homes in Britain) over £160 billion. Others of the 10 announced measures would also cost billions of pounds.

That will help reduce the government deficit. Frown

But according to George, the measures will "only" cost £30 billion, "without adding a penny to the national debt".

Three questions:

What Callamity did next

I should have known better than to think that politicians and civil servants would have learnt from Callamity's disastrous tenures at Ofgem and the FSA.

In fact, he stepped straight from the FSA into a job as a Non-Exec member of the Treasury Board. Naturally, this position was obtained in the face of stiff competition and careful assessment, and had nothing to do with "jobs for the boys".

Nick Macpherson, Treasury Permanent Secretary and Chair of the Treasury Board was excited but trepidatious about his new member's fearsome reputation for holding to rigorous account the organisations that he supervises:

"I am delighted to welcome Deirdre, Callum and Michael to the Board. They bring extensive experience to supporting and challenging the Board’s work and I look forward to working with them".

Just the sort of "challenge" that a civil servant likes, I should imagine.

Starting this new role at the ripe age of 64, Callamity's public-sector pension must be looking better by the minute.

Callamity, Part II

Great timing. I blogged last night about the mind-boggling incompetence of Sir Callamity McCarthy. I wake up this morning, and what does the FT have on its front page, but an indictment of the behaviour of the FSA during Callamity's reign.

A whistleblower has written to Vince Cable, exposing the pathetic inactivity of the FSA from 2005. Remember, Callamity took over at the FSA in September 2003.

The whistleblower reports, says the FT, that "thematic reviews of mortgage books sold by wholesale lenders to building societies... had unearthed incontrovertible proof that societies had been paying big prices for what were ostensibly the safest residential mortgages but were in fact risky self-certification loans... FSA management turned a blind eye."

I wonder what sort of pension Callamity is on?

Sir Callamity McCarthy - a real villain of the depression

Photo of Callum McCarthyFingers have been pointed in the direction of many different culprits for the critical condition of our economy. I am surprised that they have not been pointed more frequently at Sir Callum McCarthy. We don't need to swab him for gunshot residue; he is spattered in blood, holding a smoking gun.

Two things in particular have made life particularly difficult for people in the past 18 months: energy prices that shot up as world prices went up and then failed to come down at the same rate, and unavailability of credit because of the failure of our financial systems. Of course, Callamity was not totally responsible for either. But he was at the scene of the crime with blood on his hands for both.

The speed at which energy prices rise and sloth with which they fall is a sign of an uncompetitive market. So is massive profit-expansion when costs are rising.

There is a reason why our energy markets are uncompetitive. When electricity was privatised, the Conservative government deliberately separated the generation businesses from the supply and distribution businesses (the Regional Electricity Companies, or RECs). It was essential to creating a liquid trading market for electricity. If suppliers generate most of their own electricity, only marginal production is traded in the markets. That leaves independent generators selling at a disadvantage, when their customers are also their competitors. And the same goes for independent suppliers, who must buy electricity from their competitors.

Early regulators under the Conservative government recognised this, and protected this separation against pressure from the industry, who would like nothing more than to get back to their cozy, lazy, nationalised ways. But from 1998, the regulator began to allow acquisitions that created combined supply, generation and distribution businesses. By 2004, none of the RECs remained independent. All had been subsumed within one or other of the Big Six - the Vertically-Integrated Large Energy (VILE) companies.

In September 1998, Clare Spottiswoode and Stephen Littlechild stood down from their jobs as regulators of (respectively) gas and electricity. Callamity took over, first at Ofgas, and then at the merged regulator of gas and electricity, Ofgem. The extent of his responsibility (and ego) can be seen in the fact that, from 2000, he was acting as both Chairman and Chief Executive of Ofgem.

Efficiencies drive down costs. Competition drives down prices. The mergers allowed by McCarthy destroyed competition. Little wonder that, by 2003, the National Audit Office (under Sir John Bourne) was reporting that the market changes enacted under Labour (many of them improvements on the original design from privatisation) had driven down wholesale prices, but had had much less effect on retail prices. Through his naivety, Callamity undid the benefits of the market improvements, and created the uncompetitive oligopoly from which we suffer.

Repeated attempts since then by the regulator, the competition authorities and the government to identify collusion between the Big Six have failed, because the problem is not underhand behaviour, but the market-power provided by their vertical-integration, which allows them to lock out competitors and maintain juicy profits, without having to literally sit down in a room and parcel out the market between them. It is obvious there is a problem, but no one dares acknowledge that the only solution is to reverse McCarthy's mistake: disintegrate the VILE companies.

