The Bank should raise rates now

No, not the European elections – the really significant news is that the Bank of England’s outgoing deputy governor, Charlie Bean, says he expects UK interest rates to rise pretty soon. He expects the official interest rate, which has been at its post-crisis ‘emergency’ rate of 0.5%, to rise in “baby steps” to around 3% between 2017 and 2019. That is below the rate of about 5% that prevailed before the financial crash, but then world conditions remain shaky, so this is where Bean expects things to settle for a while.

We have long known that all nine members of the Bank’s interest-rate-setting Monetary Policy Committee concur that interest rate rises will need to be very gradual, but there seems to be a growing mood that the process needs to start sooner rather than later if this gradualist plan is to succeed. Many economists (including me in my new book The Economics of Success) have been saying for a while that the UK economy is racing ahead too fast – reminiscent of the unsustainable credit and house-price boom that got us into our financial fix in the first place.

Any rise in interest rates, even “baby steps”, will cause problems for business and domestic borrowers. When rates are at 0.5%, even a baby step of 0.25% represents a big increase. Sure, real-world interest rates are already above this figure set by the Bank, but the point remains. There will be mortgage defaults, and some of those 40,000 zombie businesses identified by the Adam Smith Institute will fail.

That is not entirely a bad thing. Our present economic pain is the result of our cheap-credit binge of the late 1990s and early 200s. It is the hangover after the party, and sadly, a hair of the dog will not cure it, but make the inevitable reckoning worse. Boom-time assets, financial, physical and human, need to be reassigned to more productive uses. We cannot live in a fantasy economy forever.

The most pain, as usual, will be felt by taxpayers. The government does get away with paying very low rates for its borrowing – partly because in these turbulent times it is regarded as about the least-unsafe place to put your savings. Even if rates go up in baby steps, the impact on the government’s interest bill will be large. There will be more business-killing calls to “make the rich pay more”.

It all goes to show: F A Hayek was right: the best policy is not to get into boom-bust cycles in the first place.

Liberalism day is 16th June

Monday 16 June has been chosen as Liberalism Day. The idea is to recapture the world ‘liberal’ from the American left – who, with their extravagant plans for government spending and taxation are far from Liberal in the true sense. As Milton Friedman put it in his 1955 article, Liberalism, Old Style:

“Liberalism, as it developed in the seventeenth and eighteenth centuries and flowered in the nineteenth, puts major emphasis on the freedom of individuals to control their own destinies…. Liberals favoured free competition at home and free trade among nations. They regarded the organisation of economic activity through free private enterprise operating in a competitive market as a direct expression of economic freedom and as important also in facilitating the preservation of political liberty.”

That is all a far cry from American ‘liberalism’. as the term has been used since the 1930s. That is not about free competition and individuals controlling their own lives, but about the New Deal era of public works, Lyndon Johnson’s Great Society and direct market interventions like the Community Reinvestment Act (which kicked off the whole sub-prime mortgage debacle) and Barack Obama’s recent, forlorn, efforts to completely reconstruct the healthcare sector, not on market principles (which it sorely needed) but according to the political conception of himself and his party.

Liberalism is a perfectly good word, but it does not actually mean anything like all that. it is about time that we Liberals took back out own word, without having to quality it by the foreword ‘Classical’ or the afterwords ‘in the European sense’. Check out the website, and tweet the hashtag #LiberalismDay on or around 16 June.

Minimum wages cost jobs

The leader of the UK’s opposition Labour Party, Ed Miliband, outlines plans today to tackle low pay with a five-year plan to set a new, higher, minimum wage, linked to average earnings. This, it is said, firmly puts tackling inequality at the heart of the party’s 2015 general election campaign.

The motive may be noble, but the policy itself is mistaken. A minimum wage helps only those who are already in work. It makes life more difficult for the very poorest, namely those who are out of work.

A minimum wage raises the cost of employing people. That is its whole purpose. But higher wage costs mean that employers – already under financial pressure from domestic and foreign competition, from everyday business costs, and from the costs of government regulation and taxation – have only two options. They can either hire fewer people, or toughen working conditions – cutting holidays, providing fewer breaks, spending less on the work environment.

Professors Richard Vedder and Lowell Gallaway from the United States – which has a much longer history of minimum wage legislation than the UK – explained all this as long ago as 1995, in their Adam Smith Institute report Minimum Wage Costs Jobs.

And the evidence is clear. When minimum wages were introduced in the UK in 1999, they did not seem to add to unemployment. But the starting rate was set very low initially; and the UK was then already on the cusp of one of the biggest (and as we now know, disastrous) credit-fuelled booms in history. With business and employment racing ahead, the job-killing effect of a low minimum wage was hard to see.

It became much easier to see after the 2008 financial crash, though. The first people that hard-pressed employers dispense with, and the last they choose to hire, are people like unskilled workers, young people who need to be trained up, women who want flexible hours, minority groups, and people on benefits who may have to learn or re-learn the habits of work.

