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"Little else is requisite to carry a state to the highest degree of opulence from the lowest barbarism, but peace, easy taxes, and a tolerable administration of justice" - Adam Smith

The virtues of John Lewis-style businesses

Written by Eamonn Butler | Tuesday 17 January 2012

UK Deputy Prime Minister Nick Clegg has argued that firms should get tax breaks to encourage them to structure like Britain's successful John Lewis department store chain. Basically, the staff in John Lewis stores are not employees so much as partners – they all have a stake in the success of the business. And this is what Nick Clegg wants to encourage.

Up to a point, I agree. Back in 1989, the Adam Smith Institute did a report, Incentive Through Ownership by the entrepreneur Michael G Bell, arguing the case for just such arrangements in business. They make sense particularly in 'people' businesses, where making profits hinges wholly or mainly on the talents of the staff. Where people are a business's main asset, it makes sense not just to reward them with bonuses for exceptional effort, but to cut them in for a share of the business themselves. That gives them an asset they can trade and use, a stake in the business and in the country.

So these arrangements can be valuable, but are not for everyone. Businesses where the individual workers are less important than the land or capital that is employed have little scope to use such schemes, and might well not benefit much from installing them. And the other point I would make is that the tax system ought to be neutral It should not be used to promote one kind of business arrangement that particular politicians happen to favour, over any other. Sure, there may be other factors – such as other parts of the tax code or other regulations – that skew the way businesses are put together, and then there might be a case for using the tax system to restore the balance. But generally it's better to restore the balance by not having the distorting taxes and regulations in the first place.

Having said all that, our report Incentive Through Ownership made a strong case for the virtues of employee share ownership, and the evidence it produced in support was overwhelming, as it continues to be. In politics, good ideas usually come out in the end, though it can take a lot of time. In this case, over twenty years, which is about average in fact.

I wonder whether firms based on partnerships may benefit, not just from the incentive effect of share ownership, but from a possible reduction in employment regulation. Hire a single employee and you are immediately drenched in a mountain of tax law and employment regulation. That's why many people don't. Take on a self- employed colleague and things are different. So it is quite possible that, if such partnerships took off, so would growth.

Just don't tell Her Majesty's Revenue and Customs, which has campaigned for years to stamp out self-employment. Nothing irritates it more than people who don't fit its standard tick boxes, and whom it can't simply capture money from every month through their firm's finance department. If it came to a contest between Clegg and HMRC, that would be messy indeed.

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A guaranteed mistake

Written by Eamonn Butler | Monday 28 November 2011

I rejoice in UK Business Secretary Vince Cable's ability to believe in two contradictory things at the same time. One is that the banks should strengthen themselves by putting more money into reserves. The other is that they should lend more to small businesses in order to kick-start economic recovery. The logical problem, of course, is that money which the banks keep in their vaults isn't then available to lend out to businesses – or anyone for that matter.

In his Autumn Statement (or soon after), Chancellor George Osborne is expected to resolve this dilemma by providing government guarantees on loans that the banks make to certain businesses. It parallels his announcement last week that the government would provide guarantees on loans made to first-time house buyers.

Guarantees are cheap. You don't have to shell out the money unless things go wrong. That doesn't stop them being immoral and counterproductive. With the government guaranteeing 95% mortgages, and with interest rates so low, I wonder how many people will be seduced into taking out home loans which – when interest rates rise – they won't be able to afford. Encouraging such sub-prime mortgages is surely immoral. And taxpayers bailing out banks when such loans go wrong…well, haven't we been here before?

The business loan guarantees being planned by George Osborne pose the same moral hazard. And they are bad for business, too. Sure, credit is tight. Curiously, that might be because interest rates are too low, not too high. Why would anyone lend money when the interest they earn doesn't even keep pace with our 5.2% RPI inflation rate? Inasmuch as the new guarantee scheme encourages businesses to borrow – which might be marginal, given the gloom that infects nearly all businesses right now – it will encourage people to make more bad investments. It's surprising, but business failures are lower at the moment than they have been in decades: it's simply cheap credit that is propping them up.