In September 2003, Callamity left Ofgem and became Chairman of the Financial Services Authority (FSA). What happened next is common knowledge. The financial services industry engaged increasingly in imprudent activities, prompted by various government measures, and unconstrained by any regulatory action, even as they moved more and more risk off-balance-sheet. An excellent analysis of the development of the problems - "How Not to Solve a Crisis" has been produced by Bill Stacey of the Lion Rock Institute and Julian Morris of the International Policy Network. When eventually the economy could no longer stand all the systemic imbalances that had been allowed to develop, the necessary correction revealed the extent to which Callamity had allowed short-termism and corporate interests in another industry to take priority over good governance.

Callamity's story gives the lie to Gordon's claim that Britain is a victim of global forces and American failings. Britain led the race to the bottom of regulatory supervision. What does Gordon think drove the American government to repeal Glass-Steagall, other than the inability of Wall Street to compete with the lax conditions in the City of London? Wall Street's shackles having been thus loosened in 1999, it would take a regulator of quite stupendous incompetence and lassitude to keep the City ahead in the race. In Callamity, Gordon had just the man for the job. No wonder Callamity had to be quietly shuffled out of his role, as the consequences of his reign became clearer. His continued presence would be a clearer reminder than Sir Fred Goodwin's pension of who is really to blame for our woes.

In another era, Callamity would have been left in a room with a whisky and a loaded pistol. Earlier still, his neck would be on the block. We ought to find some similar punishment for him. But what do you want to bet, if politicians are now sensible enough to keep him away from any further public-sector work, that Callamity can look forward to some well-remunerated Non-Exec positions from his corporate friends? Or would even they be too embarrassed to be seen around him?

More evidence that it's terminal for Labour

Denial, anger, bargaining, depression, and then...

Polly Toynbee, discussing Labour's and Gordon's failings on Newsnight tonight, was unusually reasonable and realistic. Has she reached the acceptance stage of dealing with Labour's terminal condition?

If you missed it, it's on iplayer, from 40:40 in. Fraser Nelson's final punch is brutal.

Government auctions - good or bad?

I have been having a debate with Paul Lockett on Tim Worstall's site, which I have found very interesting and illuminating. The topic was the TPA's green-tax-calculator, and what it said about costs of carbon in this country. I claimed that one thing it showed was that road-use is overcharged and domestic heating is undercharged. Paul gave some very interesting reasons, which I hadn't considered before, why road-use is not as overcharged as I (and I suspect many others) tend to think.

He has certainly persuaded me of his basic point, which (if I have understood it correctly) is that the crude comparison that many of us make between costs of construction and maintenance of roads on the one hand, and revenue from vehicle excise and fuel duty on the other, cannot be taken as a rough indicator of the extent of overcharging (whether for "green-ness" or any other attribution), because there is an element of charging for the use of a scarce resource (road-space) within that balance. As you can see from the exchanges on Tim's site, I still think that there are reasons to believe that the government is charging us more than a market price for use of the roads, but I guess we won't know unless we actually move to full road-use pricing. In my opinion (and this is something I didn't put into the debate, because I am happy to accept the concept, if not the reality of road-use charging), the transaction costs and civil-liberties implications of road-use charging exceed the economic benefits of more accurately tailoring charges to supply and demand, so in a sense, I hope we never find out whether we are being over- or under-charged. But it is an interesting thought experiment.

Anyway, I expanded the debate into a question of the merits (or otherwise) of government auctions, on the basis that the question of whether there was a high initial capital value in a road-use charging system would depend on whether the market created by the government was truly competitive or embedded monopoly privileges. I (unwisely) cited the 3G auction as an example of a bad government auction of monopoly rights. Paul observed:

"I find this comment extremely odd. What else would you propose to do to allocate the use of spectrum, which is a scarce resource? The government hasn’t created a system where competition is limited in the case of spectrum, it is inherently limited."

To which I replied:

"I agree with your distinction between natural scarcity and artificially-enhanced scarcity. This wasn’t the best example for me to pick. I should have used the example of the Non-Fossil Fuel Obligation, which was the first case where I became aware of this problem, but it’s rather obscure. In the case of NFFO, government created artificial scarcities of unknown quanta for a dutch auction. Their monopoly position was so effective that they drove prices down strongly. The problem was that it was so effective and people were thus so desperate to win one of the unknown number of contracts that would be let for their technology, that the optimists bid down the price below where most projects were viable and many realists were shut out. NFFO ended up being a tremendously successful way of driving the price down to a level at which it prevented development of the thing it was supposed to encourage.

