Sharing the Proceeds of Recession
Having seen a shop on the high street advertising that it would pass on the proceeds of the VAT cut, one wonders what will happen when it gets raised to 18.5% later on.
Will they continue to pass the costs on, resulting in reduced trade, or will they keep their prices down, reducing their profits and thereby risking downsizing? Either way, any apparent recovery will be stymied.
It looks more and more like cynical positioning than sensible economics.
Sphere: Related ContentExploiting the Market
Looking at the VAT reduction and its timing there appears to me something of a cynical motive.
I may be completely wrong. But given that much of the mini-budget has dates that would appear to cooincide with electoral periods, it is an idea worth exploring.
I have had a job in retail, fluctuating between full and part-time employment, for the last year and a half. It is in a sector that is particularly sensitive to the state of the economy.
There has been a noticeable slump in sales this year. This is in part due to the recession, but the extent of the silence on the high street is also the result of people saving their money to buy their Christmas presents closer to the holiday.
The high street expected sales to increase in the next four weeks regardless of the PBR. Those sales will be higher this year because people are condensing their Christmas spending period. The cut therefore seems to be an attempt by the government to take credit for the actions of the invisible hand and the Christmas season. But as Freakonomics points out, correlation is not the same as causation. It is unlikely to be some sort of market rally inspired by Mr. Darling.
People spending more in the next four weeks appears more likely to be the result of Christmas than the state of VAT. The government should not be allowed to take the credit that easily.
Sphere: Related ContentPub Taxation
Courtesy of Tory Bear (who in turn copied it from somewhere else), an interesting way of thinking about taxes.
Sphere: Related ContentSuppose that every day, ten men go out for beer and the bill for all ten comes to $100. If they paid their bill the way we pay our taxes, it would go something like this:
The first four men (the poorest) would pay nothing.
The fifth would pay $1.
The sixth would pay $3.
The seventh would pay $7.
The eighth would pay $12.
The ninth would pay $18.
The tenth man (the richest) would pay $59.So, that’s what they decided to do.The ten men drank in the bar every day and seemed quite happy with the arrangement, until one day, the owner threw them a curve.
“Because you are all such good customers,” he said, “I’m going to reduce the cost of your daily beer by $20.”
Drinks for the ten now cost just $80. The group still wanted to pay their bill the way we pay our taxes so the first four men were unaffected. They would still drink for free. But what about the other six men - the paying customers? How could they divide the $20 windfall so that everyone would get his ‘fair share?’
They realized that $20 divided by six is $3.33. But if they subtracted that from everybody’s share, then the fifth man and the sixth man would each end up being paid to drink his beer. So, the bar owner suggested that it would be fair to reduce each man’s bill by roughly the same amount, and he proceeded to work out the amounts each should pay. And so:
The fifth man, like the first four, now paid nothing (100% savings).
The sixth now paid $2 instead of $3 (33% savings).
The seventh now pay $5 instead of $7 (28% savings).
The eighth now paid $9 instead of $12 (25% savings).The ninth now paid $14 instead of $18 (22% savings).
The tenth now paid $49 instead of $59 (16% savings).Each of the six was better off than before. And the first four continued to drink for free. But once outside the restaurant, the men began to compare their savings.
“I only got one dollar out of the $20,” declared the sixth man. He pointed to the tenth man,” but he got $10!”
“Yeah, that’s right,” exclaimed the fifth man. “I only saved a dollar, too. It’s unfair that he got ten times more than I!”
“That’s true!!” shouted the seventh man. “Why should he get $10 back when I got only two? The wealthy get all the breaks!”
“Wait a minute,” yelled the first four men in unison. “We didn’t get anything at all. The system exploits the poor!”
The nine men surrounded the tenth and beat him up.
The next night the tenth man didn’t show up for drinks, so the nine sat down and had beers without him. But when it came time to pay the bill, they discovered something important. They didn’t have enough money between all of them for even half of the bill!And that is how our tax system works.
The people who pay the highest taxes get the most benefit from a tax reduction.Tax them too much, attack them for being wealthy, and they just may not show up any more. In fact, they might start drinking overseas where the atmosphere is somewhat friendlier.
Once Upon a Time
There was a Labour Chancellor of the Exchequer committed to sound money, tax cuts and free trade. “He was raised in an atmosphere which regarded borrowing as an evil and free trade as an essential ingredient of prosperity”. He was subsequently expelled from the Labour Party.
