All 41 entries tagged Economics

Taxing the Rich: Redistribution Versus Citizenship

Writing about web page http://www.ft.com/cms/s/0/30177568-61fa-11e1-807f-00144feabdc0.html#axzz1tpB8SkZF

Always a hot potato, the top rate of tax is getting hotter. George Osborne is under fire for cutting taxes on incomes over £150,000 from 50p to 45p (this rises to 56p in the pound if you include payroll taxes). In the United States the marginal rate on incomes over $388,000 is 35 cents (rising to 42.5 percent with Medicare and payroll taxes) but many allowances mean it's not always paid. Barack Obama wants to put in place a "Buffet tax" to ensure those earning more than a million dollars pay at least 30 percent on average. François Hollande, likely winner of the French presidential election, wants to set a 75 percent tax rate on incomes above a million euros.

One way to understand the issues at stake is to recognize and reflect on two conflcting purposes of taxation in a democracy. In one view, taxes go along with citizenship. In the other, taxes help to re-engineer society. Where should we strike the balance?

• Taxation in a democracy

Many journalists and some economists write about taxes as if the optimum rate should be the one that maximizes the revenue from it. As a general principle, that can't be right. To understand why not, ask yourself what rate a coolly rational totalitarian dictator would set who treated the public finances as his personal housekeeping money and cared nothing for social welfare. This ruler would set taxes to maximize his revenue -- would he not?

What level would that be? Even for a dictator, the optimal tax rate is not 100 percent. The reason is that all taxes are in some degree "distorting," that is, they are a disincentive to engage in the activity that is taxed, so that the economy becomes less efficient and less is produced. Think of taxes as a proportion t of income, so if T is the revenue and Y is the income then T = tY. Because taxes are distorting, as you push up t, Y falls. When t = 100 percent, the disincentive to produce is so overwhelming that Y is zero and so is tY. Reduce t; Y will grow and so will tY up to a point. At some point, the product of t and Y is maximized.

Actually, a farsighted ruler might set today's taxes below even this level, and forego some of the revenue available today for the sake of more revenue tomorrow. Why's that? He would be aware that higher taxes may cause lower growth (Heady et al. 2008; Arnold et al. 2011). If so, the dictator who maximizes his revenue today will encounter lower revenue tomorrow. Given this, a dictator might well choose to hold back today and encourage the economy to grow so that he will be able to levy taxes from a larger base in the future.

If we take the dictator as a benchmark, how should a well-meaning democratic leader set taxes, having internalized the welfare of society? As Mançur Olson (1993) pointed out, the dictator values only his own welfare; the democratic leader values the welfare of society, which includes private income as well as public revenues. In the same spirit, the dictator seeks to avoid the distortions associated with taxation only to the extent that they undermine his own revenue, and will be indifferent to private losses; the democratic leader will set some value on the private losses too.

For these reasons the democratic leader should set income taxes at much less than the rate that a dictator would set. If even a dictator should go below the rate that maximizes revenue in the short term, the democratic leader should go some way below that.

Summary: maximizing revenue is not a legitimate purpose of taxation in a democracy.

• Taxing top incomes

Why then do some economists advocate setting the upper rate of income tax at the revenue-maximizing rate? In a recent paper Peter Diamond and Emmanuel Saez (2011) argue that the optimal rate that should be levied on the top 1 percent of U.S. incomes is more than 70 percent. They find this to be optimal because it would extract the maximum revenue from upper income recipients, taking into account the fact that they will probably reduce their taxable income in response. For given revenue needs, extracting the maximum out of the richest in society would then minimize the burden on taxpayers with lower incomes.

The underlying logic is diminishing marginal utility. The social benefit of a dollar consumed by the rich, Diamond and Saez argue, is much less than that of a dollar consumed by the poor. For example, if the benefit of consumption increases in proportion to the logarithm of income, then each doubling of income would increase well being by a given amount. They estimate that a dollar of consumption when income is at the top-1-percent margin in 2007 (around $1.4m) is worth less than 4 percent of a dollar when income is at the median ($53k) in the same year. One way of improving social welfare, they conclude, is take dollars from the rich family (which hardly misses them) and give them to the poor family (to whom it means a lot). On this argument, the result of putting up taxes on top incomes and reducing taxes on middle incomes is that well-being will rise on average.

Where do you stop? Because 4 percent is close to zero, Diamond and Saez summarize, the value of marginal income to the very rich is so low that we can ignore it. It follows that the tax rate on upper incomes that maximizes social welfare is pretty much the same as the tax rate that maximizes the revenue from the tax -- and this turns out to be around 73 percent.

Summary: Diamond and Saez make a case for maximizing revenues from top incomes -- even in a democracy. Since this is pretty much textbook stuff, what is there to disagree with? I'll set out two views of taxation. In one view, taxes are an instrument for redistribution. In the other, taxes go with citizenship. Both views can be taken to an extreme. I'll argue that both extremes are undesirable, but it's important to acknowledge the link from taxes to citizenship. There is no such link in Diamond and Saez.

• Taxation for redistribution

In this debate, Diamond and Saez are extremists for social engineering. That is, they subordinate all other considerations to distributing welfare as evenly as possible. Before I go on to the other view, I'm going to say why I think this is economically misconceived. There are several reasons.

First, the Diamond-Saez framework presumes that everyone maps income onto personal well being at the same rate at each income level. I've explained the average relationship. But people are not all average. An example can give the intuition. Suppose my income is $1.4m. (It's not, and never will be. I make this clear for those readers that don't easily get the difference between a working assumption and a tax declaration.) To repeat, suppose my income is $1.4m. At that point, I may well value a dollar of consumption at less than 4 percent of a dollar when my income falls to $53k. It does not follow that I will value a dollar of my consumption at less than 4 percent of the value the next guy puts on a dollar when his income is at $53k.

Think about it: If my income was 30 times his, was I luckier, or better connected, or more talented than him, or did I just want money more than he did? A new paper by Eugenio Proto and Aldo Rusticchini (2012) suggests that the slope of the relationshp between income and life satisfaction differs systematically for people with different personality traits, so this is not an abstract possibility. If so, taking money from me, given that I have more because I value it more highly, and giving it to him, when he has less because he values it less, is not an obvious way to improve average well being.

[Now for a short digression. Some readers might stop short here and ask: "Why ever not? That's exactly what I want to happen!" Maybe you'd get personal satisfaction from taking money away from me, precisely because I value it. I understand that; if so, however, your preference is likely to be rooted in a dislike of rich people and high consumption. Some people who take this line dislike bankers, neglecting the simple fact that many people with high incomes have nothing to do with finance. Others do not think anyone should receive an income 30 times the median on principle -- even though their own consumption may well be 30 times what was the median in their own country just 200 years ago, or 30 times the median income of some other country just 2,000 miles away. All these people are expressing a third view of taxation, namely taxing people because you don't like their values and want to punish them. That's enough about that.]

The same issue has a more general form. It is about giving the government the authority to treat everyone as an average citizen with average abilities and average preferences, to discount entirely the welfare of some of them at the margin, and radically to re-engineer the distribution of income, motivated by the wrong assumption that we are all the same (or if we're not that's too bad). It's egalitarian, certainly; but not, perhaps, in a good way.