The 3G auction nearly had the same effect, delaying roll-out, and nearly bankrupting some of the winning optimists and shutting out some of the realists. But in this case, the water is muddied because the scarcity, as you say, is genuine. Someone would have taken the profits from the excess of demand over supply, and who better than the government on our behalf? All the same, I would have structured it in a different way, separating the natural-monopoly infrastructure-provision part from the service-provision part more clearly (analagous to the structure of the electricity industry in that brief halcyon period after supply and distribution had been split but before Sir Callamity McCarthy* allowed the competitive market to be undone by vertical-integration), and creating a more flexible market for accessing the infrastructure. This would have maintained the competitive threat from new entrants and removed the need for regulation of this part of the business, with tighter but limited regulation (of compliance with the rules, not of prices) over the natural-monopoly part. Having the revenue from sale of bandwidth-rights come in to the infrastructure-provider rather than the government in the first place would make the provision of that infrastructure well-funded and relatively low-risk, which would have helped to get the systems built, rather than being delayed by cash being sucked out of the system by the government maximising its revenue at auction. The risk and benefits could be further shared with society, by government-underwriting of minimum returns for the infrastructure-provider (highly unlikely ever to be needed), and provision for a proportion of profits above the minimum returns to go to the Treasury. This would have kept the cost of money as low as possible, getting the systems built, maintained and expanded as quickly and cheaply as possible.

You may say that if idiots want to overbid (or under-bid in a dutch auction), that is their lookout, it is the market working as intended, and not a sign of a bad mechanism. But we see it time and time again where government is letting contracts for monopoly positions. We have seen it in many public-sector construction projects, where standard practice is to bid a non-viable price in order to win the contract, and then hope to claw it back by renegotiation once the project is under way and the government is frightened to let it fail or be further delayed. That is the real reason why so many of these projects go over-budget and over-time - they were never going to come in on-budget and on-time. The amazing thing is that some occasionally do, not that so many don’t.

The incentives in government-auctioning are to drive honest men out of the market and encourage the crooks. It also tends to inflate ultimate costs, because it is more expensive to put right something done badly than to get it right in the first place. The government is in a unique position, and should try as hard as possible to design mechanisms that ameliorate this impact, even at the expense of reducing the amount of revenue raised. But of course, the public-choice incentives for the government strongly encourage the opposite behaviour."

I have created this post, partly because it is a topic on which I have strong negative experiences (in NFFO) that I wanted to highlight, partly because I don't feel that I have properly explored the alternatives and whether they are any better, and partly so that, if the debate on this subject were to continue, it wouldn't have to divert the debate on road-use charging on Tim's site.

* I was going to explain in a note who Sir Callum McCarthy is, but the incompetent, lackadaisical, credulous fool deserves a post all of his own.

Carbon tax petition

Nick Monether of Greenfields Consulting has launched a petition on the No.10 website, to press the Prime Minister "to Adopt a Carbon Tax ratified and harmonised with the EU and the G20".

As the petition explains:

"The tax payer and/or energy consumer is currently paying to subsidise low carbon technology through a variety of levies and subsidies that share no common price for their efficacy in reducing carbon (or C equivalent) emissions. A well designed tax on carbon emissions, in concert with internationally agreed application methodology, would deliver huge cost and carbon savings to society, with parity and without excessive and costly bureaucracy. We the undersigned urge Government to press to replace costly local, regional and national policies with a global approach that reflects the unity achieved in the removal of CFC emitting products."


There are many details not covered in this petition, but that is the nature of an online petition. I understand that Nick wanted to add a detail that I suggested (to address many people's fears with regard to the impact on "fuel poverty"), but the system wouldn't let him.

Fundamentally, carbon tax is the best way to internalize carbon externalities, and showing support for the principle is important. If you would like to see our myriad nit-picking, micro-managing, counter-productive, bureaucratic, supposedly-green interventions replaced with one simple mechanism that applies equally to all carbon emissions regardless of source, then sign up to this petition now.

Dollar or Euro votes?

Noticed this poster at a tube station today:

EU elections 09 poster: biofuels

My immediate thought was: none of your bloody business.