A prize to whoever works out who it is.
Sphere: Related ContentThese Are Not Tax Cuts
Gordon Brown’s proposed tax cuts are nothing of the sort.
The measure can only be funded by increasing already high levels of government borrowing
Borrowing-funded tax cuts with a national debt at roughly 150% of GDP will have to be repaid at another time. This is not responsible economics; it fails to tackle any of the underlying problems in the British economy instead opting for superficial measures.
It’s loan-sharkery. The present financial crisis was brought about by irresponsible lending. We should not be promoting more of the same.
Sphere: Related ContentThe Limits of Keynesianism
Back in Fashion
The Writings of John Maynard Keynes have experienced something of a renaissance. The apparent success of the bailout to save the global financial system from itself has exposed the limitations of concepts based on absolute rationality and brought back an emphasis on the need to adopt special measures in periods of economic turmoil. With the Prime Minister finally admitting that Britain is going to enter a recession, discussion on the measures to take could not be more appropriate.
The underlying concept, that governments need to spend more during recessions, is a fundamental truth of finance. The level of public spending as a proportion of income inevitably rises during a recession as tax revenues dry up. Intervention is also a necessity in a market that operates according to the complex realities of human behaviour rather than idealised abstractions. It preserves order and prevents the irrational anarchic panic of a downwards spiral into a brutal recession. Intervention is required to establish the limits on moral hazard; protecting those liable to suffer from the irresponsible actions of others. Keynesian interventions are also necessary to preserve some of the core skills that underpin the economy. An open letter to the Times today by business and Trade Union leaders emphasises the importance of retaining the skills base of the UK economy.
It is important to remember though that Keynes was by no means an opponent of capitalism. The ideas put forward in The General Theory of Employment, Interest and Money were designed to operate as an additional refinement of the only system that has repeatedly demonstrated its effectiveness in achieving prosperity. Keynesianism does not replace capitalism, nor should it. The burdensome and inefficient economies of the 1960s and 1970s were the result of trying to operate according to such systems beyond recessions, and were in many ways woefully ineffective. Growth and demand ultimately come from below in such systems and the state is rarely a particularly efficient or effective agent. Interventions must be there for as long as necessary, not as long as possible. After the recession has ended, governments will have to reduce the size of their programmes in order to save money for the next downturn.
Bearing this in mind however we must concede that we are very poorly placed to act. Ideally, governments should run a surplus during boom years to save for the rains of the bust ones. Reductions in tax revenues during recessions make this sort of saving necessary, particularly as Keynesian programmes often need to be further supported by responsible borrowing. Unfortunately for the United Kingdom, obscene levels of public spending masquerading as “investment”, coupled with gigantic levels of public debt concealed within Private Finance Initiatives and further burdened by the nationalisations of banks that over-lent, means that very little money is available to fund such Keynesian programmes. Further spending risks completely bankrupting the country, and placing us in an even worse position than if no intervention happened at all.
Still going to happen, but the aim is to reduce their size
Nonetheless the moral imperative of intervention to insure against a complete catastrophe is necessary. Given the unpropitious political and financial circumstances any programmes will have to be limited. They must focus on more than just spending, and instead on building the infrastructure and maintaining the skills required to underpin a future period of economic growth. Projects must have clear ends beyond mere maintenance of employment, and instead focus on greater long-term goals. Keynesianism is not about eliminating recessions, but lessening their impact. It is not a panacaea, but an analgesic. Politicians must bear this in mind and avoid an orgy of self-righteous public spending that risks deepening and lengthening a recession.
One must also be aware of the limitations of projects capable of implementing the objectives of Keynes’s economics. A new government spending project takes, from conception to implementation, roughly eighteen months. That often means that by the time it is able to intervene, much of the recession has passed and a well-meaning initiative becomes just another financial burden to bear during the process of economic reconstruction. Governments should therefore be wary of new projects and initiatives proposed by various interest groups promising greater employment and infrastructure. Unless it can be demonstrated that any such projects are genuine investments (and not just expenditure masquerading as investment), they should not be supported. Unless there are genuinely good reasons to shorten the conception to implementation period, this process should, in general, be avoided. A far better method would be to expand the scope of existing projects, accelerate their implementation, and move further towards implementation those projects that have already been conceived. Working with what one has is infinitely better than having to start such projects from scratch. Crossrail and the London Olympic developments here stand as good examples, as others have already mentioned.