If you followed the logic of taxes as social engineering to the limit, you'd want the government to set everyone an individual personal tax schedule, based on knowing deeply each person's individual capabilities, endowments, and preference map. That way lies a dystopian nightmare. We should neither pretend to have this information nor expect to be able to gather it. The collection of such knowledge in one place woujld be more consistent with a totalitarian state than with a decentralized, free market economy.

Finally, we all pay an economic price for social engineering. On top of the other evidence linking higher taxes to lower growth, Arnold et al. (2012) also show that a higher top rate of personal income tax is damaging specifically to productivity growth in industries that have high rates of firm entry. They suggest this arises because new firms have to take more risks and are also less likely to be incorporated. In other words, there is a channel through which raising taxes on top incomes is likely to make the market economy less dynamic. That matters too.

Summary: I've given several reasons not to follow the logic of taxation for redistribution to the limit.

• Taxation and citizenship

The alternative view can be summed up as "no representation without taxation." In a democracy, taxes are a membership due, or a moral obligation on the citizens to share society's burdens as well as benefits. Our democracy needs most families to pay their dues and so, when they vote, to have a stake, however small, in how (and how much) public money is raised. This view is also widely held, although it pops out most commonly when people react against tax loopholes for the rich and tax allowances for charitable giving. Shouldn't these people pay their taxes first?

The logic here is that you pay because you're an citizen. Equal citizens should contribute equally. Again, this is not something to take to extremes. Why not? The logic of taxes as membership dues is that everyone pays. To my British readers I'll say: Remember the poll tax. For others, the poll tax was Margaret Thatcher's attempt to fund local government through a level tax on all householders, and it arguably destroyed her premiership. In fact, not everyone can pay; their ability to pay is not equal. Many regular clubs and societies recognize ability to pay through concessionary rates for the young, the old, the sick, and those out of work. Just about all tax systems recognize ability to pay through income tax thresholds and marginal rates that rise with income. In this way, they modify the citizenship concept with a necessary nod to redistribution.

Diamond and Saez call their paper "The Case for a Progressive Tax." As far as I'm concerned, the case for income tax to be progressive was already made. I didn't need convincing. Given unequal ability to pay, the rich should pay more than the poor in proportion to their incomes. But the case Diamond and Saez make goes far beyond that: they advocate a tax system that completely confiscates the marginal social benefit of consumption from top incomes in order to minimize the burdens lower down. In their framework the middle and lower income families become clients of the state, not citizens. There is no acknowledgement that citizens have obligations, or that voters should have a private stake in how public revenue is raised. They push redistribution to an extreme, diminish citizenship, give the government too much power, and threaten long term damage to the market economy.

Summary: While remaining progressive, our fiscal system should leave room for an element of tax-paying as an attribute of citizenship. Everyone who can should pay something; only the neediest should pay nothing. The rich should pay at a rate higher than that on the middle and poor, but taxes on upper incomes should not aspire to confiscate all the gains from effort, enterprise, and talent. (And, if we leave untaxed a signficant share of the returns to effort, enterprise, and talent, we'll also have to accept that we leave undisturbed some part of the gains to connections and luck.)

In British terms, if the poorest pay nothing, and the middle pay 20 percent, then the rich can clearly pay 40 percent. That seems fine. The rest is politics.

References

• Arnold, Jens Matthias, Bert Brys, Christopher Heady, Åsa Johansson, Cyrille Schwellnus, and Laura Vartia. 2012. Tax Policy for Recovery and Growth. Economic Journal 121:550, pp. F59-F90. Available at http://ideas.repec.org/p/ukc/ukcedp/0925.html
• Johansson, Åsa, Christopher Heady, Jens Arnold, Bert Brys, and Laura Vartia. 2008. Tax and Economic Growth. OECD Economics Department Working Paper No. 620. Available at http://ideas.repec.org/p/oec/ecoaaa/620-en.html
• Olson, Mançur. 1993. Dictatorship, Democracy, and Development. American Political Science Review 87:3, pp. 567-576.
• Diamond, Peter, and Emmanuel Saez. 2011. The Case for a Progressive Tax: From Basic Research to Policy Recommendations. Journal of Economic Perspectives 25:4, pp. 165–190. Available at http://ideas.repec.org/a/aea/jecper/v25y2011i4p165-90.html.
• Proto, Eugenio, and Aldo Rustichini. 2012. Life Satisfaction, Household Income and Personality Traits. The Warwick Economic Research Papers no. 988. Available at http://ideas.repec.org/p/wrk/warwec/988.html

Mark Harrison : 04 May 2012 12:27 |  Tags: Economics Politics Taxes |  Comments (0) |  Close comments |  Report a problem

Political Costs of the Great Recession

Writing about web page http://www.ft.com/cms/s/0/5b1b5556-8d1d-11e1-9798-00144feab49a.html#axzz1styV0LMT

Monday's Financial Times recorded the dismal showing of Nicolas Sarkozy in the French Presidential first-round election, the record vote for France's far-right National Front, and the openings to the right of Sarkozy and François Hollande, who remain in the contest, as they compete to sweep up the votes of the eliminated candidates.

It reminded me of a recent NBER working paper by Alan de Bromhead, Barry Eichengreen, and Kevin O'Rourke on Right-wing Political Extremism in the Great Depression. (There's a non-technical summary on VOXeu.) What these authors show is that the rise of right wing extremism in the Great Depression was not just a German phenomenon. They define extremist parties as those that campaigned to change not just policy but the system of government. They look at 171 elections in 28 countries spread across Europe, the Americas, and Australasia between 1919 and 1939. They find that a swing to right-wing "anti-system" parties was more likely where the depression was more prolonged, where there was a shorter history of democracy, and where fascist parties were already represented in the national parliament. In short, de Bromhead and co-authors conclude, the Depression was "good for fascists."

I don't mean to imply that either Sarkozy or Hollande are fascists. They aren't. Neither of them wants to replace electoral democracy by authoritarian rule. But they are responding to the protest vote in their own country by proposing "solutions" to the problems of the already weakened French market economy that will weaken it further by increasing government entitlement spending, government regulation, and tax rates.

Where does the protest vote come from? There is anger and pessimism. There is a search for alternatives to free-market capitalism and representative democracy. The problem is that all the alternatives are worse. But none of the candidates (perhaps with the exception of François Bayrou, who did badly) has been willing to say this.

How do we know that all the alternatives are worse? We know it from history.

The chart below shows the total real GDPs of twelve major market economies from 1870 to 2008 (the countries are Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Italy, Netherlands, New Zealand, Norway, Sweden, Switzerland, United Kingdom, and United States; data are by the late Angus Maddison at http://www.ggdc.net/maddison/). The vertical scale is logarithmic, so the slope of the line measures its rate of growth.

You can see two things. One is the steadiness of economic growth in the West over 140 years up to the recent financial crisis. The other is that two World Wars and the Great Depression were no more than temporary deviations. They are just blips in the data. For many people they were hell to live through (and sometimes these were the lucky ones), but in the long run the economic consequences went away. In fact, recent work by the economic historian Alexander J. Field has shown that the depressed 1930s were technologically the most dynamic period of American history.