Some time, businesses have to grit their teeth and write off all the over-optimistic investments they made during the Brown Bogus Boom years. Then perhaps their investment cash can be put into things that have a better prospect of returning a profit. Painful, but better than living in a fantasy world underwritten by taxpayers. But giving them cheap credit, and more of it, just prolongs the the illusion, and the slow agony.

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Home truths

Written by Eamonn Butler | Saturday 26 November 2011

houseOh, dear. A few days ago, worried about flatlining or falling house prices – always bad for politicians – the UK government announced a whizzo new scheme to underwrite 95% mortgages. We warned that this was encouraging just the sort of over-borrowing that got us into this mess in the first place.

Now the Centre for Economic and Business Research predicts that house prices will rise by 15% over the next five years, with the average three-bedroom semi-detached going up over £25,000 to £202,000. But that's nothing to do with the government's latest price-boosting mortgage initiative. No, it is simply because of a shortage of property on the market (planning controls), rising demand (immigration, demographics) and the fact that the banks are starting to lend again thanks to all that money the Bank of England has injected into them by way of Quantitative Easing. And the buy-to-let sector will boost the market too, as worried savers look for hard assets to put their money into.

So – if that is right – the net effect of the government's mortgage-guarantee plan will be to boost a market that is already about to rise. Rather than preventing prices (and the government's electoral prospects) from falling, it will add further to price increases.

The government should read its Milton Friedman. The Nobel economist researched the effects of 'stimulus' packages as a supposed way of smoothing out economic cycles, and concluded that they did more harm than good. By the time government realise business is declining, work out what to do, pass the legislation, and wait for it to have its effect, the trough is usually over and the policy ends up reinforcing the cycles. Today's house-price situation looks much the same: reinforcing the boom, which will mean we will suffer even more painful adjustment in the long term.


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On Nick Clegg's "youth contract"

Written by Eamonn Butler | Friday 25 November 2011

Nick Clegg, the UK's Deputy Prime Minister, today unveils a 'youth contract' scheme to help UK employers hire more young people and expand youth apprenticeships. He's concerned that over a million 16- to 24-year olds – almost one in five – are not in education, employment or training.

So am I. But another Gordon Brown-style government 'initiative' is not the way to get young people into work. We need to reduce the cost and the risk that employers face when taking on young people. We need to get rid of the minimum wage, which is pricing young people out of starter jobs, and radically cut back workplace regulation.

Employers are petrified about taking on young people, who may have little workplace experience and are therefore an unknown quantity, because they fear they cannot get rid of them if they do not work out. They would much rather have experienced employees. So it is no surprise that youth unemployment is so high.

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Skyrocketing executive pay is a symptom, not the disease

Written by Eamonn Butler | Tuesday 22 November 2011

moneyThe High Pay Commission sounds like an official body. That's the whole idea, and that may be why it is being so widely reported. But in fact it is not a government body. It was established by Compass (slogan: 'Direction for the Democratic Left'). Its Chair, Deborah Hargreaves, who has been doing all the media on it, is a former Guardian business journalist. The panel of six also included one LibDem peer, the TUC General Secretary, two fund managers (no friends of high executive pay they) and the former Director of Christian Aid.

So it is maybe no surprise that this crew complain about bosses' pay. It's risen 40 times since 1980, they claim (except they say 4,000%, because it sounds a lot more), and FTSE chief executives now earn a hundred and more times that of the average worker. This is 'corrosive' they say and at this rate we will create 'inequalities last seen in the Victorian era'. So this 'Commission' is not exactly a restrained and objective survey, then.

But let's not forget that the world has changed since 1980, and rather dramatically at that. We had the big bang, for a start, which transformed the UK's rather sleepy capital markets into a global financial force. That gave businesses here the power to expand and to become truly global. More than half of the investment in the FTSE 100 now comes from overseas. The FTSE index is not a UK index any more, but an index of global companies that just happen to be listed on the London Stock Exchange precisely because our capital market is so vibrant. And it hardly needs saying that if you want someone to run a massive international company, you need to pay them a lot more than someone running a small UK-focused company. It's chalk and cheese.