In all this one must however remember that much of the existing data on Keynesian programmes is skewed by the events of the late 1930s. The transition of much of the United States, Britain and Germany into total war economies means that the level of acceptable state intervention is far greater than what one could even begin to countenance in a time of relative peace. The results are therefore difficult to discern having been overtaken and distorted by events.
What none of this must conceal however is the moral necessity of reductions in public spending. The arguments for nationalisations in previous weeks does not detract from the legitimate criticisms of the inefficiency and waste of the public sector. At a moment no more timely, a report released by the Chartered Institute of Personnel and Development suggests that the public sector wastes billions by failing to adequately deal with people taking spurious sick leave. Denis MacShane, a former Labour minister, bemoaned “the waste of money on pointless projects, publications, or legions of press officers that add no value“. These inefficiencies have restricted our ability to effectively finance the measures necessary to lessen the blow of a recession, and during a recession itself, such abuses of power are inexcusable. The case for cutting spending is clear: the money is now urgently needed to be allocated to those projects and parts of the economy that are genuinely deserving of money.
The re-appraisal of Keynes in this period is necessary, but we must not accept any policy with his fingerprints on it uncritically. The government has to realise that it cannot cure the recession but only lessen its impact, and resist the nostrums many will attempt to sell under such an illusion. We must acknowledge that we are poorly placed to implement an effective series of Keynesian programmes, and that our efforts must be specific, limited, temporary and with a clearly-defined set of objectives. We should favour expanding existing programmes over new ones. Spending in non-essential sectors will have to be cut to make room for vital projects and the expansion of welfare to accommodate the unemployed. Above all, the damaging hyperbole favoured by many on the left must be resisted in favour of a more measured long-term view. We must accept the limitations of Keynes’ ideas, and must not accept any programmes with its label uncritically.
Sphere: Related ContentOn Regulation
Predictably, members of the Labour Party have begun to use the failure of the regulatory system in preventing the collapse of the UK banking system to launch a wider attack on a Conservative deregulation agenda. Bob Piper describes himself as “shocked and amazed” that
Having spent years complaining about too much regulation, excessive red tape and bureaucracy stifling innovation, some Tories have now got the brass neck to complain that there wasn’t enough regulation!!!
The question is not a case of more or less regulation per se but of better regulation. Nobody seriously disputes that regulatory frameworks are necessary for the efficient, free and fair operation of a market. The objection is the way in which those regulations were implemented. One can have the best system of rules in the world, but if they are not supervised and implemented properly, then they are useless. The Conservative objection has been to the tripartite framework that ultimately hampered our ability to effectively regulate the finance system. Tripartition slowed down decision-making processes, restricted the flow of information to the right people at the right time, and promoted a diffusion of responsibility that created unnecessary gaps in the regulatory structure. The problem was identified over a year ago, and the government failed to do anything about it.
What this misses though is that the conservative opposition to regulation is not an argument primarily related to the financial services sphere, but to a different sort of regulation. It is an argument about the excessive and burdensome level of regulation that has permeated throughout society. The sort of asinine and petty rules that discipline firemen for using their own sleeping bags, or that a computer cannot be carried 200m without appropriate training. Leaving aside the social arguments against this arbitrary extension of state power (which the previous link addresses), the conservative economic argument is that these rules ultimately restrict the ability of businesses to operate efficiently in return for dubious benefit. I invite anyone who seriously believes that all these regulations are necessary to look through the following list of risk assessments and suppress their laughter or groans. Imposing the levels of regulation and paperwork on businesses ultimately distracts them from performing their primary functions: making money and providing jobs. In so doing they limit the growth of the economy.
Paranoid “Health and Safety” regulations are not the same thing as the rules on which the financial system operates, and it is a specious argument to suggest that they are.
Sphere: Related ContentCommon Responses to the Crisis
This is a reposting of an article that originally appeared on John Redwood’s blog, but given the proliferation of misinformed opinions around the financial crisis it deserves wider dissemination.