One conclusion might be that the economic consequences of the current recession are not the ones that we should fear most. I don't mean that the economic losses arising from reduced incomes and unemployment are trivial; life today is unexpectedly hard for millions of people, young and old. Young people, even if they will not be a "lost" generation, will suffer and be scarred by the experience. If you're old enough, you could be dead before better times come round again. At the same time, the kind of pessimism that says that our children will be never be as well off as we were is groundless. The economic losses associated with the recession will eventually evaporate, just as the economic losses of the Great Depression went away in the long run.

We should be more afraid of the lasting political consequences. The effects of the Great Depression on politics were very deep and very persistent. World War I ended with the breakup of the German, Austro-Hungarian, Romanov, and Ottoman Empires. In the 1920s, most of the new countries that were formed became democracies. Then, we had the Great Depression. Across Europe there was anger, pessimism, and a search for alternatives to free-market capitalism and representative democracy. By the end of the 1930s Europe had recovered economically from the depression but most of the new democracies had fallen under dictators. That led to World War II, in which as many as 60 million people were killed. Fascism was defeated, but then Europe was divided by communism and that led to the Cold War.

It took until 1989 for the average of democracy scores of European countries (measured from the Polity IV database) to return to the previous high point, which was in 1919.

In short, the Great Depression stimulated a search for alternatives to liberal capitalism. This search was extremely costly and completely pointless. For a while in various quarters there was admiration for Hitler, Mussolini, or Stalin, their great public works, their capacity to inspire and to mobilize, and their rebuilding of the nation. But both fascism and communism turned out to be terrible mistakes.

Memories are short. Today's politicians want your vote. And many voters want to hear that some radical politician or authority figure has a quick fix for capitalism. It seems like we may have to learn from our mistakes all over again. Let's hope that the lesson is less costly this time round.

Mark Harrison : 24 Apr 2012 22:04 |  Tags: Economics Hitler Politics Recession Stalin |  Comments (1) |  Close comments |  Report a problem

Russia's Great War, Civil War, and Recovery

Writing about web page http://www2.warwick.ac.uk/fac/soc/economics/news/?newsItem=094d43a2365e99f001366436ff461cde

Tomorrow I'm flying to Moscow to collect a prize, which I will share with my coauthor Andrei Markevich. This is the Russian national prize for applied economics, which was announced last week. The prize, sponsored by a consortium of Russian universities, research institutes, and business media, is awarded every second year. The award is for our paper "Great War, Civil War, and Recovery: Russia’s National Income, 1913 to 1928," published in the Journal of Economic History 71:3 (2011), pp. 672-703. A postprint is available here.

The spirit of the paper is as follows. In 1914 Russia joined in World War I. In 1917 there was a revolution, and Russia’s part in that war came to an end. A civil war began, that petered out in 1920. It was followed immediately by a famine in 1921. We calculate that by the end of all this Russia had suffered 13 million premature deaths, nearly one in ten of the population living within future Soviet borders in 1913. After that, the Russian economy recovered, but was soon swept up in Stalin's five-year plans to "catch up and overtake" the West.

We calculate Russia’s real national income year by year from 1913 to 1928; this has never been done before on a consistent GDP basis. National income can be measured three ways, which ought to give the same answer (but rarely do): income (wages, profits, ...), expenditure (consumption, investment, ...), and output (of industry, agriculture, ...). We measure output. Data are plentiful, but of uneven quality and coverage. The whole thing is complicated by boundary changes. Between 1913 and 1922 Russia gave up three per cent of its territory, mainly in the densely settled western borderlands; this meant the departure of one fifth of its prewar population. The demographic accounting is complicated not only by border changes but also by prewar and wartime migrations, war deaths, and statistical double counting.

Our paper looks first at the impact of World War I, in which Russia went to war with Germany and Austria-Hungary. Initially the war went went well for Russia, because Germany found itself unexpectedly tied down on the western front. Even so, Germany quickly turned back the Russian offensive and would have defeated Russia altogether but for its inability to concentrate forces there.

During the war nearly all the major European economies declined (Britain was an exception). The main reason was that the strains of mobilization began to pull them apart, with the industrialized cities going in one direction and the countryside going in another. In that context, we find that Russia’s economic performance up to 1917 was better than has been thought. Our study shows that until the year of the 1917 revolution Russia’s economy was declining, but by no more than any other continental power. While wartime economic trends shed some light on the causes of the Russian revolution, they certainly do not support an economically deterministic story; if anything, our account leaves more room for political agency than previous studies.

In the two years following the Russian revolution, there was an economic catastrophe. By 1919 average incomes in Soviet Russia had fallen to less than half the level of 1913. This level is seen today only in the very poorest countries of the world, and had not been seen in eastern Europe since the seventeenth century. Worse was to come. After a run of disastrous harvests, famine conditions began to appear in the summer of 1920 (in some regions perhaps as early as 1919). In Petrograd in the spring of 1919 an average worker’s daily intake was below 1,600 calories, about half the level before the war. Spreading hunger coincided with a wave of deaths from typhus, typhoid, dysentery and cholera. In 1921 the grain harvest collapsed further, particularly in the southern and eastern grain-farming regions. More than five million people may have died in Russia at this time from the combination of hunger and disease.

Because we have shown that the level of the Russian economy in 1917 was higher than previously thought, we find that the subsequent collapse was correspondingly deeper. What explains this collapse? The obvious cause was the Russian civil war, which is conventionally dated from 1918 to 1920. However, we doubt that this is a sufficient explanation. First, the timing is awkward, because the economic decline was most rapid in 1918 and this was before the most widespread fighting. Second, there are signs that Bolshevik policies of economic mobilization and class warfare were an independent factor spreading chaos and decline. These policies were continued and even intensified for a year after the civil war ended and clearly contributed to the disastrous famine of 1921.

Because of the famine, economic recovery did not begin until 1922. At first recovery was very rapid, promoted by pro-market reforms, but it slowed markedly as the Soviet government began to revert to mobilization policies of the civil-war type. We show that as of 1928 the Russian recovery was delayed by international standards. The result was that, when Stalin launched the first five year plan for rapid forced ndustrialization, the Soviet economy's recovery from the Civil War was not complete. By implication, some of the economic growth achieved under the five-year plans should be attributed to delayed restoration of pre-revolutionary economic capacity.

In concluding the paper, we reflect on the state in the history of modern Russia. It seems important for economic development that the state has the right amount of "capacity," not too little and not too much. When the state has the right amount of capacity there is honest administration within the law; the state regulates and also protects private property and the freedom of contract. When the state has too little capacity it cannot prevent outbreaks of deadly violence, and security ends up being privatized by gangs and warlords. When the state has too much capacity it can starve and kill without restraint. In Russian history the state has usually had too little capacity or too much. In World War I the state had too little capacity to regulate the war economy and it was eventually pulled apart by competing factions. Millions died. In the Civil War, the state acquired too much capacity; more millions died.

Andrei Markevich and I have many debts. Our first thanks go, of course, to the sponsors of the prize. After that, we are conscious of owing a huge amount to our predecessors, many of whom should be better known than they are, but I'm going to leave the history of the subject to those interested enough to consult the paper. A number of people helped us generously, especially Paul Gregory, Andrei Poletaev, Stephen Wheatcroft, and the journal editors and referees. Of course, I'm personally grateful to Andrei. It’s hard to say which of us did what (between May 2009 and January 2011 our paper went through exactly 50 revisions), but you’ll see that Andrei is named as first author.