These are the very groups that the policy is intended to help. But the post-crash unemployment statistics, with close to a million young people out of work, show that it does exactly the opposite. Starter jobs (remember all those cinema ushers, petrol-pump attendants, and bag-packers in grocery shops?) dry up. Young people or those on benefits cannot even get on the first step of the jobs ladder.

As well as harming those it wants to help, the minimum wage helps those who are already better off, or soon will be. They include students doing low-paid jobs that they regard as purely temporary, a means of getting skills and references for a better job. And second or third earners in a household, working to bring in a little extra cash for luxuries. But these are not the people that the minimum-wage policy is designed to help.

The minimum wage is well-meaning policy – but sadly, a wholly counterproductive one. If you really want to help the poorest, you should help them by improving their access to paid work, by cutting workplace regulation and taxes.

Twelve problems with Piketty’s capital

Piketty’s thesis is that the rate of return on capital exceeds the general rate of growth (r > g). So, barring wars, capital owners accumulate a larger and larger share of the world’s wealth.

1. This theory does not fit the facts. In the modern economy, it is not the rich who are getting richer, but the poor. The failure of communism and the spread of trade has lifted perhaps 2 billion people off dollar-a-day- poverty.

2. Capital is not like a tree that drops fruit into the owner’s lap. Capital has to be created, accumulated, applied, managed and safeguarded if it is to produce any income at all. Capital owners can and do fail at any one of those points.

3. Capital is certainly destroyed by war from time to time. But it is destroyed every day by folly, misfortune, miscalculation or being outperformed by competitors. The difficult thing is keeping wealth. Losing it is easy.

4. Capital carries risk, not a word that features much in Piketty. Utility-type capital with more predictable returns produces higher returns, entrepreneurs making risky investments demand higher returns. There is no one ‘r’.

5. Even a small amount of risk undermines Piketty’s belief that capital owners will get richer for ever. Stuff happens: it is hard to predict what returns will be next year, never mind in ten years or a hundred.

6. The risk-adjusted rate of return on capital is modest, and falling, as it has been doing for decades. Adjusted for risk, Piketty’s thesis does not fit the facts.

7. Capital is only one factor of production. You need labour and brains too. If capital took a larger and larger share, wages would soon be bid up. The 19th Century saw huge capital accumulation – but huge rises in living standards too.

8. The most important form of capital in our service economy is human capital. That’s not confined to a few rich people, but owned by all of us. Investing in it delivers a far bigger payback than the returns on financial or physical capital.

9. The success and rapid rise of poor immigrant groups, from Ellis Island to modern Europe, shows that you do not need to own financial or physical capital to generate income and accumulate wealth fast.

10. Capital-owning societies are actually more equal. Pre-tax, not greatly; but post-tax, with their health, education and welfare programmes, they are very much more equal. And it’s better to be poor in a rich capitalist country.

11. Piketty’s savage global redistribution would destroy capital, and sacrifice its productive power for society. Massive capital taxes create instability (Cyprus) or ruin (Zaire). High taxes also cut people’s investment in their own human capital.

12. If you want to make the world more equal, try open immigration. The world’s poorest live where capital is sparse and unprotected by the rule of law. Let them become participants in the productive, capitalist, wealth-creating process.

HMRC and the rule of law

Plans to allow Britain’s tax authorities, HMRC, to take money directly from the accounts of tax delinquents have been criticised by a Committee of MPs on the grounds that HMRC ‘sometimes makes mistakes’.

A sharper criticism would be that the plan is a fundamental assault on the rule of law.

Next year is the 800th anniversary of Magna Carta, but the basic civil protections it gave citizens against arbitrary power are being systematically eroded. Governments have become elected dictatorships.

Magna Carta laid down that there could be no taxation without the ‘common consent’ of the people. It also insisted that no official can take anything from a person – nor fine them, nor imprison them, nor ‘in any way destroy’ them – without due process of law. Right now, the tax authorities would have to apply to the courts before they could take cash or other assets from a citizen.

But the new HMRC plans flout both these Magna Carta principles. HMRC can already decide that someone owes tax that they have deliberately ‘avoided’ – even if they have complied with every tax law. This is arbitrary power that we cannot safely entrust to any official. Reinforcing that power with further powers of confiscation – in the absence of any magistrate or court decision – is even more dangerous.

The MPs are right that even fair-minded officials make mistakes. Worse, the new plan passes the burden of proof – and the costs of proving it – from the authorities to the citizen. That again is contrary to the fundamental principle that people are innocent until proven guilty.

HMRC says that the new powers would be used only in extremis. But then they say that they expect perhaps 17,000 people will be affected each year. Many of them will, of course, be people who are completely innocent and the subject of official mistakes. Some will see their businesses ruined, and their employees losing their jobs, because of officials arbitrarily raiding their accounts. Others, worryingly will be people who the authorities decide to bully and make an ‘example’ of just because they are well known.

Recent history – like people being arrested under terrorism legislation for heckling the Home Secretary or walking down a cycle path – shows that when you give officials sweeping powers, they will be used. And when you exempt them from the rule of law, those powers will be abused.