Sphere: Related ContentLast night I travelled to Hatfield to speak at a dinner. The roads were eerily emptier on a Friday night - a sign of things to come. I am grateful to the audience - and to all of you bloggers - for your thoughts on the crisis. I would like to comment on some of the most common responses.
“Too much deregulation caused this mess” - showing the eternal power of Labour spin. The extreme version blames Margaret Thatcher for this “crisis of capitalism”!
The great difficulties in banking have occured in the most regulated of industries. Regulation of banks and other financial institutions has expanded greatly in recent years. This is a failure of regulation as well as a failure of banking. It is not that we had too little regulation - we had the wrong type of regulation regulating the wrong things, allied to weak regulation of what matters, capital and liquidity.“People like you called for deregulation, so you caused the problem”!
This is the fatuous BBC line. It ignores the fact that I issued warnings about the dangers of the Bank of England have too little power to regulate banks and other financial institutions. It also is a muddled proposal in its own terms, as an Opposition MP calling for something does not mean that something happens! I thought Labour was in government and calling the shots on how much regulation we needed.“Banks should not be allowed to lend more than they get in deposits, so they would be stable.”
The run on the Rock which brought the Rock down shows that deposits are not a stable source of cash if confidence goes. There is a lot to be said for a model where a bank draws its money from a wide range of sources, to reduce risk.“Banks should not borrow short and lend long”
Borrowing short and lending long is a normal banking approach to making money and helping the economy. Done in moderation it makes sense. The interest rate is usually higher for longer term loans than for short terms. Intelligent exploitation of this difference can earn a return for bank shareholders. Of course, taking it to extremes can jeopardise confidence. The problem in the summer of 2007 was the Central banks, especially the Bank of England, left markets so short of short term funds a crisis was likely.“It’s not fair of you to call for lower interest rates - this means savers will be hit”
In this crisis we are all going to be hit. Savers can only enjoy high rates of interest if people and companies can afford to pay even higher rates of interest to borrow the money. If rates are too high too little money is borrowed, and too high a proportion of exisitng borrowings are not repaid. Savers and borrowers depend on each other. At the moment it is too difficult for borrowers, so the savings rates have to come down to prevent the system breaking down completely. I would have thought the experience in the Icelandic banks might start to show savers the dangers of wanting too high a rate of interest for current conditions.“We should limit people to borrowing just 3 times their income again, as they used to do, when taking on a mortgage”
I agree banks and Regulators need to look again at how much they are prepared to lend against any individual property, and how big a multiple of income they will allow. Today, however, the problem is not limiting the amount banks will lend, but getting them to lend enough. This is a something for the future when banks do want to lend more. Many of us were warning against the extreme deals we saw being advertised in 2006-7 before the crunch.“Nationalising the banks would sort all this out - why don’t they just do it?”
Transferring problems from the shareholders to the taxpayers sorts out nothing. The day after you still have the same underperforming loans and the same need for extra cash and capital. The banking sector is too big as a whole for the UK state to take on. Why should the UK taxpayer have to pick up the losses, when we did not enjoy the bumper years for banking profits and bonuses?
Time for Fiscal Conservatism
At this juncture the efforts of all parties to alleviate the financial crisis has focused on extracting the nation from the turmoil rather than any general questions of principle. Nick Clegg summarised this mood at Prime Minister’s Questions, saying “when the ship is sinking you send for the lifeboats, you don’t argue about who sailed it into an iceberg”. Her Majesty’s Loyal Opposition would not want to appear opportunist or opposing for its own sake, lest they be blamed for thwarting a rescue plan without very good reason.
Nonetheless when the dust settles and the immediate crisis gives way to a more lingering period of gloom it will become necessary to unravel the myths of the Age of Irresponsibility and articulate a new economic agenda for the coming years.
We must observe some basic realities. First, capitalism is neither discredited nor dead. It remains the only effective economic system available to humanity, and no alternative has emerged in the past few weeks that would have fared any better. The failures at the heart of the current crisis are ones that have been committed by both public and private sector alike, and there is nothing to demonstrate that full state ownership of the economy or its strategic sectors would have made much difference. The British government is just as culpable for excessive borrowing, failure to properly account for risk, hidden debts and regulatory failure as any single bank. Outside the narrow focus of the financial sector, the fundamentals of a market based around the private ownership of property remain, and with little to challenge them.