Beyond any personal feelings, I'm thrilled by the recognition of economic history. When he announced the award, the jury chairman Professor Andrei Yakovlev was asked if this wasn't an "unexpected" outcome for an award in applied economics. Yakovlev described it as an "important precedent," recognizing that "explanations of many of the processes that we have seen in Russia in the last twenty years lie in history." He pointed out that most western countries have historical national accounts going back through the nineteenth century (and England's now go back through the thirteenth). Such data help us to understand the here and now, by showing how we got here.

Mark Harrison : 02 Apr 2012 12:58 |  Tags: Economics History Russia Stalin War |  Comments (2) |  Close comments |  Report a problem

The EU Shows the Risks of Selective Intervention

Writing about web page http://www.bbc.co.uk/news/world-europe-16803157

As Europe's leaders leave Brussels with a new fiscal treaty, I found myself thinking back to last June when Nicolas Sarkozy said:

Without the euro there is no Europe and without Europe there is no possible peace and security.

It makes you wonder how we got to this. If true, it would make the well-being and security of all Europeans hostage to the future of the Euro. Yet the euro is a relatively recent invention. It was not around for the first half century of the postwar era. Europe was peaceful and the European Union was working effectively long before the euro was brought in.

Given the model was already working reasonably well without the euro, you could understand Sarkozy to mean that Europe's architects willfully introduced a new feature that, if then removed one day, would bring it crashing to the ground. How dangerous is that!

Confronted by the possibility of eventual Eurozone disintegration, which the new fiscal treaty does not remove, I caught myself thinking:

If only Europe's builders had stopped with the single market.

The single European market, enacted between 1987 and 1992, was a huge achievement. The single market eliminated physical, technical and tax-related barriers to free movement [of goods and people] within the Community. The single market was enforced by tough laws that improved competition. In turn, competition and free trade within the community raised average productivity and incomes.

The European economy wasn't perfect. The common agricultural policy remained a blot on the European rural landscape. There was continual pressure on the member states to harmonize national social, employment, and fiscal policies. Within the single market itself there were still national currencies. The single market was marked by regional price differences arising from exchange rate fluctuations, currency exchange costs, and the lack of transparency associated with pricing in different currencies. The transaction costs alone might have been worth a few billion euros.

But perhaps it would have been better to have stopped there with the single market, and gone on paying those billion-euro costs, than to move on to the next stage of currency unification, ultimately facing today's trillion-euro costs of Eurozone bailouts and possible collapse.

Why didn't we hold the line there? What I forgot for a pleasant moment was the logic of the time. This logic led remorselessly onward from the single market to the single currency.

With hindsight the logic is sometimes portrayed as a simple economic inevitability, as if the single market just demanded to be made even better by a single currency, and would have been forever incomplete without it. "Without the euro there is no Europe"? Not so. There was an inevitability at work, it's true, but this was determined by politics, not economics.

You can think about it on the lines of what Oliver Williamson once called the impossibility of selective intervention. We'd like selective intervention to work like this. We live in a market economy, but from time to time the market fails. Then, when it fails, and only then, we'd like the government to step in and sort it out. When they've done that, we'd like them to stop.

In other words, in the best of all possible worlds, government intervention would be limited selectively to those measures that can improve social welfare over the results of the market economy. That way, surely, we would have the best of everything: the market when it succeeds, and government intervention to fix it when the market fails.

What could be wrong with that? Why can't we have the best of everything? The fundamental reason why selective intervention is impossible can be put like this:

A government that has the power to intervene when it chooses in the interests of the community also has the power to intervene when it chooses to serve its own interests.

In the case of the single market, Europe's leaders once saw an institutional deficit. For centuries, the competing nations of Europe were sources of technological, cultural, commercial, and industrial revolution. Revolution was spurred by rivalry. Too often, rivalry led to war. There was an institutional deficit, Adenauer, Schuman, and Spaak believed, that led European countries to make war, not trade. They decided to intervene to fix it.

The solution they sought was to bind Europe's nations together commercially. The European Economic Community, the forerunner of today's European Union, was the means to fill the institutional deficit that they perceived. But that turned out not to be enough. The next project was the European Union and the single European market.

In the process, they created a self-serving international bureaucracy. The European Commission in Brussels was supposed to oversee the single market. A legislature in Strasbourg was supposed to oversee the bureaucracy. But the lack of a strong popular European identity that could frame political competition on a continental scale led to Europe to exchange one institutional deficit for another.

Instead of an institutional deficit there was now a growing democratic deficit. That deficit became a refuge for politicians that had failed on the national stage or, as we sometimes call them, "elder statesmen." Defeated in a national election? Stand for the European Parliament. Just lost your party leadership? Become a European Commissioner. With a few exceptions these were vain, limited people. Unlimited only in their ambition, they tried to take control of Europe's destiny and shape it in their own interests.

What were the interests that the single currency served? It was another grand project. The worst fate of any political bureaucrat must be to enter office and be told there's nothing to do. Whoever got reelected or promoted by doing nothing? Every politician needs a stream of projects to oversee, institutions to build, offices to fill, and funding to allocate.

For such people, building the single market could never been enough. They needed something more to build after that. The single market was just a phase that added to their momentum. The logic of selective intervention is that nobody tells you when it's time to stop, and there is always good reason to go on. We could never have just "stopped there."

Not knowing when to stop is at the core of the impossibility of selective intervention. Selective intervention is supposed to improve things. And it can do this, up to a limit. But in the real world the limit of improvement is always fuzzy. If the government fixed one thing that needed fixing, this creates the justification for it to go on to fix something else. If that turns out to have made things worse, then this too becomes justification for another fix. There's never a reason to call a halt.

This is how a beautiful dream went too far, and so became a bit of a nightmare.

Mark Harrison : 31 Jan 2012 08:41 |  Tags: Economics Euro Politics |  Comments (1) |  Close comments |  Report a problem

A Flood of Cheap Chinese Goods

Writing about web page http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1964156

Late in the Old Year, I listened to a radio interview. The question was: "What has the world gained from China's emergence into global trade?" The response was something like this:

A few countries have gained by selling raw materials to China -- Australia, Canada, parts of Africa.

What about the rest?

The rest of us have just had to face a flood of cheap Chinese goods.

To me this neatly encapsulated one of the central tenets of Do-It-Yourself Economics:

Production (and exports) good. Consumption (and imports) bad.

The mixed feelings with which the world's media greets the deluge can be readily illustrated by Googling the search terms "flood" and "cheap Chinese goods." On a recent morning, the first page of search results yielded the following:

Brazilian factories tested by Chinese imports - FT.com
But a growing flood of cheap Chinese manufactured goods into Brazil is testing the relationship. “The relationship with China is important but, ...

Why do we allow cheap chinese goods to wreck the western economies ...
Why do we allow cheap chinese goods to wreck the western economies? we sell them very little where they flood our markets with cheap products that used to ...

artificially cheap Chinese goods « Savvy Writers & e-Books online
What many American, Canadian and European citizens don't grasp is this: The flood of artificially cheap Chinese goods, putting America out ...

UK retailers tell Brussels: we want cheap Chinese goods | Business ...
UK retailers tell Brussels: we want cheap Chinese goods ... He has warned that a flood of cheap T-shirts and flax yarn is harming producers in Italy, ...