(After a moment's additional thought, perhaps I should moderate that to: none of your bloody business between the two on the right, and between all three if you internalize carbon externalities with a mechanism more rational than the EU-ETS.)

It turns out that this is part of a series. The others are shown below.

EUobserver points out that these exaggerate the powers of the European parliament. Typical euro-deception. But would it be better if they didn't?

Is this the Euro equivalent of a dollar vote? In free markets, how much gets produced of which goods is determined by the dollars (or other currency) that customers spend (vote) on the products.

In the EU, it seems, how much gets produced of which goods is determined by the political trade-offs between politicians returned as a result of an election on multiple issues.

In a free market, we will gradually discover what works in which circumstances, and are free to have horses for courses, and to change the balance in response to changing market information.

In the EU, the parties who form the ruling coalition (and their electors) are assumed to have 20:20 foresight, deciding what immature technologies will be best for all of us, and imposing them on us by legislation, with all the associated responsiveness and flexibility.

It tells you something about the mindset of the Eurocrats and politicians that they think this is the job of the European parliament, and that the suggestion that they have this power will attract people to the project.

If this is a Euro vote, I don't want it, and I don't want other people to have it either. I want us to cast dollar votes for economic choices. Political votes are to decide those rules that we need for effective cooperation, on questions that cannot be decided more efficiently by dollar votes.

EU elections 09 poster: energy   EU elections 09 poster: packaging  EU elections 09 poster: work/life balance

Is this the dumbest economic argument in the world?

What is market value other than "the community's valuation of the external costs and benefits of the activity"?

External costs and benefits are, by definition, costs and benefits that are external to the market value. If they were within the market value, they would have been internalized, and therefore not be externalities.

So the answer to this rhetorical question is: exactly not that. Or perhaps more precisely: don't talk bollocks.

This guy (Mark Wadsworth) is a free-marketeer, so I am embarrassed to see him displaying such fundamental lack of economics, or even basic logic. But it's typical of the crowd that support Land-Value Taxation.

He must work in financial services.

More political funding from Gordon's Investment Bank

It is not clear how these projects meet the EIB's objectives, but very clear how they meet the Government's political objectives. How much money is being laundered through the EIB to bail out the Government's favourite projects and corporate friends?

It seems I am not the first to notice that the EIB is being used primarily to bail out projects favoured by its shareholder-governments, most of which have little relevance to the supposed objectives of the bank. See CounterBalance and CorporateWatch.

Gordon's Investment Bank

The European Investment Bank (EIB) "has 6 priority objectives for its lending activity":

  • Cohesion and Convergence
  • Support for small and medium-sized enterprises (SMEs)
  • Environmental sustainability
  • Implementation of the Innovation 2010 Initiative (i2i)
  • Development of Trans-European Networks of transport and energy (TENs)
  • Sustainable, competitive and secure energy

Our company (an SME in renewables) recently approached them about funding for a project in a remote part of Scotland to produce sustainable heat and power (including district heating to social housing), and sustainable heating fuel to be distributed from the local port (which needs the business since the decline of the fishing industry) to parts of the UK where resources for sustainable heating are scarcer. This ticks most of the above boxes, but we were told by the EIB that the project is too small. They have a "priority objective" to support SMEs, but a project costing tens of millions of pounds is too small? How big are these SMEs that they hope to support?

Still, no one is guaranteed finance, and perhaps the EIB have more suitable projects elsewhere. Happily, there have been a spate of announcements recently on projects that have received or are in the running for funding from the EIB, so we can see how they are meeting their objectives:

A delightful list of innovative projects by SMEs, promoting cohesion, convergence, sustainability, competitiveness and security in the transport and energy sectors.

The Socialist Utopia

From the English Eclectic blog of Paul Halsall, a socialist historian, in somewhat self-deluding response to Iain Dale's suggestion that we might have to cut public spending:

'I would expect that within less than 10 years we will have the computing ability to make effective economic planning possible and ditch the drang und sturm of imaginary "rational markets."'

Right-to-Move-Out, not Right-to-Move

ConservativeHome's ToryDiary reports on a Right-to-Move policy to be announced tomorrow by Grant Shapps. Under this scheme, "good social tenants can demand that their social landlord sell their current property and use the proceeds, minus transaction costs, to buy another property of their choice – anywhere in England.  The new home will remain a state-owned property but will aid mobility."

