Thursday, 25 December 2008

Another reason to like Paul Walter

Perhaps we should set up a small factory making these.

Wednesday, 24 December 2008

The pot calling the kettle black

According to the Daily Mail, the Pope has been accused of spreading fear about homosexuals.


Are our leaders misrepresenting Keynes?

Central Banks appear to be citing Keynesian monetary policy as a reason for pushing down interest rates to dangerously low levels.

Yet it is far from clear that the dead economist would himself have approved of low or no interest rates.

According to his General Theory of Employment, Interest and Money, when the "rate of interest has fallen to a certain level… almost everyone prefers holding cash to holding debt which yields so low a rate of interest," as a result of which central banks can "lose effective control over the interest rate" (p. 207).

The problem, as I have noted repeatedly, is that if interest rates are low, there is no incentive to lend money, thus furthering the very “liquidity trap” that the Central Banks believe they have to resolve. As Keynes understood, people have no incentive to hold bonds (or deposits) rather than cash. In fact, the rational investor would shift their money abroad.

Rather than resolving the problem, today’s low interest rate policy is sowing the seeds of the next economic crisis by encouraging further credit expansion which, in turn, will lead to further misallocations of resources and requiring future punitive interest rate rises.

The role of the economist as policy advisor

Economists are not traditionally popular as policy advisors. Economics teaches that resources are limited, that choices made imply opportunities forgone, that our actions can have unintended consequences. This is typically not what government officials want to hear. When they propose an import tariff to help domestic manufacturers, we economists explain that this protection will come only at the expense of domestic consumers. When they suggest a minimum-wage law to raise the incomes of low-wage workers, we show that such a law hurts the very people it purports to help by forcing them out of work. On and on it goes. As each new generation of utopian reformers promises to create a better society, through government intervention, the economist stands athwart history, yelling "Remember the opportunity cost!"
Peter G. Klein: Why Intellectuals Still Support Socialism.

Monday, 22 December 2008

The Green Road to Nowhere

History is repeating itself, though whether as tragedy or farce awaits to be seen. As our economy enters another of its periodic recessions, caused as ever by government meddling in the economy, politicians race to solve the problem with further doses of the same poison.

Sadly, in an age where politicians fear differentiating themselves from one another and parties squabble over a consensus they disingenuously call the middle ground, there seems to be no real debate over how best to ensure that the recession that we are now in is as brief as possible. Just as President Hoover’s failed interventions were succeeded by President Roosevelt’s even greater interventions, so today politicians seem to be in a bidding war to intervene in the economy.

The latest dose comes from the Liberal Democrats, who have joined the chorus with their latest call for action. Nick Clegg has announced a Green Road Out of the Recession that is built on the same errors that underpin Labour’s proposals and the $4.61 trillion US bailout.

It is a simple error, summed up by Henry Hazlitt when he notes that “The art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups.” It is the error of looking at the immediate results of what one does but not the damage that doing it causes; specifically, of believing that one can utilize a resource (in this case, money) for one purposes without denying it to another.

So let us be utterly clear: when the Lib Dems say “Now is the time for big investment to get the wheels of the economy turning again”, any rational observer should immediately ask “From where is the money coming, and what will be sacrificed so that this investment can be achieved?”

It is an impressive list the Lib Dems have compiled: new trains; new railways; new track; social homes; insulated lofts; smart meters. It will “create jobs and ensure that once this recession is over, we have something to show for the money we borrowed.” All of which is true, but what it does not show is all the jobs that will not be created because the money that would have been spent creating those jobs has been siphoned off by government to pay for its own projects.

There is absolutely no reason why government spending of £12.5 billion (as the Lib Dems propose) should create more jobs than private spending of £12.5 billion. On the contrary: while markets operate specifically to maximise economic efficiency – by, for example, allowing people to spend money on projects that will maximise their own utility – government’s have no such built-in discipline and no means of weighing the efficiency or efficacy of different projects. In fact (as the sorry litany of failed government projects demonstrates) governments all too often blow vast sums of taxpayers’ money on projects that promise big benefits but deliver dubious or disappointing outcomes.

I should add that this is not a criticism of any individual project and certainly not of the environmental (“green”) thrust of the proposals. That the “road out of recession” is “green” is irrelevant. We could as easily talk about the white heat of technology or indulge in some blue-skies thinking. The point is that this is being sold on economic, not environmental, grounds; if the Lib Dems were as keen on agriculture as we are on environmentalism, we could as easily advocate policies akin to President Hoover’s New Deal farm programme, and the proposals would be no less flawed. Government cannot spend the country out of recession.

The reason for this is that government money must come from somewhere, and not matter what its source, it merely transfers money from one use to another. If we spend £12.5 billion on new trains to “create jobs” and “stimulate industry” then the money, workers and materials that are diverted to those ends are no longer available to make shoes, televisions, meals or whatever else we might buy. The net effect in jobs created, wages spent and economic activity stimulated is zero.

Indeed, while we may scoff at the 2.5% cut in VAT and say that the £12.5 billion could be better spent insulating lofts, it ignores the fact that the £12.5 billion would otherwise have been spent by consumers on (for example) carpets. The criticism that the VAT cut would not in fact encourage people to buy is valid in as far as an individual price reduction of 2.13% is not going to make a product hugely more attractive to buy. But the fact that the money remains in people’s pockets means that it will eventually be spent somewhere. It will still represent an increase in consumer demand and so will stimulate growth.

Thus the one part of the Green Road Out of the Recession which is sound is the bit that promises “big, permanent tax cuts”. It is the bit that has been policy for over a year and upon which conference voted. It would transfer spending from inefficient governments to efficient consumers and so allocate resources in the marketplace (that is to say you and me and our respective savings) most efficiently.

A couple of additional points need to be made, to head off possible comments (welcome though all comments are, of course!). Firstly, it makes no difference if the government gets the money through taxation, inflation or borrowing. Borrowing has exactly the same effect as taxation in as much as it diverts savings from being invested in industry and instead invests it in public services; there is still no net gain. It also lands future taxpayers with a bill, so diverting money from future generations to the present. Inflation is effectively a flat tax: if we “print” an additional 1% of money, we are reducing the value of everybody’s savings and wages by 1% - an “inflation tax” that falls as heavily on the poor as it does on the rich (except that rich people are more likely to own commodities or foreign assets that are inflation proof, so inflation may actually be regressive). It also creates imbalances in the economy that will lead to further crises in the future.

Secondly, it makes no difference that this is supposedly “investment” rather than mere “spending”. It is certainly true that this sort of government spending will ensure that “once this recession is over, we [will] have something to show for the money we borrowed.” I have a house to show for the money I borrowed in December, but it does not follow that I made a sound “investment”. Had my internal chancellor not borrowed and spent, my internal taxpayer would not now be saddled with debt.

As Adam Smith noted over two centuries ago, “What is prudence in the conduct of every private family can scarce be folly in that of a great kingdom”. What is more, the fact that we can see what the borrowing has financed should not blind us to the fact that we cannot see the things that the borrowing has denied us: other investments will have been sacrificed. And finally, even spending on consumer fripperies stimulates long-term investment: if demand for MP3 players and trainers increases, so does investment in the production and retailing of these (so creating jobs) and in the infrastructure needed to move them about. Indeed, as taxes/inflation/borrowing tend to make it particularly hard for new businesses to arise, because capital formation (i.e. saving) is harder and credit is absorbed by government, new start-up businesses such as those marketing new solutions to environmental problems struggle to get off the ground. Big government spending may therefore be counter-productive even environmentally!