Chinese tyres cause accidents: police | The Zimbabwean
The flood of cheap Chinese goods has also retarded the reopening of many industries which cannot compete with the goods of cheaper quality. “I urge people to ...

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The reality is somewhat less dramatic than these quotes would suggest. What proportion of the goods that our firms and households buy is actually sourced from China? Almost certainly, less than you think.

In 2010, for example, the UK imported goods from China worth £30.6 billion (see the 2011 edition of the Pink Book published by the Office of National Statistics). This sounds like a lot, but is only two percent of the UK's £1.5 trillion national expenditure, or three percent of household consumption. Even this will overstate the proportion of British expenditure originating within China's borders since many Chinese exports incorporate components previously imported into China from abroad. In short, the Chinese economic tsunami is really more of a ripple, although a growing one.

Why is the perception so much more dramatic than the reality? Several reasons.

• China sells things that nearly every household is likely to buy, such as clothes, toys, and consumer electronics.
• These things are especially salient because they are sources of pleasure.

Oh -- and the domestic firms that are displaced by the Chinese goods we prefer then noisily beat the drum of "unfair" competition by tricky foreigners in pursuit of a clever plan to wash away our industries. You can hear that drumbeat clearly in the Google search results above.

Anyway, never mind the facts. Just how bad is this and how much worse can it get? We can learn something from a historical parallel: the tale of Indian textiles in the nineteenth century.

The last time we saw a flood of cheap goods from a single country was in the nineteenth century. At this time British factories sent a tidal wave of cheap textiles across the world. By 1913, Lancashire was providing four yards of cotton cloth for every man, woman, and child on the planet. The world price of textiles came crashing down.

Who lost and who gained? Most obviously, they gained whose labour and capital was employed in the Lancashire cotton mills. At its peak, cotton employed half a million English workers. These won a living wage, while the profits went to the Manchester millocracy and their agents overseas. At the same time the English cotton interest took only a small fraction of the total gain. They had to share the rest with 1.8 billion global consumers, many of whom found they could afford comfortable, washable, durable clothing for the first time. The mechanism that distributed this global gain was the market: as prices plummeted, more and more people in distant lands could pay for a cotton shirt or even a suit.

There were a few losers. These were the world's artisan spinners and weavers. The products of their hand labour were previously a luxury; only the well-to-do could afford them. When a new product came along that consumers preferred and could pay for, the same market mechanism that shared the gain from Lanchashire's high productivity across the world told the handloom weavers: "Stop now. You can find something better to do."

When the history England's industrial revolution came to be written, Lancashire's contribution was well remembered. But its gift to the world was little emphasized or ignored. Instead, what was remembered was the destruction of Indian hand spinning and weaving.

How were Indian consumers affected by the destruction of native artisan textiles? Did the flood of cheap British goods wash away the basis of Indian economic life? It should be possible to tell. A simple test would be this: Whatever happened to India's production of textiles, what happened to consumption? If the Indian economy was truly wrecked by imported cloth, then India's masses would surely have been excluded from the benefits.

A new paper by Tirthankar Roy tells the story. It comes in two parts:

Part 1. 1820 to 1860

• The Indian price of imported cloth relative to prices of hand-spun cloth fell by 80 percent.
• The outputs of Indian hand spinning and weaving did not change.
• Cloth imports into India rose from nothing to around four fifths of the level of domestic cloth production.
• Consumption of cotton cloth per head of the Indian population rose by about 60 percent.

Part 2. 1860 to 1900

• The price of imported cloth relative to those of hand-spun cloth fell by a further 50 percent.
• Hand weaving fell by one third and hand spinning disappeared.
• But it was new Indian cotton mills, not English mills that displaced the products of Indian handloom weaving; the total output of Indian cloth did not change.
• Cloth imports rose by two thirds, reaching around twice the output of domestic weaving.
• Consumption of cotton cloth per head of the population rose by a further 40 percent.

What's important here? Two simple facts:

• First, the flood of cheap English textile did not destroy the Indian textile industry. Native spinning and weaving were restructured by competition and became much more efficient.
• Second, however difficult was the transition, Indian consumers became better off on average at every stage of this process, and were markedly better off at the end compared with the beginning.

To summarize, innovation is local but the gains from innovation are global. Adjustment to changes in national competitive advantage is psychologically painful and economically difficult, as the English textile industry discovered in the twentieth century. But the same competition in international trade is the mechanism that redistributes the gains from innovation in one country to consumers in all countries.

In conclusion, whatever you think of Chinese politics or nationalism, the flood (or floodlet) of cheap Chinese goods is not a threat. Those whose business competes directly with Chinese products should aim to beat the competition or get out of the way. Whether they succeed or fail is up to them, and that's how it should be. Either way, there is a gain to be won from China's entry into the world market, and the gain will accrue to all the world's consumers, that is to say, to every one of us.

Mark Harrison : 03 Jan 2012 13:03 |  Tags: China Economics India Politics |  Comments (0) |  Close comments |  Report a problem

The Euro: What If …

Writing about web page http://blogs.ft.com/the-world/2011/12/eurozone-crisis-live-blog-19/#axzz1fweCvEJB

What if the Euro collapses? There's already more than enough speculation about that. I'm wondering what will happen if the Euro survives.

Since survival is always conditional, let's ask: What happens if the Euro survives the next three years, which should be enough to take us into the next upswing. Also, we know for sure that the Euro cannot survive in its present form, but let's say there is just enough peripheral shake-out (say, a Greek exit), enough extra liquidity (a "wall of money" to shield the other vulnerable countries from contagion), and enough institutional reform (movement towards a fiscal union) that in 2014 a currency union is still in place with most of its current members.

What then? With all eyes focused on financial and fiscal turmoil, the underlying problem is being forgotten: The Eurozone is still not an optimum currency area.

Robert Mundell (1961) first set out the conditions for a group of countries to benefit from monetary integration: He argued that, to make an optimum currency area, the member states must be convergent in at least one of the following:

• They should experience similar shocks, and respond similarly to them.
• Or. they should have flexible (high-mobility) labour markets.
• Or, they should have competitive (flexible-price) product markets.

If these conditions were met, the real exchange rates of the different member states of a currency union would remain aligned. Without them, a structural mismatch would inevitably evolve. Full employment with low, stable inflation in all parts would be impossible. Unless some parts of the currency union would accept rising inflation, other parts would risk permanent depression.

Using forecast bilateral exchange rate volatility with Germany to measure convergence, Bayoumi and Eichengreen (1997) showed that, from the start, many current Eurozone member states did not not "fit" the Eurozone. Encouragingly, they did find a pre-existing trend towards convergence on the part of countries like Greece, Italy, Spain, and Portugal (but not France or the UK).

There was then a short debate about whether the Eurozone might experience continued convergence so that, although not an optimal currency area at the outset, it might become one. Frankel and Rose (1997, 1998) were for. Feldstein (1997) was against. Then, the Euro was launched. For a while everything seemed fine. But we know now that Feldstein was right.

Behind the scenes, with the Euro in place, previous efforts towards convergence stopped. Greece, Italy, Spain, and Portugal moved further and further away from Germany, not towards Germany. This is shown by statistical series from productivity growth to real exchange rates, trade integration, and fiscal imbalances.