The policy was developed by Tim Leunig (of the LSE) for Policy Exchange. Tim has some interesting ideas, but he is stronger on transport (which I understand is his speciality) than housing and planning issues. It was Tim, for example, who was partially responsible for the Policy Exchange paper suggesting that we should stop resisting London's economic gravitational force, allowing some northern cities to die and developing more cities in the south (as though it is the job of a central-planning office to decide this sort of movement). And it was Tim who came up with the scheme to deliver cheap social-housing by getting landholders to sell land cheap to councils who would then grant themselves planning permission and sell the land to developers at a large profit.

This latest idea exceeds Tim's usual daftness when he ventures away from transport. As I posted in the comments at ToryDiary:

Right-to-buy was about moving people from the public sector to the private sector.

Right-to-move is about keeping people in the public sector, but trying to pretend that the public sector can be made to offer similar flexibility and freedoms to the market.

I'd rather social-housing was as inflexible as possible, to give people the incentives to get out of it. It should be a minimal safety-net, not a public service.

Better still, change the welfare system to a Basic Income (BI) including an allowance for minimal rent, place an obligation on councils to provide housing to minimal standards at costs linked to the BI to people falling into tightly-controlled eligibility criteria (with costs recovered from local taxation), and leave it to people and markets to choose what to do about their accommodation.

Typical Cameroon/Policy Exchange idea. It has little in common, other than the name, with Right-to-buy. Tim, you're much better at transport; I'd stick to that, if I were you.

"Falling emissions in declining economy" shock!

Preliminary data released today (as reported in EurActiv, and picked up by OpenEurope) indicates that emissions from the sectors covered by the EU-ETS fell 6% in 2008.

Naturally, the pro-EU-ETS brigade have hailed this as evidence that the EU-ETS is working. I think they should be a little more cautious.

We need to know to what extent the reduction was the result of the economic downturn, to what extent it was the result of increased energy prices, and to what extent it was the result of the incentives provided by the EU-ETS.

The data is not yet available for the purposes of comparison, but there will be an easy way to test the effect of the EU-ETS, if not the relative roles of the other two factors (and there are probably others).

If we see emissions carry on up in those developed countries not covered by a cap-and-trade scheme while they fell in the EU, it will be reasonable to attribute some of the success to the EU-ETS. If, on the other hand, emissions fell in 2008 in countries that were not subject to a cap-and-trade scheme, we may reasonably infer that the fall was more the result of other factors such as economic tightening and higher prices, and less to do with the EU-ETS.

We also ought to look at emissions relative to indicators of economic health, not in abstract form. Most economic indicators of national prosperity are unsatisfactory in one way or another, but if we take GDP as an imperfect but widely-accepted measure, we should compare the change in emissions relative to changes in GDP in the different areas, not simply the absolute changes in emissions.

We should probably also take account of changes in population, as each additional head in developed countries tends to increase emissions by the per capita average.

Another give-away would be if the reduction over the course of a Phase of the EU-ETS were more than required by the mechanism. The mechanism is designed only to deliver just enough, and provides absolutely no incentive to go further, so if we see emissions fall to well below the cap, we will know that something else (e.g. economic decline or offshoring of industry) was up.

And we ought to remember that one swallow does not make a summer. We would need sustained evidence over several years that industries covered by the EU-ETS were reducing their emissions relative to their output by more than industries outside the EU-ETS (or other cap-and-trade schemes), to be able to attribute the reductions to the EU-ETS rather than to other factors. 

The preliminary figures for 2008 emissions strongly suggest that the price of EUAs (allowances under the EU-ETS) should fall further than their already low level (at which many large companies are already saying that there is insufficient incentive to invest in emissions-reducing technologies). With a minimal carbon-price, delivering further emissions-reductions over the coming years, other than as a result of a general reduction in output due to the state of the economy and the cost of energy, will be a challenge.

Scrappage and broken windows

Henry Hazlitt, in his marvellous Economics in One Lesson, cites Frederic Bastiat's exposition of the broken window fallacy. The fallacy is that vandals breaking a shopkeeper's window have benefited the economy, because the glazier will get work and money that he otherwise would not have got, and he will spend that money on goods that also would not have been sold if he had not had this piece of business, and the producers of these goods will likewise spend their money, etc...

What those taken in by this fallacy have failed to notice, observe Bastiat and Hazlitt, is that the shopkeeper is now as much down for the cost of replacing the window as the glazier is up. The money that the shopkeeper spent on the window would otherwise have been spent on other goods (for instance, a suit), whose producers are also therefore disadvantaged by this outcome, and will therefore have less money to spend on other goods, etc...