I also ought to add that members of other parties shouldn’t’ take too much pleasure in seeing me demolish my own party’s latest policy initiative. Neither Labour nor the Conservatives have exactly covered themselves in glory during the present economic crisis and both are participating in the flawed concensus politics outlined above. This article focuses on Liberal Democrat policy only because errors are doubly galling when they come from within one’s own camp and I would like to see the Lib Dems taking a braver, more distinctive and more honest approach to the current crisis that did not argue that more government can get us out of a problem that government made in the first place. The alternative norm of passing money through the hands of politicians instead of citizens has been Labour and Conservative policy for the last century and it has been a tragic disappointment.

Wednesday, 10 December 2008

Gordon Brown: Superhero!

Gordon Brown saves the world!

Tories: if it’s fun, ban it; if it delivers papers, spy on it!

The Conservatives sometimes like to think that they believe in freedom. I’m not entirely sure where they get this delusion, but I am always assured that sooner or later they will expose themselves as the paternalistic autocrats that they naturally are.

So a hat tip to Conservative Home for highlighting

Tuesday, 9 December 2008

The generosity of T-Mobile and other retailers

I received an email from T-mobile today telling me that they were kindly passing the 2.5% cut in the VAT rate on to their customers and I would see the reduction in my next bill. They are not the first to make this statement.

Excuse me, but is somebody a bit confused here?

T-mobile is not my bank. Nor are any of the retailers now offering to pass the VAT cut onto customers.

The 2.5% cut in the rate of VAT is not a shift in the rate at which they buy energy from the government, which they may then choose to pass on or not depending on their own whim and the details of my contract.

VAT is a tax on consumption of luxuries (at least in theory). In fact, at the bottom of every receipt it says how much of the bill is tax. Therefore, a cut in VAT should automatically be passed onto consumers.

In fact, it is not the phone company or the retailer that is charging me the 17.5% (or now 15%) VAT in the first place. It is government. So for the retailers to “not pass it on” they would have to raise their prices by just under 2.5%.

So let us thank T-mobile and other retailers for not taking the opportunity of a reduction in VAT to raise their prices in a manner that would either have left them individually less competitive or collectively guilty of operating a cartel.

CEBR forecast 30% rise in property prices

Why the Government’s plans to rescue the economy don’t seem to be working

The Times captures the mood perfectly: “The economy is plunging deeper into recession despite emergency tax cuts and the multibillion-pound bank bailout, the Bank of England said yesterday.”

What it fails to mention is that this is all utterly predictable and indeed inevitable. The reason that “Cutting the base rate to its lowest level in more than 50 years, the Bank said the outlook now was worse than a month ago, with manufacturing and consumer spending in sharp decline” is that cutting the base rate is not going to have much impact.

The base rate is just one driver of credit, and it is not by far the most important. What is more, it does not address the real problems in the economy, which is that the credit expansion of the last decade has fooled entrepreneurs into thinking that investments were viable when in fact they were not. In some cases, whole businesses will now need to be liquidated as reality crashes in on those who had been fooled by artificially-low interest rates.

Reducing interest rates again cannot solve the problem. Just as the first rule when one finds oneself in a hole is to stop digging, so the first rule when one finds oneself facing the inevitable crash following an inflationary spike is to stop inflating. Further interest cuts (as preached by all political parties) are simply attempts to stimulate more credit expansion, which means further inflation. This will lead to more poor decisions by entrepreneurs and more unviable businesses being created, expanded or propped up. That can only lead to an even bigger crisis in the long run.

“The Bank of England pinned much of the blame for the economy’s slide on the borrowing drought that high street banks have inflicted on consumers and businesses alike” according to The Times, but in doing so the Bank misses the point. The borrowing drought is the result of banks making sensible economic decisions in avoiding making the same kind of loans that got us into this mess in the first place.

For let’s be clear about this: the loans that the banks are currently proving reluctant to make are those that they fear may not be repaid; those that, in American parlance, are “sub-prime”. In a market where asset prices are falling, many homeowners are in negative equity and many businesses are destined for bankruptcy, further lending would not only be stupid, it would be irresponsible.

Far from cutting interest rates, the Bank of England should be raising them so as to reduce the demand for credit and increase the desire of savers to provide it. In doing so, it will not only redress the massive imbalance between saving and borrowing that has led the West to borrow trillions of dollars of the (thrifty) Asians as well as creating money through government-backed central banks, but it will also accelerate the reallocation of “factors of production” between unviable and viable industries. As a result, it might just make this a sharp but short recession, instead of another painfully-drawn-out one.

Monday, 8 December 2008

Henry Hazlitt on the so-called “free market”

I have recently been reading Economics in One Lesson by Henry Hazlitt, and this section from the end of Chapter XVI particularly caught my attention:

[B]y the greatest miracle of all, this postwar world of super-international controls and coercions is also going to be a world of "free" international trade! Just what the government planners mean by free trade in this connection I am not sure, but we can be sure of some of the things they do not mean. They do not mean the freedom of ordinary people to buy and sell, lend and borrow, at whatever prices or rates they like and wherever they find it most profitable to do so. They do not mean the freedom of the plain citizen to raise as much of a given crop as he wishes, to come and go at will, to settle where he pleases, to take his capital and other belongings with him. They mean, I suspect the freedom of bureaucrats to settle these matters for him. And they tell him that if he docilely obeys the bureaucrats he will be rewarded by a rise in his living standards. But if the planners succeed in tying up the idea of international cooperation with the idea of increased State domination and control over economic life, the international controls of the future seem only too likely to follow the pattern of the past, in which case the plain man's living standards will decline with his liberties.

So much for “peak oil”

It seems a long time ago, now, but just prior to the recent recession the price of oil reached new heights and wild predictions of $200 a barrel and more were flying around. At the time, many energy- and environment-pundits, including some among the Liberal Democrats, believing that we had now reached “Peak Oil”, that mythical time when the increase in our rate of consumption outpaces the increase in our rate of discovery and so initiates an accelerating decline in supply until the oil runs out and civilisation as we know it ceases to exist.

Those who talk about it often have a slightly excited look upon their faces, as though they cannot wait for the final cataclysm to come so that they can say “I told you so” as the cities begin to go up in flames and people collect together in small bands to try to eke out some semblance of survival in the mountains.

They appear to have gone rather quiet recently, however. Once again, “peak oil” has turned out to be nothing more than a foothill in the great undulating range of energy prices. Oil prices have fallen by two thirds in the past six months to end up $100 a barrel below their Summer peak at just $50 a barrel.