In other words, the Eurozone today is no more of an optimal currency area than it was in 1999 when the Euro was launched. The peripheral countries have not made their markets more competitive. With rare exceptions, labour is unwilling to move across frontiers. The economies of the Eurozone remain "otherwise different" in fundamental ways.

Behind current efforts to save the Euro is still the theory that Greece and Italy can eventually be made more like Germany. If fiscal union is not to commit Germany to subsidize the periphery forever, then it can only mean the application of ever more pressure. German prices must be allowed to bear down cruelly on Mediterranean costs. Their public finances must be topped and tailed to fit the Procrustean bed of German frugality. In the face of ever increasing pressure, the culture of the periphery must surely give way.

But this is almost exactly the same theory that was applied from 1999 to the present, and was found wanting. Pressure was tried before; the only difference in current efforts is the addition to "pressure" of the words "ever increasing."

In other words, whatever their short run expedients, in the long run, Merkel and Sarkozy plan to hold the Eurozone together by the exercise of pure will. Just as Europe's leaders ignored the Mundell criteria in 1999, they will continue to do so. They believe politics can trump economics.

Leadership matters. The price tag of a disorderly collapse of the Euro looks large enough that its leaders should try to avoid our having to pay it. But what can one say of leadership into a cul de sac? The willpower required to hold the Euro together in anything like the form currently envisaged is completely lacking in any Europe-wide popular mandate. The belief that Europe's leaders can look each others' national cultures in the face and remake them arbitrarily goes against all evidence.

In short: What if the Euro survives its present stage? Current efforts will buy time, at best. When time has been bought and paid for, the original flaw will still be there. A Eurozone that is sustainable indefinitely will be limited perhaps to Germany, Austria, and Benelux. It might not even include France, however hard that is to imagine. It will not include the UK.

References

• Bayoumi, Tamim, and Barry Eichengreen. 1997. Ever Closer to Heaven? An Optimum-Currency-Area Index for European Countries. European Economic Review 41:3-5, pp. 761-770.
• Feldstein, Martin. 1997. The Political Economy of the European Economic and Monetary Union: Political Sources of an Economic Liability. Journal of Economic Perspectives 11:4, pp. 23-42.
• Frankel, Jeffrey A., and Andrew K. Rose. 1997. Is EMU More Justifiable Ex Post Than Ex Ante? European Economic Review 41:3-5, pp. 753-760.
• Frankel, Jeffrey A., and Andrew K. Rose. 1998. The Endogeneity of the Optimum Currency Area Criteria. Economic Journal 108:449, pp. 1009-1025.
• Mundell, Robert. 1961. A Theory of Optimum Currency Areas. American Economic Review 51:4, pp. 657-665.

Mark Harrison : 08 Dec 2011 12:18 |  Tags: Economics Euro Greece Politics |  Comments (1) |  Close comments |  Report a problem

The Return of DIY Economics

Writing about web page http://www.ft.com/indepth/autumn-statement-growth-review-2011

Some years ago, David Henderson coined the phrase"do it yourself economics." DIY economics, he argued, was made up of the practical models of causation that ordinary people use to understand the economic world around them. In the world of DIY economics, he noted, public spending and exports are good because they create jobs;industry is more deserving of support than services; cheap goods made by foreigners are a curse, not a blessing; and whatever the problem is, the government ought to do something.

DIY economics is clearly expressed in responses to yesterday's autumn statement by the Chancellor. I'm going to comment on just one aspect: the length of causal chains. In the world of DIY economics there is never more than one step from cause to effect. I will give two examples, one concerning the burden of taxes and another concerning the housing market.

First, who bears the burden of taxes? In the world of DIY economics, if you tax the rich and give a benefit to the poor, the rich become poorer and the poor become richer. Full stop. In other words, the burden of taxes is borne by those that write the cheques. The converse must also be the case, as Polly Toynbee argues in this morning's The Guardian:

George Osborne's autumn statement blatantly declares itself for the few against the many ... What was missing from his list? Not one penny more was taken from the top 10% of earners. Every hit fell upon those with less not more. Fat plums ripe for the plucking stayed on the tree as the poorest bore 16% of the brunt of new cuts and the richest only 3%.

The chain of causation suggested by modern economics is somewhat longer, yet each step is still simple and transparent. The burden of taxes is spread beyond those that write the cheques to the government. Ultimately, who pays for a tax on profits? A tax on profits increases the cost of capital to firms, so that less capital is employed and every worker is less productive. The result is lower wages (as well as lower profits). A tax on labour increases the cost of labour to firms, so that fewer workers are employed. The result is fewer jobs (as well as lower wages and profits).

In short, who writes the cheque is a poor guide to whether a particular tax will help the poor. Whether taxes are levied on capital or labour, the workers bear much of the cost, which is likely to exceed the revenue raised.

Second, who should we blame for the mess that George Osborne is trying to tackle? In the world of DIY economics, there is only one step from cause to effect. So, if you see the effect, you only have to go one step back to find the cause. The recession began with a credit crunch, so the suppliers of credit, the bankers, are to blame for everything. Most certainly, we are not to blame. This morning, as public sector workers strike to protect their pensions, my facebook page is full of comments that replicate the following confident assertion:

Remember when Teachers, Policemen, Police staff,Ambulance staff, Nurses, Midwives, Doctors and Fireman crashed the stock market, wiped out Banks, took billions in bonuses and paid no tax? No, me neither. Please copy and paste to status for 24 hours to show your support against the government's latest attack on pensions and public sector workers.

Behind this, however, lies a longer chain of causation that implicates us all. Where did the credit crunch come from?* The sub-prime housing market. Mortgage lenders in western economies had overextended credit to households that had no hope of repaying from their incomes. What provided the impetus to excess housing credit? Well meaning government policies that had responded to rising inequality by promoting and subsidizing "affordable" housing (actually the opposite). Bankers and mortgage lenders colluded actively with this, of course. So I'm not particularly delighted that part of the British government's strategy for economic revival is new help for homebuyers. Haven't we been here before?

Then, why did the housing crash ripple so devastatingly through the economy? Because the same governments had already given up their room for fiscal manoeuvre by bloating their public sector wage bills and unfunded pension promises. (Promises to whom? Oh! Teachers, policemen, ambulance staff, nurses, midwives, doctors and firemen.)

So, Mr or Mrs Public Sector Worker: No, I don't let you off the hook. In fact, no one should feel free of responsibility. I might blame the last Labour government, but somebody must have voted them in. (It might have been me.)

Not everyone will agree with this diagnosis. In the real world, causal chains are long and complex. For the same reason, they are also generally uncertain. That is enough reason for disagreement, before we get around to ignorance, bias, and vested interests! The one claim I make confidently, however, is that one-step causation is rarely enough.

* To anyone who wants to read more, I recommend any of the following. There's an American tilt in my list; I don't think our own investigators have done a good job yet (but more recommendations are welcome).

• Gretchen Morgenson and Joshua Rosner, Reckless Endangerment: How Outsized Ambition, Greed, and Corruption Led to Economic Armageddon (Time Books, 2011).
• Raghuram Rajan, Fault Lines: How Hidden Fractures Still Threaten the World Economy (Princeton University Press, 2010)
• John B. Taylor, Getting Off Track: How Government Actions and Interventions Caused, Prolonged and Worsened the Financial Crisis (Hoover Press, 2009).