Bosses make the argument that if they weren't paid telephone-number salaries, they would all go abroad. Ms Hargreaves retorts that in fact, we don't see much movement abroad, and very few would. Well, if we are paying competitively, and people don't (at present) have to jump ship, how does she know? And in any case, the real problem is not so much people going abroad as people simply refusing to come to the UK. At present, FTSE companies attract talent from all over the world. If you can't pay that talent, that international edge

Ok, so you may not like high pay, but what is to be done about it? Ms Hargreaves' panel says companies should publish their pay multiples, that shareholders should vote on remuneration, and that workers should sit on remuneration committees. Oh, and there should be a new quango to 'monitor' high pay. Spare me.

The underlying agenda here is that there should be official curbs on high pay. There's no point in setting up bodies to 'monitor' something if you are not going to do something about what they monitor. But I would much prefer for companies to be deciding the pay of their staff rather than Vince Cable or some quango putting caps on it, which would be the next inevitable populist measure if we went down this road.

Still, I do agree that there is much that is rotten about executive pay in the UK. But that is mostly because we have too much boardroom regulation, not because we have too little. Following various other – official this time – commissions on corporate governance, executive pay is now decided by remuneration committees run by non-executive directors. Non-execs, of course, are often directors of other companies. So the impact of this regulation is a 'you sit on my committee and vote for my pay rise, and I'll sit on your committee and vote for yours' culture. Putting some shop steward on these committees to try to make them feel guilty won't do any good. The bosses will just decide everything over coffee beforehand and rubber-stamp it at the meeting. You know how committees work.

And yes, shareholders should have a lot more power, including the power to decide future pay policy rather than just complain about what has been. Again, corporate law gives far too much power to executives and far too little to shareholders. And shareholdings are, these days, dominated by investment funds who may not want to rock the boat and so damage their quarterly returns. So is it any wonder that executives pay themselves handsomely? Don't try to cure the symptoms, though. Cure the disease. Prescribe not more regulation, but more competition and better governance.

Update: This article initially said that the High Pay Commission was funded by the Joseph Rowntree Foundation. In fact, it is funded by the Joseph Rowntree Charitable Trust and the reference has now been removed.

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Wind turbines increase carbon!

Written by Eamonn Butler | Tuesday 22 November 2011

Now here's an interesting mini-point. We all know that wind turbines don't work when the wind isn't blowing, which can be pretty annoying if you want to cook your Christmas dinner and the country is beset by an eery calm. So you need to maintain other methods of generating electricity to step in when the blades aren't turning. Right now, that generally means fossil-fuel generation – gas or coal. You turn it on when the wind isn't blowing, and off when the turbines are making juice. Simple and efficient, eh?

Not quite. Bentek Energy, an energy market analytics and data company in Colorado, points out that you can't just turn a fossil-fuel power station on and off. If you do, you find that the emissions caused by the thermal inefficiencies when you are warming up and cooling down outweigh the reductions in emissions from the wind generators themselves. You would be better to run the coal-fire stations at their efficient level all the time.

So you might think that wind turbines are a good way to reduce carbon emissions. Actually, they are a good way to increase carbon emissions!

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Bank reform: getting the policy right

Written by Eamonn Butler | Wednesday 16 November 2011


Create new, 'safe' banks if you want to – but not at the cost of lots more regulation and dismembering Britain's hugely important financial services sector. That's the message of a new report and briefing paper being published by the Adam Smith Institute today.

The Independent Commission on Banking (ICB) – set up by George Osborne – was told to work out ways to make the banks more secure and avert future banking crises. Their first suggestion was to split up the banks into 'safe' high-street and 'risky' investment operations. Then load them with higher reserve requirements, so they have to keep a bigger cushion of 'safe' assets.

Both prescriptions are wrong. It wasn't the 'risky' investment banks that caused the UK's problems. It was the retail banks and building societies that got into trouble, mostly by lending too much on mortgages during the housing boom, or buying US investments that they did not understand. When the boom subsided, their customers couldn't repay their mortgages and the US investments turned out to be highly toxic. Regulators daydreamed while this was all happening, and the Bank of England – having fuelled the boom – squeezed hard just when the banks needed more cash to tide them through this rough patch. The retail banks just ran out of money.