Of course, peak oil is nonsense anyway. Firstly, it is based upon a deliberate obfuscation of known, economically viable reserves on the one hand, and what is in fact under the crust on the other: oil companies only list the reserves that they have so far identified, and they do not list reserves that are, at current prices, too expensive to be viable, while at a higher price they would be worth drilling for. As Russell Lewis explains,

Oil reserves are never remotely equivalent to all the oil in the earth’s crust.
The proven reserves are what the oil companies have decided to look for and
which are known to be exploitable under prevailing technical and economic
conditions. They are designed to provide the oil industry’s working inventory of
oil stocks. There is a limit to the amount of money the oil companies can spend
on searching for more or deeper wells because prospecting and drilling are
expensive, and there are other competing obligations which affect their
long-term profits, such as advertising, marketing, research, building refineries
and distribution. The best indicator of whether oil is getting scarcer is its
price, and though prices have risen sharply in the last two years [and bearing
in mind that this was written before the collapse in prices in the last six
months], that fact does not necessarily point to a long-term upward trend.
This does not mean that oil could never run out, however. That is left to the price mechanism. As the supply of oil diminishes, the price will inevitably rise. This will not, however, trigger a mad rush to capture ever shrinking reserves until the oil economy collapses; rather, it will lead to a steady rise in prices that will encourage greater efficiency, spur research into make alternatives more cost-effective. For example, if fossil fuels quadrupled in price, wind turbines would be able to generate electricity more cheaply and so they would become a viable alternative. The increase also pushes up the cost of high-energy products and services (such as flights) and so discourages consumption. And finally, as we have already seen, rising fuel costs encourage consumers to pay more attention to the miles-per-litre that their car can achieve and so encourage producers to invest in more efficient engines.

In fact, this last points to another flaw in the peak oil theory: it ignores human ingenuity. Even accepting that there is a set amount of oil, it is irrelevant to our ability to produce power from it. By inventing an engine that is twice as efficient, or a new means of producing plastics that requires half and many hydrocarbons, we have effectively doubled the amount of fuel available even if we have the same number of litres. If we invent alternative technologies, lakes of oil are made available for the remaining needs. In truth, we will never run out of oil, because before that ever happens human action and rising prices will have rendered oil surplus to requirements.

So the next time you see that fuel prices are rising and hear somebody mutter about peak oil, you can rest assured that new research is underway that will soon bring prices back down, and that there is plenty of oil left under the ground. More, in fact, than we will ever need.

Wednesday, 3 December 2008

Queen's Speech a textbook example of meddling and failure

Today’s Queen’s Speech is another fine example of government meddling and failure.

One Bill after another is being introduced to interfere with people’s legitimate freedoms and try to paper over the cracks in their interventionist system.

I have recently written on the phenomenon that government intervention is doomed to fail and that in doing so it encourages further intervention as governments try to repair the unintended consequences of their own legislation. Clear examples of this are to be found in the Queen’s Speech.

There is too much in the speech, and there is too much as yet unclear, to make a comprehensive attack on the Labour agenda for 2008-9, but the following is an analysis of some of the problems raised.

Business Rate Supplements Bill

The proposals to enable upper tier local authorities and the Greater London Authority to levy a supplement on their business rates, and use this to promote economic development, have a certain charm in that they restore a tiny modicum of tax-raising discretion to local authorities (though not, infuriatingly, to the 32 London Boroughs!).

Of course, any wise local authority would exercise the better part of discretion and not exercise the power. Increasing business rates by up to 2p in the pound will simply squeeze business profits, putting some out of business, driving others away and reducing the ability of the remainder to invest in capital goods (including training) that improve their productivity (and thus the wages of staff). The money raised will never achieve the level of “economic development” that would otherwise be achieved by individuals allocating resources based on their own priorities (a level of information detail that no government can hope to emulate) but will instead be wasted on schemes that appeal to legislators and those who are best able to influence them. It will replace the freedom, efficiency and effectiveness of the market with imperfect politicised outcomes.

Interestingly, the Bill makes provision for allowing businesses to vote on any proposals. It must be assumed that this vote will not be extended to those businesses (with rateable values of less than £50,000) that will not be taxed, as representation without taxation would just allow them to pillage the profits of their more-successful rivals.

It does raise an interesting question, however: why not allow Council Tax payers a similar freedom: a plebiscite enabling them to veto any council policy that would be funded primarily by local taxation. That would certainly put the wind up spendthrift officers and councillors.

Local Democracy, Economic Development and Construction Bill

The devil is in the word “Construction”. Little detail is available on this one, but it does appear to include provisions for a more level playing field for construction businesses, particularly smaller local ones, in construction contracts. Whether this is more anti-success regulation is unclear, but considering the onerous costs that businesses and authorities already have to incur putting tenders through OJEU and other legal competitiveness tests, this can only be detrimental to business. Fairness is best achieved through a free market, where those that discriminate against providers for any reason other than efficiency will be forced to pay higher prices for poorer goods or services and so will see their businesses suffer.

Saving Gateway Accounts Bill

The government’s plan to establish a Saving Gateway scheme, administered and approved by HMRC, with the government “matching” every pound saved with 50p from government up to a maximum of £300 (not the “matching” that Anglophones will be familiar with!), is old-fashioned redistribution of wealth with an added paternalistic twist: the poor must “do the right thing” – by which Labour means save money in bank accounts – to earn their redistributed wealth.

Glossing over questions about the sense of or justification for transferring wealth, this is bad legislation for two reasons: firstly, because it creates a massive dead-weight cost in that the government will have to pay people who would have saved the money anyway; and secondly because it will encourage rent-seeking as people make arrangements to borrow-to-save, for example by borrowing on credit cards (at rates of, say, 25% or 30%) knowing that there is a guaranteed profit of 50% in the first year.

Children, Skills and Learning Bill

The Children, Skills and Learning Bill promises to enforce compliance with the Standard Teachers’ Pay and Conditions Document. The very existence of this document is a problem, as the setting of national standards across England ignores the different costs of living and levels of supply and demand, and further undermines educational independence. At worst, it could see pay and conditions set at too low a level to attract staff to some areas, while being unnecessarily generous (with the resources of local taxpayers) in others.

It also creates a statutory entitlement to apprenticeships for all those suitably qualified by 2013. Unless the meaning of “apprenticeship” has changed, this is idiotic. Apprenticeships involve qualified individuals working for established providers so as to learn on the job; the government cannot increase the number of apprenticeships beyond the demand among qualified workers for apprentices. The proposed duty on the Learning and Skills Council to provide apprenticeship places may easily morph into the provision of further course-based training, which would defeat the supposed purpose.

Policing and Crime Bill

A bill to protect vulnerable groups, particularly women and children, may seem welcome at first. But one has to wonder at a government that considers 51% of the population to be a “vulnerable group” simply because of their gender!

The main problem with this bill is the plans to tighten regulations on lap dancing clubs and the sale of alcohol. Lap dancing clubs are places where consenting adults go to watch other consenting adults perform erotic dances; it should have nothing to do with the government what these individuals (or groups) choose to do. Similarly, government has no business interfering with the right of businesses to sell, or adults to buy and consume, alcohol. As I have noted before, this kind of legislation is never directed at our claret-swilling elites, but at those whom they see as they look down their wine-flushed noses.

Where there are ancillary problems (for example, anti-social behaviour in the environs of the club or pub) they should be dealt with in their own right,

Marine and Coastal Access Bill

The Marine and Coastal Access Bill continues the assault on private property by forcing property owners to allow trespassers to walk over their land simply because they happy to have bought property adjacent to the sea. If the proposal was applied to all properties, so that ramblers may cross anyone’s land at will, it would be fair, but it would also be as welcome as the Poll Tax.

Constitutional Renewal Bill

Finally, something good in the government’s proposals. Thank heavens they are finally repealing their own, oppressive legislation. One law down, 10,000 more to go!