Mark Harrison : 30 Nov 2011 08:14 |  Tags: Economics Politics Recession |  Comments (7) |  Close comments |  Report a problem

Plan B or not to B

Writing about web page http://clients.squareeye.net/uploads/compass/documents/Compass_Plan_B_web.pdf

Plan B was launched over the weekend to much fanfare. There was much excited analysis in The Guardian. In The Observer, one hundred economists told George Osborne that Plan A is failing.

I will focus on one small aspect, the Plan B critique of current fiscal policies. Behind Plan B is the idea that "current policies … may do the very opposite of their avowed intention, by actually increasing the deficit." The logic underlying this argument extends he Keynesian multiplier: public spending cuts put people out of jobs and reduce their incomes, so that they pay less in tax; if taxes fall by more than spending, the deficit will widen, ending in higher, not lower public debt. Turn this argument around and there would be scope, apparently, for Britain to spend its way out of debt.

Another idea behind Plan B is that "the UK national debt is not large by long-run historical standards." Judging from the historical record, it seems, Britain can easily afford a higher public debt. While debt reduction may sound virtuous, it is suggested, it is currently unecessary (and the policies designed to achieve it may be actively harmful).

The outcome of Plan A, according to Plan B, is economic "sado-masochism": We are enduring the pain of public spending cutbacks to no purpose (since the cutbacks will not reduce the deficit) when the purpose (to reduce the public debt) is not even necessary in the first place. Or is there pleasure for some in the pain of others?

This weekend, by coincidence, the Royal Economic Society Newsletter (no. 155, October 2011) published my short paper Surely You're Joking, Mr Keynes?This paper makes two points.

First, it's true that Britain has carried much larger debts relative to its GDP in the past, but this was almost entirely the result of wars; do we have a comparable excuse today? It's completely unhistorical, moreover, to compare Britain's credit today with that obtainable when Britain was the world's dominant economic and financial power. The world has changed; is that something we still need to get used to?

On this, I conclude:

Historically, having a debt twice the size of the national income has been a sign that something went terribly wrong: a run of major wars, for example. Faced with the worst recession in 80 years, the British government was right to let its budget go into deficit temporarily. At that moment an increase in Britain’s debt was inevitable. Now it looks essential to bring it back under control over a few years.

Second, there is no robust evidence in the historical data that deficit reduction is self-defeating. There is claimed to be evidence, but I show that it crumbles when you touch it. On average, in fact, deficit reduction has reduced the national debt -- as one would expect.

Here, I conclude:

It remains true that, once the public debt is set on a particular course, it is hard to change that course quickly. But this is only momentum that takes time to reverse; there is no evidence of destabilizing pushback from Keynesian multipliers.

To sum up: I have taken aim at two common beliefs about the British public finances. One is that we should borrow our way out of recession; the other is that we can spend our way of debt. These beliefs are based on intriguing stories. But, like many good stories, they are fictions. Our country cannot spend its way out debt. In today’s world, we can afford to borrow much less than in the past, and that may be just as well.

Mark Harrison : 31 Oct 2011 15:26 |  Tags: Economics Politics Recession |  Comments (4) |  Close comments |  Report a problem

Predator v Wealth Creator … Or Not?

Writing about web page http://www.bbc.co.uk/news/uk-politics-15081234

"Are you on the side of the wealth creators or the asset strippers?" Ed Milliband asked the Labour Party conference (September 27, 2011).

Milliband tells a morality tale with two sides. On the good side are the producers, who "train, invest, invent, and sell." On the bad side are "the predators ... just interested in the fast buck, taking what they can out of the business." The example is "what a private equity firm did to the Southern Cross care homes. Stripping assets for a quick buck and treating tens of thousands of elderly people like commodities to be bought and sold. They may not have sold their own grandmothers for a fast buck. But they certainly sold yours."

In reality, the Southern Cross story is not one of asset stripping. There are two ways to think about this, one simple and one more complicated, but they lead to the same conclusion.

Here's the simple story. In 2004 Blackstone, a private equity firm, bought Southern Cross for £160 million. When Blackstone sold its last stake in 2007, Southern Cross was profitable, solvent, and worth £770 million. This was a story of asset growth, not assets stripped.

Now for the more complicated story. Over this period, Blackstone actually bought, amalgamated, restructured, and eventually sold three care providers: Southern Cross, NHP, and Ashbourne Care. Before acquisition, all of these companies were already operating predominantly on leased property. This included NHP, but the latter owned the property company as well as the care provider, with the latter leasing its homes from the property company. Blackstone separated out the property company and sold it. The care provider continued to lease the same homes, but these were now under the ownership of RBS, which sold them on to the sovereign wealth fund of Qatar. Southern Cross itself also sold off and leased back 21 properties -- a small number within its eventual total of 750 homes.

Why did this make sense? At this time the housing market bubble was inflating rapidly; a collapse was inevitable. Blackstone did exactly what my colleague Andrew Oswald was recommendingfor private families: sell property, put the proceeds into shares, and move into rented accommodation. What Blackstone did was not strip assets but change their form -- property for cash, which could go into business expansion.

In the process the Blackstone directors made a huge amount of money. Where did this money come from? It did not come from selling anyone's grandmother. Blackstone's profits came from two sources. One was a rationalization of the assets of the three care providers. On this, you'd have to say that Blackstone took a long view of the future of the care industry. You could call that view right or wrong, but it was a long view. The other source of Blackstone's profits was from selling near the peak of the housing bubble. Here there was a clear loser, but it was not the customers or shareholders of Southern Cross, who were saved from a huge capital loss. It was the Qatari investment authority, which was holding the homes when the crash came.

Why then did Southern Cross fail subsequently? As a public company, Southern Cross saw its revenue squeezed by government austerity, and allowed its occupancy rates to sag, while at the same time borrowing too much. You could blame it on circumstances, or on poor management, but it was not a result of asset stripping, which did not take place.

If Southern Cross is not a good example of asset stripping, then what of Ed Milliband's larger point? Asset stripping does happen; aren't we all its victims? Here we need a little precision. Some asset stripping is criminal. Suppose the employees of a company steal the roofing and wiring and sell off the materials on the side. The victims are the shareholders. That's rightly against the law. But that's not the point here. Milliband was talking about legal asset stripping by the owners of a business. What this means is that you buy a business and, instead of operating it, you sell off the property, the machinery and stocks, sack the employees, and take the cash.

You have the right to do it; does that make it right?

It sounds terrible.

But think for a moment: why would someone do that? You would make money on it, only if the market value of the parts of the company were greater than the value of the company as a whole. If that were not true -- if the value of the company as a going concern exceeded the sum of values of its parts -- you'd make more money by keeping the company going and either running it yourself, or hiring someone to run it for you, or selling it to someone else who would do just that.

In technical terms, when the market value of the parts of the company exceeds the value of the company as a whole, its Tobin's q is less than one. Now, any first year textbook will tell you that, if Tobin's q is less than one, you can increase the value of the company as a whole by shrinking its capital -- not replacing it as it wears out, or selling it off. Oh -- that sounds like asset stripping!

There are three points of interest. One is all the economics textbooks that tell us that what the world calls "asset stripping" is a normal response to a normal situation. Of course, that in itself doesn't make it right.