So breaking up the banks isn't going to make any difference. And raising their capital requirements higher than anything being contemplated by Brussels or Basel will just put them at a huge disadvantage against world competition. It also means they will have less cash lying around to lend to small firms – the drivers of employment and growth in the UK. Small firms will find it harder to get loans, and will pay more for them.

Investment-bank customers are savvy enough to look out for themselves, but ordinary families and businesses want banks that are safe. So, instead of trying to dismember existing banks, why don't we simply allow people to create new ones? We suggest a new form of banking licence that allows people to create Trust Banks to do just that. They could operate as they pleased, but the Bank of England would have to be sure that they were sound, and could survive the failure of any parent or sibling company. And Trust Bank customers would be the only ones who would get a government guarantee that they would not lose their deposits. It's a market solution to a problem caused by over-complex regulation, badly enforced.

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We need to cut inflation down to size

Written by Eamonn Butler | Wednesday 16 November 2011

Yesterday's inflation figures showed that the Consumer Price Index (CPI) measure of inflation in October dropped slightly to 5%, from 5.2% last month. CPI is the government's preferred measure, which does not take housing costs, such as mortgage repayments, into account. But those of us who still have mortgages to pay off might prefer to look at the more traditional Retail Price Index (RPI), which is even higher at 5.4%, down from 5.6%.

The Bank of England reckons that inflation is largely an effect of the falling pound, which makes imports more expensive, particularly the things it is hard to do without, such as fuel and food, which are largely imported. It is not helped by rising commodity prices as Asian countries bounce back from the slowdown and start building things again. They figure these pressure will ease, and when the VAT rise drops out of the calculations after it has been in place a year, the indexes will fall again, they say.

Well, they would say that, wouldn't they? It rather diverts attention from the £75bn of new money which the Bank 'printed' (in the form of Quantitative Easing) before expanding the programme to £200bn later that year and increasing it again recently to £275bn. And as we know, thanks to Milton Friedman, inflation is always and everywhere a monetary phenomenon. When you print too much money, it loses its worth.

So is that what is going on here? It's hard to say. The other folk who create money are the banks. Indeed, they can create it at the stroke of a pen, just by giving loans to their customers. The trouble for lots of their customers is that the banks have been more reluctant to do that recently, having had their fingers burnt by the crisis of 2007/8. So the Bank of England figures it is just replacing the money that the banks are no longer creating.

Maybe. For quite a long time through the noughties, the Bank had a target of 2% inflation which it failed to meet, month after month. And that was despite the fact that a strong pound and cheap imports from the likes of China meant that, if anything, prices should have been falling. The Bank stoked up a boom, and it was the inevitable bust of that boom that led to our present problems.

Yes, we need an big enough quantity of money around the place that banks and businesses have enough to lubricate the wheels of commerce. But you don't want to take risks with inflation. it is corrosive. When all prices are rising, it becomes harder to distinguish the 'signal' of real price rises and falls from the 'noise' of prices rising everywhere. How many people really know whether their house has gained or lost value, when the cost of living is rising so fast? How many entrepreneurs, for that matter, know if their investments are really paying off, after inflation is taken into account? They don't – and that is why inflation causes people to put their time, effort and money into the wrong things. That's a luxury we really can't afford in these times. We need to get inflation down. And fast.

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Milton Friedman - libertarian or statist?

Written by Eamonn Butler | Tuesday 15 November 2011

miltonThe US Nobel economist Milton Friedman was one of the most effective critics of big government of his time – mainly, the second half of the twentieth century. But this week I found myself at a meeting of the Libertarian Alliance, having to defend him against charges of statism.

Friedman thought of himself as a liberal rather than a libertarian, and 'the consistent liberal,' he once argued, 'is not an anarchist.' Human beings are not angels, in his view, so they need government to restrain them. He thought government had a wide role – to maintain law and order, dispense justice, define the rules of property, promote competition, maintain sound money, and protect the destitute. Equally, he believed that governments were too big, to avaricious, too centralised, too bloated, and far too likely to fail in anything they took on.