Sunday, 30 November 2008

I’m inside so shut the door

I was saddened to read comments today by the Indian-born entrepreneur Sir Gulam Noon.

According to the Daily Mail, the “controversial Labour donor” has called for a ten year ban on immigration to the United Kingdom so as to give time for the current immigrant population to settle in and integrate and to make sure that there are enough jobs to go around.

In his modestly titled autobiography, Noon, with a View: Courage and Integrity, the so called ‘Curry King’ writes “Bluntly, I think we are self-sufficient now. We should wait for five or ten years, until all the newcomers have been properly integrated and assimilated into the country. Until then we should just shut the door.”

This is a shame, as Noon is a perfect example the benefits of immigration to the UK economy and society. Arriving in 1966 with just £50 in his pocket, he has since made a fortune of £65m, employed thousands of people and satisfied many thousand more customers. He has contributed hugely to the economy and (through taxation) to the funding of public services. A few more Noons (Labour donations notwithstanding) would be welcome.

However, it a sad example of double-standards, he would now seek to deny that opportunity to other would-be immigrants and entrepreneurs.

His thinking is clearly flawed, resting on common errors such as the idea that the UK is ‘full’ (we in fact have far lower population density that the Netherlands, Belgium or Taiwan and approximately the same as Germany) or that there are only so many jobs to go round.

He also cites the rise of the British National(ist) Party as an example of the dangers of “disturb[ing] the balance and upset[ing] the … host community”, as though those fascist thugs represented mainstream opinion. Sadly, his comments are more likely to play into their hands – I can already imagine them reproducing his words on their literature.

The truth is that the quantity of work available in an economy adjusts with demand, so that the more people one admits the more work is needed. Of course it would be harmful to the economy if immigrants did not work, but the suggestion that immigrants arrive to take advantage of our welfare state and live I life of idleness is simply not born out by evidence. Many immigrants pay several thousands of pounds to reach the UK, which they would hardly do just for the privilege of living off £60 a week.

There is a regrettable tendency among some immigrants to wish to close the door after them, stemming the competition from the next wave of immigration. It seems that Sir Gulam has decided to throw his lot in with those who oppose immigration even though he is himself a prime example of how it benefits the UK . It is both ignorant and hypocritical.

Tuesday, 25 November 2008

An eerie echo of the past

Earlier on I set out how 80 years ago an Austrian economist predicted the ineffectiveness of current efforts to intervene to improve economic conditions.

I have since been directed to an interview with another Austrian economist (this one also a British citizen) that - aside from the poor quality and the stilted voices - could have been recorded yesterday.

In it, Nobel laureate Prof. Friedrich von Hayek explains that inflation is always the result of government action, is the great evil against which we need to battle, and that efforts to intervene to prevent recessions that follow from periods of government-led inflation are doomed to failure.
The part of the inteview from 14.00 minutes to 16.50 minutes is particuarly chilling!

The following is a summary of what he says (I have slightly augmented it with my own understanding of his take on economics, though where possible I have enclosed these additions in square brackets):

  1. Germany out-performed the UK in the three decades after WWII because the German trades unionists remembered that inflation is the enemy of the working man;
  2. If people do not recognise the danger of inflation they will continue to believe that it can be used as a short-term solution to economic problems, as a result of which inflation will continue to wreak havoc upon the economy;
  3. Unemployment results from inflation, which encourages the misdirection of labour [because easy money is made available to enterprises that would not, under normal conditions, be viable, allowing them to offer higher wages than would be possible if the easy money had not been thrown into the system by Government], so it is wrong to suggest that in the long term one needs to tolerate unemployment to curb inflation;
  4. Curbing inflation will cause short-term unemployment, but this need only last a year or so [before the market re-asserts itself and labour is employed once again];
  5. As Jeffrey Tucker notes, the “hilariously naive and idiotic” line of questioning demonstrates how “people really believe that policy makers can manipulate the economy like a machine, trading off unemployment for inflation and back again, with no trouble”
  6. Non-compulsory planning will have no effect and so can do no harm [or, indeed, any good];
  7. “Stopping the printing presses” is a euphemism as the real cause of inflation is credit expansion rather than the actual printing of hard money;
  8. “All inflation is ultimately the problem of activities which government determines and can control. And all inflations have been stopped in the past by the governments stopping creating money or preventing the central bank from creating more money” [thus putting the lie to the government’s suggestion that inflation is caused by outside factors such as rises in the cost of commodities];
  9. A tax cut will not work to stimulate the economy because deficiency of aggregate demand is not the problem. Rather, the problem is that the boom and employment that has been created by the previous inflation can only be sustained by further inflation [which, if perpetuated, would lead to hyper-inflation and ultimately a crisis];
  10. If government continues to inflate to sustain the boom it may have to try to ameliorate the effects by imposing price controls which will lead to the imposition of a planned economy [i.e. socialism];
  11. Political freedom exists hand-in-hand with economic freedom and the former cannot exist without the latter;
  12. The power of labour unions and corporations does not lead to inflation unless that power is used to encourage inflationary policies;
  13. Wages/Prices/Incomes policy is utterly ineffective except as a means of managing in the very short term the period of deflation/restoration;Not all problems are solvable in the short-term and trying to do so may cause more harm than good;
  14. Equities remain a good investment in the long term;
  15. “Inflation is like over-eating and indigestion. Over-eating is very pleasant; so is inflation. Indigestion comes only afterwards and so people do not see the connection”;
  16. Economists are intellectually attracted to the concept of a system that they can control and therefore are instinctively opposed to free markets and non-intervention;
  17. Continued government-induced inflation and subsequent intervention by government will inevitably destroy capitalism [as Karl Marx predicted and hoped for].
Hat tip to Kit for drawing it to my attention, and to for hosting it.

Forced bank lending the latest instalment in Labour’s doomed spiral of intervention

Alistair Darling appears set to commit an 80 year old mistake. In his misguided attempts to control the UK economy and force businesses to conform to New Labour’s agenda, he is again going to intervene between banks and their customers.

He has already intervened countless times over the past year, but this latest intervention is pitifully predictable. Indeed, as was explained 80 years ago, it was inevitable that his previous interventions would have unintended consequences that would be the opposite of what he intended, and that to counter those consequences he would be obliged to intervene again and again to ever greater degrees.

Published in 1929, just as another depression was about to rock the world economy, Ludwig von Mises’s Critique of Interventionism demonstrated that as soon as politicians began to intervene in the economy, they would have to continue to do so until ultimately the entire system came under their control. According to von Mises, interventionism was simply unsustainable: either one accepted the laws of economics or one was forced to implement socialism.

We can see how this works if we consider price controls – an example that has striking relevance to Mr. Darling’s current dilemma.

If government tries to fix the price of a commodity, it will not be able to sustain prices below those that the unhampered market would set. This is because with price controls:
"Sellers are forced to sell their goods at lower prices, so that proceeds fall below costs. Therefore, the sellers will abstain from selling and hold on to their goods in the hope that the government regulation will soon be lifted. But the potential buyers will be unable to buy the desired goods."
The result, therefore, will not be the increasing availability that the government sought but a reduced availability of the good resulting from suppliers having no wish to supply at such a low price. To raise supply to the level the government desires at the price the government has mandated, it must therefore intervene again to force suppliers to supply the good: “…it tends to supplement the price ceiling with an order to sell all goods at this price as long as the supply lasts."