Second, there is no such thing as an absolutely “free market”. It is an abstraction that forms the basis of an economy from which reality dictates that we must on occasion deviate. Human limitation necessitates government intervention to preserve the good of the market as a whole. Interventions are required to limit contagion and panic, preventing irrationality bringing the system crashing down. They are also needed to protect the innocent and provide the investment required to get the economy moving once again. Intervention in times of crisis has been a part of capitalism since the days of John Maynard Keynes.
Faced with these basic economic realities, the basis for new economic policy ought not to come from some crude reworking of Marx or Smith, but a re-affirmation of fiscal conservatism. Briefly, this can be considered a commitment to living within one’s means in both the public and private spheres. It is wedded to a wider conservative intellectual tradition in its respect for traditions and acknowledgement of history, with a cautious approach to new ideas. In this analysis, it is also worth including the general conservative suspicion of social engineering as tending to hurt those it most desires to help.
In the United States it has become clear that the sub-prime mortgage crisis that helped trigger the financial downturn was the result of this social engineering. The Clinton administration, keen to get poorer people onto the property ladder, pressured banks into relaxing their rules on mortgage lending. As a result the banks took on bad debts that they knew were particularly risky. The poorest were encouraged to take on debts that they could not repay in the event of a downturn, encouraged by a government that saw this as the promotion of a public good. This social engineering reached its ultimate conclusion with the most vulnerable now facing a widespread threat of repossession as they default on debts many can never hope to repay.
A basic understanding of history would have helped rein in the excesses of state and private sector spending. The hubristic rhetoric of an end to “boom and bust” that inspired people to spend like there was no tomorrow should have been viewed with suspicion. Human limitations render any economic system liable to downward spirals fuelled by the combination of self-interest and fear. The historic phenomenon of the economic cycle must be respected, acknowledged and planned for accordingly. Instead the government entertained and promoted an arrogance that discouraged any preparation for the proverbial rainy day. The favouring of abstract idealism over prudence and the evidence of the past made us particularly vulnerable.
Likewise a respect for traditions and established practices within the financial sector would have limited the extend of the toxic assets plaguing western economies. Conservatism argues effectively against the radicalism of the social engineers who pressured banks into overly risky lending, favouring established practices that underpinned a stable financial system. More importantly, a traditionalist philosophy provides an effective critique of the complex systems of derivatives that concealed so much bad debt. The very novelty of these instruments and their application should have been grounds for suspicion. Rather than eagerly jumping on the bandwagon, banks should have been more sober in their approach, looking for hidden flaws and unintended consequences, and integrating these instruments gradually and carefully into the financial system. Their failure to do so gave rise to assets that failed to be properly assessed, and whose toxicity is only now starting to emerge. The fear gripping Wall Street and the City is the direct result of its failure to adequately assess these financial instruments for risk when they were first introduced.
At the levels of personal expenditure this form of conservatism would have urged far more sensible habits. The culture of debt that has left so many now facing greater financial hardship was inspired by these twin views of infinite economic growth and an abandonment of traditional cultural attitudes to personal debt. Had governments not been telling people that the good times would never end then it is likely that people would have been more circumspect about their own borrowing. The example set by government to private citizens and enterprises over borrowing will also have helped cause some of the present pain. Rather than abandoning our cultural disdain for debt, we should have preserved the tradition in favour of ill-conceived mathematical sleights of hand.
Fiscal conservatism calls on governments to live within their means. As established earlier, governments have to intervene in economies in order to preserve them. During these periods they have to increase public spending. This bails out businesses to limit the spread of contagion; funds the increased demands on welfare to accommodate those who become unemployed in a recession, and funds both tax cuts and investment in infrastructure required to stimulate growth. What differentiates this from socialist systems of market intervention is its temporary and limited nature. For such interventions to be effective, let along possible, it is necessary for governments to strictly limit their borrowing and spending during years of growth. They must maintain a system where ideally a surplus is run up or, more realistically, debt is kept at a low, manageable, level. This is necessary because the reduced company profits and employment levels during a recession lowers the amount of revenue governments can raise through taxation. The principle of this school of fiscal conservatism is that it makes governments save in the good times to provide for society in the lean years.
