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The last couple of days have seen several commentators raise fundamental questions about the role and optimal size of the financial sector. Free Exchange very helpfully links to three pieces, including one discussing the extraordinary statements (given their provenance) by Lord Turner, chairman of the British FSA. Turner suggests that a lot of what the City does is socially useless, and that finance has gotten too large.

There are lots of issues to be discussed here, so let me just pick up on one for now. That is the argument that the UK (and arguably other Anglo-Saxon economies) is suffering from a form of Dutch Disease, with an expanding financial sector sucking in too many resources, and depriving other sectors of much-needed inputs.

A standard thing to say about the Dutch Disease is that it isn’t a disease at all. If workers flock into the booming sector (say natural gas) because of higher wages, that is efficient, since those higher wages reflect higher productivity in the booming sector. (The higher productivity is due not just to the physical productivity of the workers in that sector, but to the price of the sector’s output.)

The term ‘Dutch Disease’ is thus a misnomer.

On the other hand, you can clearly argue that high wages and bonuses in the City have reflected bubble conditions, and the relative prices guiding resource allocation have thus been ‘wrong’. There is therefore a much better case for regarding financial services expansion as a ‘disease’, and for government intervention of some sort to reduce the consequent misallocation of resources.

So: can anyone think of a nice alliterative label to replace ‘Dutch Disease’?

(Text slightly amended as previous text referred to a comment now dated)
Apologies for starting a distracting thread. This blog is unmoderated for very good reason, namely that people have busy jobs. I suggest a couple of rules:

1. No personal insults

2. No direct unsubstantiated accusations

3. Use some sort of unique signature. Not necessarily an identifier. Most of the people who comment here have a clearly identified signature whether anonymous or not. There seems to be disagreement on whether this is necessary. To me it would avoid a lot of potential confusion.

Michael Hennigan continues the debate on research funding in today’s Irish Times.

Research funding is good, but so are decent primary schools, a decent health service, and many other things. From what we read in the papers, it seems likely that the state is going to cut social welfare payments this winter. Against that background, vested interests seeking state money need to carefully justify their demands for public funding. If the argument people are making in favour of university research funding is economic, then we are entitled to expect rigourous cost-benefit analysis of some sort from them, rather than the faith-based appeals we generally get.

(My own view, for what it is worth, is that academics are very foolish if they allow the argument in favour of university research to become an economic one. If that argument becomes generally accepted, then the most important research funding which any of us receives — that is, the portion of our salaries not related to teaching, which allows us to study whatever we want, including such arcana as economic history — will presumably come under scrutiny, in which case it will be time to pack it in.)

More generally, Ireland is a small open economy, and we are only ever going to make a vanishingly small contribution to pushing back the world technological frontier. Does it not follow that the priority here should be on innovation policy — helping companies apply best-practice technology — rather than on invention policy — creating the best-practice technology ourselves? In order to evaluate such a proposition, I guess you would need empirical evidence on inter alia the extent to which new technologies are geographically mobile.

As a final note, I am pleased that Michael picks up on the utterly embarrassing references to Stanford we heard earlier in the summer.

Today’s inflation numbers show further falls in July for both the CPI and HICP. The falls sa are not as big as the raw nsa figs. The CPI is now (sa) 6.4% below the October 2008 peak. The HICP, which excludes mortgage interest and some other small items and which I prefer, is 2.6% off its November 2008 peak (sa).

There has been, understandably, considerable reaction to the Bord Snip proposals for cuts in Social Welfare rates. These were increased in last October’s budget by 3.1 to 3.3%, the increases effective from January. In the budget speech, the Minister predicted a positive inflation rate in 2009 of 2.5%. If he had instead predicted a zero rate, it is a fair guess that there would have been no change. It now looks as if the 2009 price level will work out perhaps 5% below what was assumed in the budget. 

If the proposal to cut rates by 5% were to be implemented from January next, the resultant rates in real terms, using the HICP rather than the CPI, would still be ahead of the October 2008 level, even if there are no further falls in the HICP. If the alternative 3% cut were implemented, the resultant rates would leave recipients better off in real terms than they were prior to the October 2008 increase. Of course, the big losers from the recession to date have been those laid off and newly reliant on Social Welfare (apart from ex-billionaires), and not the (far larger) group of long-term recipients.  

Richard Tol and David Madden have posted notes here drawing attention to the distributional impact of relative price changes which deserve a more extended response when time permits. For now, I would just like to make two comments:

(i) David notes that the lowest income deciles smoke cigarettes, and it has long intrigued me that the regressive impact of sharp recent increases in cigarette taxes attracted no negative comment from the political left. They should’nt smoke, you see.

(ii) Even the 5% reduction would still keep real HICP values at about pre-budget levels, if I understand Tol et al correctly. 

Finally, if all the €21 billion gross spend on social transfers were directed at the very lowest income groups, some of the more hysterical reactions would be reasonable (‘destruction of the welfare state’, no less). As a glance at the Household Budget Survey will confirm, significant entitlements reach well up the income distribution, reflecting the presence of substantial universal, as distinct from means-tested, expenditures.