However, as the good is now on sale for below its real value, far more customers will emerge than would do so if the good was priced naturally. And since the price is "below that which the unhampered market would set, the same quantity of goods faces a greater number of potential buyers who are willing to pay the lower official price. Supply and demand no longer coincide; demand exceeds supply, and the market mechanism, which tends to bring supply and demand together through changes in price, no longer functions."

There is still not enough of the good to go round, but now it is not because of suppliers reticence but excess demand caused by under-pricing. Government has prevented the price mechanism from operating to prioritise this demand. Therefore another means must be found to decide who gets what, which leads to the third wave of intervention: Rationing.

"Of course, government cannot be content with this selection of buyers. It wants everyone to have the goods at lower prices, and would like to avoid situations in which people cannot get any goods for their money. Therefore, it must go beyond the order to sell; it must resort to rationing. The quantity of merchandise coming to the market is no longer left to the discretion of sellers and buyers."
But why, if the price is below that at which suppliers can make a profit, would they produce the good at all? Only if the government intervenes to force the production of the good. Consequently, the fourth intervention takes place:

"When that is exhausted the empty inventories will not be replenished because production no longer covers its costs. If government wants to secure a supply for consumers it must pronounce an obligation to produce."
And how can this be achieved when costs are below prices? Only by driving down costs, which requires government to intervene to set the prices of the factors of production that go into producing the good. Ergo, "it must fix the prices of raw materials and semi-manufactured products, and eventually also wage rates, and force businessmen and workers to produce and labor [sic.] at these prices."

But what, you may ask, has this to do with Mr. Darling? If one considers money and borrowing to be commodities, the answer is everything.

Government has long been intervening to keep the cost of borrowing below the market rate. This is the role of central banks: they enable governments to control the supply of money by forcing lending rates down below the market rate, so stimulating artificial and unsustainable booms that keep the voters sweet until the next election. The Bank of England did this again last month. Under normal circumstances, a “credit crunch” should result in an increase in the cost of borrowing. This would result in more saving and less borrowing until a new equilibrium was reached. However, the government has intervened to keep the cost of borrowing low.

As von Mises predicted, however, this has had unintended consequences. The government may have wanted low interest rates, but the banks were still inclined to set interest rates based on risk: as default is more likely now than it was a couple of years ago, the cost of borrowing is raised to take an actuarial account of risk. Also, as the banks have limited capital, they are bound to lend to the most profitable borrowers: those who will pay higher rates. So inevitably the government is again inclined to intervene to force banks to lower rates.

The predictable result is that banks won’t lend. They’d rather buy government securities or look abroad for more valuable investments than lend to businesses and householders at rates that are no higher than inflation or make a tiny real return but involve huge risk (companies will go to the wall; mortgagees will default). So the third intervention comes, as Darling forces the banks to lend.

Not to everybody, mind. Already the rationing is appearing: the BBC suggests that the intervention will be for favoured groups, which at this stage consists of “Small businesses” (which means it might be time to sack that 50th employee and cut one’s borrowing costs!).

One can only begin to guess at what the unintended consequences of this latest intervention will be. However, the two things of which we can be sure are that further interventions will inevitably follow as long as Labour ministers believe that they can over-ride the laws of economics, and that these interventions will continue to have unintended and negative consequences for all of society.

Tuesday, 11 November 2008

Have our leaders been drinking?

Ask yourself the following question: if you discovered that a sector of the economy had been colluding with one another to agree a minimum price for a good, rather than competing with one another, would you not be angry? Would you not accusing them of “price gouging” their customers? Would this not be a flagrant violation of competition law that ought to be investigated by the competition authorities?

Of course. It hardly takes a degree in economics or a sharp eye for injustice to see that.

Unless, apparently, the good is alcoholic. Then, apparently, the customer can go to hell, because what our beloved political masters want to intervene to raise the prices of alcohol.

And which political party is in the forefront of this paternalistic policy. I can barely bring myself to say it!

The Liberal Democrats have brought out an utterly illiberal policy that includes a proposal that we “Stop irresponsible drink promotions by introducing a minimum price for alcohol.”

Now price controls are a particularly pernicious tool with which to shape drinking policy. It is not, note, an increase in the cost of alcohol. Oh no! There will be no need for our beloved leaders to pay any extra for a bottle of Chateau Neuf de Pap. They can quaff all the Isle of Islay they like as they fashion ever-more-restrictive policies for the hoi polloi. Indeed, one has to wonder if they had consumed one too many bottles of Verve Clicquot before stumbling stupidly on this particular policy.

Because price controls will only affect those buying cheap alcohol. It is a policy deliberately targeted at the poor drinker; s/he who feels the need to avail him/herself of the three-bottles-of-white-for-ten-pounds offer at the local corner store, or those who cannot afford to drink anywhere except The Goose or a Westherspoon.

This policy means only one thing: to our political masters, it is poor people who are the problem. The wealthier classes never get drunk and cause criminal damage.

And it is not just some poor people. After all, if it were just some poor people that were causing the problem, the solution would be to target criminals and those who behave anti-socially. Price controls target everybody. The responsible father of two who wants to pop into the local for a swift pint on his way home to (Oh, lets rub this in!) cook a dinner for his hard-working wife and loving children will have to pay (Extra salt into wound!) more of his minimum wage income to unwind a little after his hard day.

But it’s good for him, right? After all, these poor people need nice, high-minded politicians to make moral judgements for them, to cajole them into behaving responsibly. It’s for their own good.

Frankly, it’s enough to drive one to drink!

Monday, 20 October 2008

How Labour caused the economic crisis

Four weeks ago I demonstrated how the current financial crisis was a disaster of government's own making. However, most of that was focussed on the American government. In so doing I failed to point out how Gordon Brown (as both Chancellor of the Exchequer and Prime Minister) created the problem.

It is true that the US governmetn deserves much of the blame for forcing banks to lend to un-creditworthy (sub-prime) borrowers and (through the para-statal company Freddie Mac) inventing the practice of securitizing the debt.

But the main source of the problem has been the massive expansion in credit - and indeed money - over the past decade. And while the American government has been as guilty as any of inflationary policies over the past decade, it is Labour that has led UK investors up the garden path with dangerously loose monetary policy.

Having spent ten years allowing Gordon Brown to fan the flames of in an inflationary boom, we are now reaping the whirlwind.

But, I hear you cry, has inflation not been running at around 2%? Isn't that very low>

Well, yes, but only if you look at consumer/retail prices. Sadly for us, economic inflation isn't caused by inflation in the price of consumer goods, which have in fact been falling in real terms since China got its act in gear in the 1990s. Inflation is caused by loose money, which floods through banks, via loans, to be invested in (particularly) capital-industry and land. So the important measure of the inflation isn't CPI or RPI but the money supply.

And how much has the money-supply been inflating over the past decade? The Market Oracle provides this handy chart, which suggests that over the last 5 years the quantity of money swirling around in our economy has doubled.

And where has all that spare cash, utterly un-backed by a corresponding doubling of growth (see GDP figures for 2002 and 2007), gone?

It has been used to bid up the prices of property, shares and capital goods.

However, as demand for them is not actually changed by the new banknotes (electronically) manufactured by the Government, the inevitable "readjustment" is at last taking place as the cost of these goods begins to fall, reflecting their real, non-inflated, value and the cost of consumer goods begins to rise to accomodate the new money in the economy.