In this light the growth in public spending and borrowing, inspired by the ahistoric and idealistic approach to economics outlined above, moves from the imprudent to the disastrous. By spending so much the government has drastically restricted its ability to intervene effectively to deal with both the crisis and the recession: it lacks the funds to do so. This will be exacerbated by its failure to address the problems in its benefits system, which will be placed under significant strain as unemployment starts to rise. Unless the government is willing to seriously curtail public spending in favour of the affordable, the United Kingdom risks becoming bankrupt. That would hurt the economy so severely as to ruin our industry for possibly a decade or more. This is not an argument in favour of cutting essential services to finance generic tax cuts, but a basic proposition of government spending only what it can afford. The profligacy of the past eight years was entirely unsustainable and irresponsible and it will have to be drastically retrenched. Any effort to do so will be particularly difficult as downsizing departments has costs of its own in the form of redundancy payments and pension obligations. Nonetheless it is essential for the wider health of the British economy and the public finances.
In these difficult times the need for fiscal conservatism is more pressing than ever. It offers an account of the events that caused the crisis, an assessment of the failures that have hindered efforts so far, and offers solutions to limit the damage and rebuild the economy. Moreover it provides a set of clear and basic principles by which governments can operate if they wish for the next downturn to be less excruciating.
Sphere: Related ContentWindfall Taxation is Lunacy
The left wing of the Labour party have written a letter to the Guardian calling for a windfall tax on the profits of oil and energy companies in the face of the rising costs of living. The problem is that this proposal is utterly illogical and counterproductive.
First, let’s look at some simple flaws in the thinking. A windfall tax can only be levied against those companies that operate in UK legal jurisdiction through ownership. When it comes to the oil companies, that leaves us with BP and half of Shell. Levying a tax on them would be damaging to British industry, hampering its ability to compete. As a result investment will go elsewhere and the overall tax revenues will decrease.
Any revenue raised will not help those in fuel poverty. With the public finances in as parlous a state as they are presently, the chances of revenues being ring-fenced for this purpose are roughly equal to Lord Lucan being found in bed with Nessie. It is a luxury the government simply cannot afford. Moreover, the proposed use of the money on a large-scale insulation scheme would take so long to implement that it would provide little in the way of tangible relief for those in fuel poverty.
More importantly, those who are going to modernise Britain’s energy supplies in the next decade will be the energy companies themselves. Taxing their profits, rather than encouraging responsible reinvestment, will hamper our ability to conduct research into cleaner forms of energy and power stations. Money will be diverted from research and development. The problems we need to deal with now will come back to haunt us later. The “victory” of a windfall tax would be Pyrrhic.
The only thing this tax is likely to provide more fuel for is the recession, worsening the lot of the poorest in Britain. The theory the proposal is based on is that the energy companies are squeezing the consumer to further their own self-interest. Just look at the language of envy the letter employs. Based on that assumption, the logical conclusion is that any increase in taxes, even if on a one-off basis, will be passed on to the consumer. The result: further rises in energy prices. A windfall tax is entirely counterproductive in that it will be the taxpayer, not the energy company, who ultimately pays it.
A windfall tax, if it is to exist at all, should only be used in the most extreme scenarios where no alternatives exist. If they are used outside these limited situations then they will scare off investors. The UK economy is already poorly placed to deal with the oncoming recession, and reducing profitability further will only worsen the investment environment. That will lead to further economic slowdown, the results of which will be greater unemployment, and rising costs of living.
The biggest oil profiteer
Let us for a moment however accept the logic of the letter. The idea is that the money gained in increased revenues from rising oil prices is hurting the citizen, and should therefore be redistributed to them. In that case the biggest culprit is not the energy companies, but the government. The UK pays the highest fuel taxes in Europe despite having some of the lowest fuel prices prior to taxation. If the money made from rising oil prices is “unearned”, then so is the increased revenue the Treasury gains from these taxes. The biggest beneficiary of the rise in oil prices has been Her Majesty’s Treasury, to the tune of around six billion pounds. That is far more than any windfall tax could provide.
If Compass seriously want to ease the cost of living for the poor, they should be encouraging Alisdair Darling to reduce its taxes on fuel and VED. This proposal for a windfall tax is little more than economically-illiterate unreconstructed envy politics. All it will do is help usher in another period of 1970s stagflation, all for the sake of a poorly conceived project that will be of little immediate benefit for those currently in fuel poverty.
Sphere: Related Content
