The poster above, produced by the National Health Service, popped up in my Facebook feed recently. Just last week, a friend posted this
“Horrified by the ‘if it’s free why shouldn’t I take it’ attitude with regards to the minor ailments scheme. If everyone takes free plasters and calpol from the NHS then there is less money in the pot to pay nurses, treat brain tumours, strokes and dementia – ya know, the things that will kill you. Ultra liberal lefty that I am, I’m sick of seeing people grasping for freebies without thinking about the consequences. Here’s a good rule of thumb – if you’ve treated yourself to a packet of fags or a glass of wine this month, you can buy your own sodding calpol.”
One of the laws of economics is that, ceteris paribus, the lower the price of something the greater the demand for it will be, even if it might not be the demand the supplier intends to meet. If you offered me, for free, a DVD of Sheffield Wednesday winning the League Cup in 1991 I’d take it and enjoy smashing the thing. Several thousand Sheffield United fans, like me, would do the same.
But if I had to pay even 1p for the pleasure of smashing that DVD, I’d say ‘No thanks’. And the higher you raised that price the more people would say ‘No thanks’. At some price, even people who would actually want to watch the DVD would say ‘No thanks’. That’s how you get your downward sloping demand curve, shown below.
lt is doubtful that enough of something could be supplied to everyone with even the slightest demand for it. The resources that produce one thing cannot, after all, be used to produce another thing. Supply is constrained. What is needed is some way of matching these various states of demand with the actual supply – of making sure the League Cup final DVDs go to nostalgic Wednesday fans and not grumpy United fans like me. In a given period supply can be considered fixed, as represented by the vertical supply curve on the chart below.
If, on the chart below, we hold the price below the market clearing price, p1, where quantity demanded meets quantity supplied (the curves above cross – the NHS effectively holds the price of British healthcare at zero), the quantity demanded rises, from q1 to q2
Queuing is the most common answer. The person with severe chest pain in the NHS poster ought not to be in a queue, but with a price of healthcare set at effectively zero, that is exactly where he will be. Alternatively you can try and rely on people to ration themselves, as the the NHS and my friend are trying to encourage. And maybe it will work.
The essential point is that in a world of limited means with competing ends scarcity is real and cannot be wished or voted away. The laws of economics are a little more stubborn than that.
Below is something I wrote for a now defunct website in July 2011. There’s finessing I’d add here and there if I wrote it now, but its exhumation seemed timely.
Greek town squares and streets have erupted in violence. A Socialist government has incurred the wrath of the left by forcing through a package of fiscal retrenchment which would have made Margaret Thatcher blush. Greek interest rates are skyrocketing yet borrowing still grows. Even so, many commentators from both right and left doubt it will be enough. Greece will almost certainly default on its debt. It’s a good bet that it may even be forced to leave the euro.
How did we reach this state? What will happen next?
The project for European integration has always been steeped in unreality. One of the great political trends of the last 200 or so years has been nationalism, the breaking down of people into political units with shared characteristics of language, history and culture. This has been seen on bloody fields from Lombardy to Rwanda. The lesson of the First World War was that the other great trend, the basing of society on class lines à la Marx, was a dud. A Sheffield steelworker would rather shoot his fellow proletarian from Essen than his capitalist boss.
The mission to integrate Europe politically runs counter to this. For a combination of reasons ranging from the noble through the potty to the plain sinister the ‘European project’ has always been an exercise in denial, in seeking to bend what is into what its makers would like. The creation of the euro, the single currency, viewed as another step on the road to the “ever closer union” the projects’ leaders alone seem to desire, was born in this atmosphere of denial.
Back in 1961 the Nobel Prize winning economist Robert Mundell wrote “A Theory of Optimum Currency Areas” a paper in which he analysed the characteristics an area must have to be suitable for a single currency. Mundell put forward five criteria; labour mobility across the region, capital mobility across the region, price and wage flexibility across the region, similar business cycles across the region and a risk sharing mechanism across the region.
The euro zone clearly has a high degree of capital mobility though in the globalised world it is not much easier to shift funds between London and Rome as it is London and Hong Kong. In theory the EU should have almost perfect labour mobility so that unemployed people in a depressed area can move to a booming area and the profusion of ‘Polski Skleps’ around the country suggests this is true. But in fact, when compared to another currency area, the United States with the dollar, linguistic and cultural factors are far more of an obstacle in a move from Madrid to Copenhagen than they are from Minneapolis to Seattle. Labour mobility in the EU is far lower than in the US as demonstrated by the shortage of unemployed Greeks and Irish decamping to booming Berlin.