As I mentioned a three days ago, further inflation, interest rate cuts and borrowing cannot stop the recession. They can perhaps delay it, and certainly extend it, but in the long run recession is inevitable. We have Labour to thank.

Friday, 17 October 2008

Gordon Brown and the financial crisis: a 1 minute comparison

Three ways to worsen a credit crunch:

1. Lower interest rates: this discourages saving because one gets little reward for delaying one’s gratification (in economic parlance, time-preferences are undervalued), while at the same time encouraging borrowing, thus further reducing the supply of credit relative to demand;
2. Allow inflation to escalate: this also discourages saving because the nominal reward for saving (the amount one’s money goes up) is eroded by the fall in the value of money (what your savings are actually worth), and for the same reason encourages borrowing: at present, the Bank of England base rate is lower than inflation which means that savings are worth less with time (in economic parlance, interest rates are negative);
3. Increase public borrowing: This takes money out of the credit markets: money that is being saved and would be invested in profitable businesses is now diverted into Government bonds and then invested in businesses that are not creditworthy (if they were, they would not need a Government bail-out).

Government policy:

1. Lower interest rates
2. Allow inflation to escalate
3. Increase public borrowing

Remember than the next time somebody tells you that Brown is having a good crisis.

Saturday, 11 October 2008

A jolly morning's voting

An unexpected treat landed on my door courtesy of Electoral Reform Services.

Yes, it's Party election time!!

No sign of the one we've all been waiting for, but in the meantime an excellent opporutnity to support old friends, laugh at people's artwork and make instant and probably utterly-unfair judgements about people.

My favourite was the chap who was standing for the peers list who wrote "60 years a liberal" at the top. How can one resist?!

Two names did jump out and me that deserve a vote:
  1. Jock Coats for Federal Policy Committee: Jock is known to many of you through his blog. He has an excellent graps of policy and has an answer for almost any problem (the same one, admittedly ;o) and would be a real asset to FPC, fighting for sound liberal economic and social policy and fending off the errors of interventionism;
  2. Tony Vickers for the peer's list: Tony is Chair of ALTER and a long serving Liberal Democrat councillor.

I should hasten to add at this point that I am not a member of ATER and my internal jury is still out (if an internal anything can be out) over LVT. But it has been a party committment for a century and yet the policy establishment have brushed it under the carpet in the Cowley Street boardroom every time it has come up.

There are also dozens of other people I know on the lists, but I can't sit here listing everybody and their attributes. That is what your artwork was for!

Anyway. Enough of all that. I've seen a photograph of a women in a barbour so I'm going to send her to Europe!

Tuesday, 30 September 2008

Dee Doocey is right for all the wrong reasons

The body fascists are out in force again.

Dee Doocey has been pressuring the Mayoral administration to remove London Development Agency funding from London Fashion Week. That’s fine in itself: I can see no reason why London’s taxpayers should be subsidising the fashion industry, let alone why Bromley residents should be paying for fashion shows in the West End.

Sadly, Doocey seems to have no concern for taxpayers subsidising special interests. Rather, she is jumping on a social-conservative bandwagon that aims to dictate how models, fashion houses and the organisers of sartorial trade fairs should market their goods.

This is, in fine social-conservative tradition, all about protecting patronised groups from themselves by dictating to third parties whom the supposedly-weak willed might emulate. In this case, thin girls are seen as at risk of emulating thin women. Doocey notes that “1 in 40 women suffer from an eating disorder, [that] the numbers are on the increase [and that] the girls are getting younger”, all of which is undoubtedly a tragedy. That the solution is censorship does not automatically follow, however.
On a very fundamental level, censorship is always the wrong solution to a problem. Neither the models nor their employers are doing any direct harm to girls who choose to emulate them, any more than Richard E. Grant and Paul McGann can be blamed for causing harm to my liver just because I occasionally like to order “Two large gins and two pints of cider (ice in the cider)”.

As I noted the last time this issue came up, “Perhaps (radical suggestion, I know!) people are making their own decisions based on a multiplicity of information and imagery. Should we control all information, vetting it to ensure it promotes only a benign or (in our opinion) positive image?“

Of course not. If we tried to order our society in a manner that prevented anybody from unwittingly influencing others in a negative manner, we would face an insurmountable censorship burden. Should we allow dangerous sports on the television? What about fat people?

In passing, one cannot help wondering whether the fact that we are concerned simultaneously by obesity and anorexia suggests that our society’s problems with eating are to do with something other than the effects of London Fashion Week.

It is also worth noting (again!) that “Size 0 models” are actually Size 4 models, but it sounds so much more dramatic to disingenuously use the American numbering. Firstly, it implies that there are twelve full sizes between a “normal” girl and one of what Doocey calls these “skeletal models”; in fact, there is only four sizes between them (unless you know where one can buy odd-numbered sized clothes). Secondly, there is a subliminal sense that Size 0 must equate to nothing. This is not ever stated, and nobody would suggest this consciously, but subconsciously Size 0 has a particularly ghoulish resonance.

Opposition to the employment of thin models will do little to help girls with eating disorders. They are surrounded by examples of norms of beauty (and behaviour) that only a draconian censor could prohibit. Their problems are psychological and so require treatment rather than censorship. And it is not clear that any government intervention is going to prevent the problem.
But it is an example of the conservative tendency to use government as a vehicle to protect people from themselves and to use the coercive power of the state to shape society (an in this case, women) in their own (unflattering) image.

If Dee Doocey wanted to strike a blow for freedom, she would object to the LDA’s funding of London Fashion Week because it was a misuse of taxpayers’ money. By allowing this subsidy to pass as long as it promotes her view of how women should look, she is striking a blow against it.

A real economic roller-coaster

Ever wondered what it would be like if the housing marked really was a roller-coaster ride?

Well, some clever wag has created a roller-coaster using Roller Coaster Tycoon 3 and using a graph of US house prices since 1890 as the shape of the track.

An amusing graphic to demonstrate the madness not only of the bubble that has just burst but the overall picture over the past 118 years.


Real Estate Roller Coaster

Monday, 29 September 2008

Sub-prime, securitisation and how government caused the financial crisis

The bogeymen-of-the-moment are clearly bankers. Photographs of bankers with their heads – or boxes of their possessions – in their hands are commonplace. The sympathy for the former Lehmans employee does not appear to match that felt for the unemployed docker or miner. Schadenfreude is de rigueur at the moment. And if the banker is the bogeyman, the free markets is the wicked system that is now being exposed for what it is (if only!).

But are our current problems really the fault of capitalists and bankers? There is an altogether different narrative that points the finger in an entirely different direction: the sub-prime and securitisation crises were created by government.

The sub-prime problem begins with the US government's 1977 Community Reinvestment Act (CRA), which allowed the Federal Reserve and other US financial regulators to pressure banks into making loans to less-than-creditworthy borrowers. Far from greed driving bankers to offer 100% loans to unreliable borrowers, this position was forced upon them by government.