At one step removed, there are as many losers as winners. But the shopkeeper himself is worse off, because after the vandalism and expenditure he simply has a new window, whereas without the vandalism, he would have had a perfectly serviceable window, and a new suit.

As Hazlitt points out, "the broken-window fallacy, under a hundred disguises, is the most persistent in the history of economics. It is more rampant now than at any time in the past. It is solemnly reaffirmed every day by great captains of industry, by chambers of commerce, by labour union leaders, by editorial writers and newspaper columnists and radio and television commentators, by learned statisticians using the most refined techniques, by professors of economics in our best universities. In their various ways they all dilate upon the advantages of destruction."

Hazlitt was writing in the 1940s, but the observation is more true now than ever.

Usually, the fallacy is quite well-disguised. But we have a blatant example being promoted at the moment: the idea of a car scrappage scheme to pay people to scrap their old cars and buy new. This is not just vandalism, but state-sponsored vandalism.

Would it have reduced the economic harm done by the vandal if the replacement window had been paid for by the shopkeeper's insurers rather than by him directly? No. In fact, the need to put money aside in advance to cover the risk that this might happen has caused the shopkeeper not to spend money on goods that otherwise would have been bought for many years before the incident. Insurance premiums, whether paid in advance or recovered through increases subsequently, and whether paid solely by the shopkeeper (e.g. if he has paid more in premiums than he claims, or if he loses a no-claims bonus) or spread across all the clients of the insurer, are an economic cost necessarily heavier (because of the operating costs of the insurer and the time-difference between provision and claim) than the value of the work to the glazier. Insurance would have increased the economic cost, not reduced it.

The fact that the costs of scrappage are spread amongst all taxpayers is equally irrelevant to the question of the economic cost of the scheme. The additional money that we all pay in tax, so that the Government can encourage people to scrap cars that were sufficiently serviceable that their owners otherwise wouldn't have scrapped them, is money that will not be spent on goods which we value and which the producers would be as keen to sell as the car producers are keen to sell their cars.

Would it have reduced the economic harm if the shopkeeper had replaced his window with an improved model - perhaps one that showed his products better, or that reduced his energy bills? Reduced the harm, yes, but not eliminated it. If the shopkeeper valued the improved window as much as the suit, he could have bought the window anyway without being forced to do so by the vandal. The fact that he was planning to buy the suit tells us that he felt he was getting more benefit from a new suit than from a new window. Making the best of a bad deal does not mean that the deal is not bad, nor that the shopkeeper was as happy to make a virtue of necessity as to spend his money how he preferred.

So it is with the benefits of the scrappage scheme - to the environment and to the participant in the scheme (who has an improved car). There are many things we can do to improve the environment, and many ways to spend our money to that end. A new car is not necessarily the best way of pursuing this objective. If the person with the old car also lives in a home with poor insulation and glazing and an ancient, inefficient boiler, they might have got more bang for their buck (both environmentally and in terms of their quality of life) from improving those other features and hanging on to their old car. The scrappage scheme will have created an incentive to spend money in a way that would disadvantage the supposed beneficiary, the producers of the unsold domestic goods, and the environment, in order to put off temporarily the necessary adjustment to a more economically-sustainable level of production in one particular (and not particularly green) industry.

The scrappage idea can seem quite attractive and relatively painless, at first sight. But it is, in reality, hopelessly and irredeemably wrong. We wait to see whether Chancellor Darling can resist the siren calls, or whether he follows the rest of Europe down this blind alley in his forthcoming budget.

The 14th century solution to moral hazard

Just looking something up in Peter Spufford's Money and its Use in Medieval Europe. Came across the following passage, which seems to have relevance to the modern day:

In Barcelona, from 1300, book entries by credit transfer legally ranked equally with original deposits among the liabilities of bankers. Those who failed were forbidden ever to keep a bank again, and were to be detained on bread and water until all the account-holders were satisfied in full. In 1321 the legislation there was greatly increased in severity. Bankers who failed and did not settle up in full within a year were to be beheaded and their property sold for the satisfaction of their account-holders. This was actually enforced. Francesch Castello was beheaded in front of his bank in 1360.

Nowadays, we don't even sack them, we seek their voluntary agreement to leave the failed institution, and pay them hundreds of thousands of pounds a year to do so. I think they had it right in the 14th century, don't you?