The euro zone scores even worse on the other measures. On price and wage flexibility the euro zone has one of the most rigid labour markets on the planet and the apparent synchronisation of business cycles prior to its launch in 1999 was aided by more than a little creative accounting which the project’s leaders, ever averse to reality, turned their blind eye to.
It is the fifth criteria however, the risk sharing mechanism, or lack of, which is of central importance now. By risk sharing mechanism we mean a way by which, in downturns, fiscal resources can be redistributed from better off areas to less well off areas. This can mean welfare payments to or government projects in depressed areas. In the current set up it has meant a chaotic series of bailouts.
So the theory goes that a single currency means a single central bank and a single central bank means a single government. Simply put, the area covered by the body with the fiscal authority, the government, has to match the area covered by the monetary authority, the new European Central Bank. But though, in the European Union (née European Coal and Steel Community, European Economic Community, European Community), Europe had a political structure which, with only occasional consultation of its subject peoples had, like Topsy, “just growed”, it still didn’t have the necessary fiscal authority to match the monetary authority of the ECB.
The Germans, for whom the old deutschmark run by the Bundesbank has worked so well, were worried by this. They were concerned that countries with less creditworthy borrowing histories, like Greece which has been in default for large chunks of its history, would use the new interest rates, held low by the German reputation for good financial behaviour, to go on a borrowing binge and demand a German bailout when it all went wrong. So the Germans got the Stability & Growth Pact which limited the borrowing of euro members to 3% of GDP. But the still fiscally autonomous Greeks ignored the pact, lied about the figures, and borrowed like mad anyway. And why not? When Germany and France broke the Stability & Growth Pact rules in 2003 neither were fined.
The Irish situation was slightly different. When it gave up some of the independence it had fought Britain for so long for and joined the euro its economy was booming, it needed higher interest rates to cool the boom. However, Germany was in a prolonged period of economic stagnation and needed low interest rates to get a boom boiling. There was no question of the tiny Irish tail wagging the ECB dog and, obeying its German paymasters, it kept euro interest rates low. This was great for Germany but in Ireland, already doing well, this flood of cheap credit stoked a wild property boom. Irish banks borrowed, lent to people to buy houses, and then collapsed when people realised that County Leitrim didn’t need three houses for every resident. The property investments of banks were worthless overnight.
But Ireland’s politicians, a particularly craven bunch, moved to save Ireland’s bloated banks by extending a taxpayer guarantee not only to all depositors, as the British government did, but also, staggeringly, to all holders of the bonds of Irish banks. In other words, the Irish people would be made liable for loans taken out by Irish banks, often from other eurozone banks, to lend on to the Irish people. The cost of this insanity was staggering; about €100,000 for everyone in Ireland. Ireland’s deficit soared above its Stability & Growth Pact limit and, like Greece, drastic fiscal consolidation followed.
So where do we go from here? It is clear that one of the major flaws of the euro, baked in from inception, was the attempt to create a central monetary authority without a central fiscal authority. In the current crisis this has changed. Many of the spending cuts and tax rises which have driven Greeks to riot and Irishmen to grumble more loudly than usual into their Guinness were forced upon them as much by European bodies trying to protect the euro as by lenders concerned about their increasingly apparent status as basket cases. So one possible outcome is that this will continue; we will see the upward evolution of fiscal power to a European body to match the monetary power the ECB already has.
But there is another possibility, one which a growing number of observers predict. The fiscal retrenchment in Greece, Portugal or Ireland could be so unpopular that no government can enact it. In that case the country would default on its debts (or write down or reschedule which amounts to the same thing) and it would be difficult to see how it could continue in the euro zone. In this case, with the country exiting the euro zone, we would see the other possible outcome; the downward devolution of monetary power to a national body to match the fiscal power the national government already has. In other words, the break-up of the euro.
Which of these is more likely? Economics dictates the break-up of the euro which would more likely mean its retreat to the core of ECSC countries. Euro bailouts are at ever higher interest rates. Economic growth when it is positive at all is sluggish and if the rate of interest is higher than the rate of growth you will see the debt burden grow ever heavier. But as we’ve seen the European project is about the active denial of realities. Adam Smith once observed that there is a “great deal of ruin in a nation” and there may be even more ruin in a supra national entity like the EU. But, as the Soviet Union eventually found, the laws of economics have a way of being enforced with the doggedness of Inspector Javert and the merciless brutality of Dirty Harry. Bet on them being enforced again.