Thomas DiLorenzo explains the problem:

When the CRA was created during the Carter administration, the administration also funded with tax dollars numerous ‘community groups’ that have helped the Fed, the Comptroller of the Currency, and other federal regulatory agencies to enforce the act. Under the CRA, if a bank wants to make virtually any change in its business operations — merging, opening up a new branch, getting into a new line of business — it must first prove to regulators that it has made "enough" loans to the government's preferred borrowers. The (partially) tax-funded ‘community groups’ like ACORN (Association of Community Organizations for Reform Now) can file petitions with regulators that stop the bank's activities in their tracks, perhaps defeating them altogether. The banks routinely buy off ACORN and other ‘community groups’ by giving them millions of dollars as well as promising to make even more dubious loans.

Not only is the sub-prime market the result of Federal legislation that forced banks to lend to un-creditworthy borrowers, but the practice of dicing up debts and selling them on in chunks that mixed prime with sub-prime loans was also the creation of a Government body.

In order to try to diversify the risk of these loans, the Federal Home Loan Mortgage Company (‘Freddie Mac’) pioneered the ‘securitization’ of bundles of these high-risk loans so that they could be sold on secondary markets. Such ‘securitization’ exploded during the 1990s as a result of government regulation. As Fed Chairman Ben Bernanke himself stated in a March 30, 2007 speech entitled The Community Reinvestment Act: Its Evolution and New Challenges,

Securitization of affordable housing loans expanded, as did the secondary market for these loans, in part reflecting a 1992 law that required the government-sponsored enterprises, Fannie Mae and Freddie Mac, to devote a large percentage of their activities to meeting affordable housing goals.”

The deregulation of banking in 1994 led to banks to elevate their CRA activities so as to avoid objections by these ‘community groups’ to their business activities. Meanwhile, in 1995 the US Treasury Department created the multibillion-dollar Community Development Financial Institutions to pour taxpayers’ dollars into subsidising sub-prime loans.

Indeed, from 1995 banks were pressurised to make loans “without the benefit of many traditional credit-worthiness criteria, such as the size of the mortgage payment relative to income, savings history, and even income verification! Instead, the Fed told banks that participation in a credit-counseling (sic.) program, many of which are federally funded, could be used as ‘proof’ of a low-income applicant's ability to make his mortgage payments. In other words, federal bank regulators required banks to make bad loans based on nonexistent credit standards.” One cannot help but think that participation in a credit counselling programme suggests that the borrower has had credit trouble in the past and may not be an ideal customer.

Though largely a US based problem analysis has three significant messages for our current situation.

Firstly, the eagerness with which journalists and politicians have blamed bankers is misguided. While there is no doubt that bankers can be and have been greedy, the sub-prime mortgage problem was forced on banks by the US government, while habit of ‘securitising’ debt began with a US government housing agency. This is a problem created by government, not greed.

Secondly, for the above reason, the eagerness with which we look to government to solve the problem is equally misguided. Our faith in more regulation to resolve the current mess is misplaced. To my knowledge HM Government did not force bankers to lend to less reliable borrowers, but the excess of credit in the marketplace as a result of Government’s toleration of inflation in the pursuit of low interest rates meant that banks had to look further down the pecking-order of borrowers to find people to whom to lend. Had money been tighter, there would have been a duel break on the problem as borrowers were more cautious due to facing higher repayments and banks were less eager to accept any borrower due to credit being limited. There might have been fewer 100% mortgages to those with poor credit histories or people who were “self-certificating” (a practice known colloquially as the “Liar’s mortgage”).

Finally, the troubles resulting form the US government’s intervention in housing markets and the deliberate policy of encouraging those on low incomes with poor credit histories to borrow against property casts a cold light upon the Labour government’s proposals to give first time buyers cheap loans, ease the payment of mortgage interest using income support and allow council’s to offer cheap mortgages. This last is particularly pernicious as it opens up the possibility that, in the future, councils will be in the invidious position of having to foreclose on defaulters and repossess their houses (which the defaulter would probably then stay in, now as a tenant of the council!).

Much of the current economic mess has been caused by governments, with the US government to blame for the specific trigger and our own to blame for the underlying mess. Our headlong rush to solve this government-made problem with more regulation risks turning a brief if sharp recession into a long depression. But right now we seem stuck with the mindset that “Something must be done”.

An insight into bloggers and their bitter little battles

My sister is reading Immortality by Milan Kundera and Peter Kussi and came across this passage:

Don’t tell me that two men who deeply disagree with each other can still like each other; that’s a fairy tale. Perhaps they would like each other if they kept their opinions to themselves or if they only discussed them in a joking way and thus played down their significance…But once a quarrel breaks out, it’s too late. Not because they believe so firmly in the opinions they defend, but because they can’t stand not to be right. Look at those two. After all, their dispute won’t change anything, it will lead to no decision, it will not influence the course of events in the slightest, it is quite sterile and unnecessary, confined to the cafeteria and its stale air, soon gone when the cleaning lady opens the windows. And yet, observe the rapt attention of the small audience round the table! Everyone is quiet, listening intently, they even forget to sip their coffee. The two rivals now care only about one thing: which of them will be recognized by the opinion of this small audience as the possessor of the truth, for to be proved wrong means for each of them the same thing as losing his honour. Or losing a piece of his own self. The opinion they advocate is itself not all that important to them. But because once they have made this opinion an attribute of their self, attacking it is like stabbing a part of their body.

It strikes me that it casts a piercing light onto the bitterness with which many bloggers and those who leave comments on websites fight their corners. Very quickly so-called debates descend into slanging matches as one or both parties become more interested in “winning” or slapping the other down harder then they (think they) have been slapped.

In the process the valuable exchange of ideas and the thought that we all might benefit from a healthy debate is lost.

Saturday, 27 September 2008

The Revolutionary Conservative Party and other oxymorons

There is and have always been concern within the Liberal Democrats that we are not as liberal as we ought to be; that our party too often looks to the State to solve problems and is willing to curb individual liberty to achieve social goals.

It has long been a criticism of New Labour that they have abondoned their roots in the labour movement and spent too long playing court to big business rather than worrying about the working man.

Now David Cameron has decided to steal Barak Obama's clothes and take 'Plan for Change' as his party conference theme.

I have long maintained that the names of the political parties have a lot more to do with their roots than with any actual reflegion of their current policies or the philosphies of their members. But when faced with illiberal Liberals, Labour capitalists and revolutionary Conservatives a start to wonder whether the parties' names are supposed to be ironic!

Thursday, 25 September 2008

Horray for the end of capitalism as we know it

Is this the end of capitalism as we know it?

Eamonn Butler, of all people, hopes that it is. Once he explained his reasoning, however, I could see his point.

"Capitalism as we know it is a creature of the regulatory authorities, who've messed it up good and proper" he argues. But frankly, that's just the start of it. Our supposedly capitalist system often looks more like Corporate Statism than any free market that our liberal forebears in the C18th and C19th would have recognised or welcomed. Big businesses larded with subsidies; investors insured by the taxpayer against bad investment; bankers bailed out to the tune of hundreds of billions of pounds.

The sooner that that sham capitalism is swept away and replaced by free exchange of goods, services, capital and labour without interference, impedence or assistance from politicians the better we will all be.

I would like to see Government's role in the economy limited to three things: ensuring the rule of law; protecting property rights (which as Tristan reminds us, includes one's own person); and providing sound money. In fact, make that two things.