Another interesting thing is that you can't decide to become an asset stripper without taking the long view into account! How's that? Think: If the company is truly worth more in the long term as a company than the disposal value of its parts now, someone will be willing to pay you that value now, to take it off your hands as a going concern and prevent you from breaking it up. And you will make more money by selling it on than by breaking it up and selling the parts. So it is the logic of the market that makes you take the long view into your calculation.

Finally, the ability to make that hard decision -- if it's better to break up and sell the assets than manage the company for the long term -- is essential for the long term health of the market economy. If we can't run down declining industries, we would still all be mining and weaving -- and we would all be as poor as the miners and weavers of today's global economy. In fact, we would be poorer, because today's miners and weavers can at least afford mobile phones that are designed and produced by people who gave up mining and weaving long ago for something more productive.

To conclude, asset strippers are not the predators of the market economy. They are the carrion eaters, the recyclers. Nobody wants to cuddle a vulture, and no party conference will ever give them a cheer. Yet they play an essential part in the global ecology. It's not a case of predator v. wealth creator, or even asset stripper v. wealth creator. All play their part.

Mark Harrison : 29 Sep 2011 12:13 |  Tags: Economics Politics |  Comments (2) |  Close comments |  Report a problem

Britain's 50p Tax Rate: The Evidence Against

Writing about web page http://www.ft.com/cms/s/0/d92b0bc4-d7e9-11e0-a5d9-00144feabdc0.html

On his excellent blog Analysing British Politics, my Warwick colleague Wyn Grant (with whom I taught The Making of Economic Policy last year) has announced: Economists disagree shock. Yesterday, nineteen other economists and I signed a letter in the Financial Times urging a rapid retreat from Britain's "temporary" 50p tax rate on higher incomes. Today, two more economists (Alan Manning of LSE and Warwick's own Andrew Oswald) have responded, noting that the evidence linking personal location decisions to marginal tax rates is unimpressive. Wyn points out, also, that the precise fiscal effects of the 50p tax rate will not be known for some time.

It is no surprise to find that economists disagree. Wyn and I teach on our course that the world is complex; we often remain uncertain about exactly how causation works, even long after the event. Uncertainty is not the same as total ignorance, however. While the letter that I signed emphasized the tax competition argument against the 50p tax rate, I supported the argument on other grounds for which there exist clear empirical foundations. Because economic causation is uncertain, there is also contrary evidence. I place particular emphasis on the evidence I've selected, partly because I regard those that have produced it as fine scholars.

First, those who support higher income taxation appear to ignore the price we pay in economic welfare. With rare exceptions, taxes distort the allocation of resource and worsen economic efficiency. Some do this more than others. We can rank them by the losses they cause per unit of revenue raised. It turns out that taxes on immovable property cause the smallest losses, followed by consumption taxes and taxes on movable property. Taxes on personal income cause more losses than any of these. Only profit taxes are worse from this point of view. This finding is from work by Åsa Johansson, Christopher Heady, Jens Arnold, Bert Brys, and Laura Vartia, based on data from 21 OECD countries, 1970 to 2005: "Tax and Economic Growth," OECD Economics Department Working Paper No. 620 (2008).

Second, those who think it's okay for the Exchequer to grab some extra money every now and then from the rich, or from banks or oil companies, ignore the price we pay for a volatile, unpredictable tax regime. When businesses contemplate long-lived investments, they must predict the structure of taxes five or ten years in the future. They need a clear idea of where the line will be drawn between public and private property, and where taxation and regulation will start and stop. Temporary taxes are bad, because they can be withdrawn or added to with equal probability. "Regime uncertainty" is bad because businesses lose confidence that they will be allowed to reap the benefits of their ventures. Our world is full of new opportunities, yet business investment is flatlining because of such uncertainties. The baleful role of "regime uncertainty" in prolonging the Great Depression in the United States under the New Deal has been documented by Robert V. Higgs in his article "Regime Uncertainty: Why the Great Depression Lasted So Long and Why Prosperity Resumed after the War," The Independent Review 1(4) (1997), pp. 561-590. From this point of view one thing that is wrong with our 50p tax rate is that it is temporary; it should not have been introduced in the first place, and our current indecision is making that worse. Another thing is what it stands for: a populist willingness to raid the rich on the pretext of collective guilt for past and future crimes.

Third, social justice is said to require tax cuts for the poor before the rich. I understand this argument but I find that it is faulty on several grounds. Richer households already pay far more than their share of income taxes. The one percent of taxpayers that pay the 50p tax rate contribute around one quarter of all income tax receipts. What is the principle of social justice that says this is not enough? Besides, the most important measures that will get low-income households out of poverty are job creation, welfare reform, and investments in the family life of children before school (because inequalities in educational outcomes are significantly formed before children ever get to school, and because higher rates of family breakdown contribute in distinct ways to both rising inequality and some children's stunted pre-school development; see The Hills Report: An Anatomy of Economic Inequality in the UK. Report of the National Equality Panel (John Hills, Chair; Mike Brewer; Stephen Jenkins; Ruth Lister; Ruth Lupton; Stephen Machin; Colin Mills; Tariq Modood; Teresa Rees; Sheila Riddell). London: The Government Equalities Office (2010)). Higher taxes on rich people are either irrelevant or harmful to these objectives.

Fourth, it has been said that the economy will benefit more from tax cuts for those on low incomes, because poor people will spend the money and the rich won't. As far as temporary tax changes are concerned there is little basis for this view in either economic theory or evidence. The best recent evidence comes from the United States where John Taylor has shown the complete lack of response of household consumption to the mailing out of millions of tax rebates in 2008 and 2009 and to the "cash for clunkers" programme. For a diagram that says it all, go to http://johnbtaylorsblog.blogspot.com/2010/10/cash-for-clunkers-in-macro-context.html.

Fifth, it has been said that the rich deserve punishment for bringing the current recession on us. I understand the sentiment but I reject it. It assumes that the only wealth is that gained at the expense of the community. This cannot be true in general: Britain is one of the richest countries in the world, despite our present troubles, because of 250 years of private enterprise, not because of government intervention or controls. I acknowledge that some people gained at the expense of others and this played a part in the financial crash that preceded and caused the recession. Some (not all) were bankers (and not all bankers were at fault in this). This is a serious issue. But the appropriate response is to punish those guilty under the law, and strengthen competition regulation and financial regulation, not to inflict arbitrary collective punishment on the entire class of people on whom we must rely to rescue our economy from its present plight. Besides, it is clear that politicians should share the blame for what went wrong. The credit crunch began in the housing market, which is already highly regulated in most western economies; politicians and regulators were deeply implicated in the overextension of subprime credit. The most convincing argument (measured by standards of evidence and logic) that I have found is that advanced by Raghuram Rajan in his book Fault Lines: How Hidden Fractures Still Threaten the World Economy (Princeton: Princeton University Press 2009).

Finally, it has been said that the signatories to the FT letter are self-interested, because they are surely all 50p tax payers. On this I speak only for myself. I am not even close, and I never will be. My only reason to oppose this tax is concern about the harm done to the community in which I live.

Mark Harrison : 08 Sep 2011 22:28 |  Tags: Economics Politics Recession |  Comments (0) |  Close comments |  Report a problem