Monday, 22 September 2008

Why the poor need tax-cuts for rich people, too

There has been a lot of (welcome) talk recently about the Liberal Democrats’ pledge to cut taxes for low- and middle-income earners. This has been broadly welcomed in the party, though many have only accepted it as long as it is accompanied by a promise that the overall tax-take will remain the same, and that richer people should shoulder more of the tax burden.
This kind of “redistributionist” approach is always very popular, as most people are in the poorer rather than the richer category. It is easy to take from the minority to give to the majority, and there is no minority less sympathetic than the rich.

A counter argument might be that the only fair thing to do (and “fairness is something that the Liberal Democrats claim to take very seriously) would be to cut taxes for everybody if we are cutting them for some. But that kind of fairness - that everybody be treated equally no matter how wealthy they are - generally only cuts one way.

However, economists such as George Reisman make a far more startling claim: that it is tax cuts for rich business people and for corporations that are in the long-term interests of low and middle income wage earners; more so, in fact, than tax cuts aimed directly at the poor themselves.

Reisman’s initial point is a simple one, but one that is too often forgotten: that human society enables one to benefit from other people’s success. “The view of redistributionists…” he explains, “is that the only wealth from which an individual can benefit is his own…” The redistributionists are mistaken, however: “in order to benefit from privately owned means of production, one does not have to be an owner of the means of production… one benefits from other people’s means of production – [not only] every time one buys the products of those means of production [but] also as a seller of labor (sic.).” Capitalists invest in improving the efficiency of production so that they can enhance their profits, but in the process they make the goods we buy cheaper and make our labour more productive, so increasing real wages.

The reason that redistribution looks so attractive is because one tends to think of redistribution in terms of individual sums being transferred from a rich person to a poor person; and there can be little doubt that £1,000 is more valuable to a poor person than a rich person. But it does not follow that £100 billion is worth more in the hands of poor people overall than in the hands of rich people overall.

The problem is that “most people tend to think of themselves as members of the class of wage earners rather than separate individual wages earners, and to think of their interests as indistinguishable from the interests of other wage earners.”

In fact, while it is more in my interests that I have £1,000 than that Richard Branson does, it is no more valuable to me that a poor man in Liverpool has that £1,000 than Mr. Branson. And it is far more likely to serve my interests that a few rich people have £100 billion than huge numbers of poor people, even if £1,000 of that £100 billion ends up in my hands. The reason for this is that poor people spend a greater proportion of their money on consumption, and are more likely to consume than to invest additional sums. As Nick Clegg said in a recent interview with The Times, "give tax cuts to the better off [and] they will just save them. You have to give [tax cuts] to people on lower incomes who will transfer them into consumption on food and fuel.”

This is ceertainly true and is entirely predictable: those on the breadline would be happy for the opportunity to buy new shoes, while those who already own a yacht are free to invest extra money in their business. This is especially true for businesses themselves: business taxes leach away the money that would either be invested in improving productivity or would be paid out in the profits that attract further investment.

There is a point here that Reisman does not fully draw out, but which we can recognise today after a decade of Labour economic mismanagement. Money in the hands of the poor would create greater wealth in the short term, as a result of a consumer boom. But these consumer booms are unsustainable: buying more clothes and electronic goods does not make their production significantly more efficient. Investment makes them more productive, but this requires an investment boom. In fact, during the past decade the consumer boom has been accompanied by a dangerously low and shrinking savings rate: the West has saved almost nothing. Consequently, productivity has not risen as it should have done, which is one reason why real wages for less skilled workers (which are set by their productivity and thus by the investment in them and in the tools that they use) has not risen. Simply taking the money that would be invested in businesses and giving it to others to consume is “eating the seed corn.”

By comparison, “A tax reduction on businessmen and capitalists will promote capital accumulation, far, far more than a tax reduction on the mass of the individual wage earner's fellow wage earners. The average businessman and capitalist will save and invest the taxes he no longer has to pay, in far greater proportion than would the average wage earner, [and the businessman] will be induced to introduce more improvements in products and methods of production, which are also a major cause of capital accumulation…” In addition, “cutting the taxes of businessmen and capitalists [will] significantly … raise the demand for labor and … reduce or eliminate unemployment”. The result of increased innovation will be to enhance “the ability of upstart new firms to grow rapidly and thus to challenge old, established firms.”

Overall, “The effect of this combination is … a continually rising productivity of labor… and thus prices of consumers' goods that are progressively lower relative to the wages of labor, which means progressively rising real wage rates, so that in not too many years the average wage earner is far ahead of where he would have been on the strength of a cut in his own taxes.”

So ironically, it seems that cutting taxes for the labourers makes capitalists rich in the short term, whereas cutting taxes for the capitalists makes labourers rich in the long term.

The reason that Reisman’s argument is so challenging is that it seems to suggest that tax cuts for the poor are not in their own best interests. This isn’t mere sophistry. If productivity does not rise, real wages cannot rise. All “labour” can do is fight with “capital” and “land” for the share of wealth. This seems to be the be-all-and-end-all solution for redistributionists, who argue that the poor can only benefit at the expense of the rich. This would be true in a static economic system. But they forget that economies are (or at least should be) dynamic. The route to prosperity is through economic growth: “The average standard of living would double in a single generation if economic progress at a rate of just 3 percent a year could be achieved. Such economic progress would also mean a halving of the average wage earner's tax burden in the same period of time — if government spending per capita in real terms were held fixed.”

Consequently, the long-term prosperity of the average worker is best served by capitalists who invest for their own benefit. In seeking to further increase their own profits, capitalists invest extra money in improving productivity, which they do by buying new and better plant machinery, "upskilling" their staff and employing new and better business systems. Improvements to productivity in turn push up real wages and so benefit labourers far more than tax cuts on their own wages would. If Government can avoid the urge to “share the proceeds of growth” then wage earners will see their taxes fall anyway – not in absolute terms, but as a proportion of their rising incomes.

If there is a problem in Reisman's plan, it is that in advocating this policy of easing taxes on business and high incomes first, he overlooks the political economy of the 21st Century. No matter how correct he may be about the long term economic effects, it would be impossible to implement such tax cuts in the face of the vast majority of voters who will understandably ask why their taxes are not being cut while those of £billion businesses and rich oligarchs are. What is needed, therefore, is a sort of liberal realism that recognises that lowly paid workers, who form the bulk of the electorate, will want to see some of the short-term gain that their richer peers will enjoy as they wait for the longer term growth-benefits to kick in. One might suggest that a little honey today will keep them sweet until tomorrow’s jam arrives.

Thus if the Liberal Democrats really want to improve living standards for those on low incomes, we need to look not just to redistribution but to cutting the overall level of taxation in the economy. And we must do this by reducing taxes on businesses and among those wealthy enough to invest as well as those who will feel the benefits most in the short term. This is not about larding the rich for their own sake; it is about recognising a fundamental lesson of liberalism – that we all benefit from one another’s success – while also understanding that it is investment, not consumption, that makes future prosperity possible.

Reisman concludes that

Of course, in a further display of their ignorance and blindness, members of the Left will undoubtedly characterize the line of argument I've presented in this article as the "trickle-down theory." There is nothing trickle-down about it. There is only the fact that capital accumulation and economic progress depend on saving and innovation and that these in turn depend on the freedom to make high profits and accumulate great wealth. The only alternative to improvement for all, through economic progress achieved in this way, is the futile attempt of some men to gain at the expense of others by means of looting and plundering. This, the loot-and-plunder theory, is the alternative advocated by the redistributionist critics…. It is time to supplant it with ... sound economic theory….