He is known, of course, for his work on money and inflation. But he did not propose, as Hayek did, competition in currency production. He thought the reality of our times is that governments are in control of the money supply, so the question is simply how to sustain them. He thought a gold standard impractical – inevitably, rather than using the metal itself as money, people would use paper (or electronic) receipts for it, so you have the same problem of potential over-printing of that paper as you do today. So he thought the best thing was to have a monetary rule, preventing politicians from over-producing the paper money we have today.

On regulation he was much more libertarian, calling for an end to rent controls, the mail monopoly, wage and price restrictions and even state licensing of doctors and lawyers. On the other hand he did support the registration of certain professions, like taxi drivers, who could cheat the public if they could not be easily identified.

He did not believe in compulsory schooling, nor in state-run universities, but supported a state-led voucher system for education. He would replace the state pension system – but with one of obligatory saving into personal accounts.

You could say, then, that Friedman simply accepted some of the political realities of his age – though he always urged economists to think radically and he himself pushed the boundaries of what was taken for granted. To him, the state was no more than a tool for the use of individuals, who necessarily had priority. It was why he pointedly – and successfully – opposed the military draft, and argued that drugs should be decriminalised. In terms of advancing the libertarian agenda, few people in recent times have done more.

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The roots of the Euro crisis

Written by Eamonn Butler | Friday 11 November 2011

The Alliance of European Conservatives and Reformists holds its conference in London today, with speakers such as Baroness Warsi, William Hague MP, Dan Hannan MEP and Mikheil Saakashvili, the President of the Republic of Georgia. Naturally, the Eurozone crisis is top of the agenda. I've been asked onto a panel to discuss the origins of the Euro crisis.

There are plenty of reasons why the Euro is falling to bits, but three strike me as particularly significant. First is the politicians' discovery that they could fund all their projects by borrowing. Politicians love spending, of course, because they can buy votes with other people's money. There was a time when people thought the only way to do that was to raise taxes. But raising taxes has its limits – for every voter you please with a cash handout, there is another whom you irritate with a tax rise.

But after the Second World War, politicians discovered another way in which to pay for their spending without having to raise taxes. You simply print money, and spend that. No gold standard to restrain you any more, so you could print as much as you like. Sure, politicians going back to Diocletian and through the Weimar Republic had already discovered this tactic, but in the 1960s and 1970s, blessed by the holy water of neo-Keynesian theory, it became a systematic policy. But eventually, politicians discovered that this too has its unpleasant obverse – rising prices. So widely and freely did they use the printing presses that world inflation peaked at 29% in 1994. Inflation at that rate, unless you act on it, soon dislocates your economy and in turn your society.

Today, politicians have found another wizard way of paying for their extravagances. You borrow the money from the next generation. They don't vote, they don't complain, so you can borrow as much as you like with no downside. Until, of course, people start looking at your books and figuring that if they carry on lending to you, you might not be able to pay them back. Then you are in another nasty hole.

The second factor I would mention is the creation of the Euro itself. Trying to bring together countries with very different histories, trading links and economies was always a brave move. But like many things, it worked fine when things were booming and it could motor ahead in a straight line. Only now, when it hits a corner, do the wheels come off.

The problem is that before the Euro, dodgy countries had to pay more to borrow precisely because people figured that there was a chance of them defaulting on their debts. After the Euro, people took the view that Euro-denominated government IOUs were pretty well much of a muchness. That the Euro countries would stick together to make sure that creditors were paid. So it became suddenly much cheaper for over-spending countries like Italy, Greece, Spain, Portugal to borrow. And the more they borrowed, the more they shored up dysfunctional economies.

The bust that followed the US boom was the third factor. Not exactly a cause, because the Euro problem is entirely home grown. But the gust of wind that blew down the whole pack of Euro cards. The US was forcing banks to give mortgages to people who, in normal times, would have no hope of repaying them. Maybe a fifth of the US housing market had become pure speculation by 2006, before it crashed. Britain's governemnt was spending and borrowing like mad, its budget rising 42% under the Blair years, and its borrowing concealed by off-balance-sheet PFI deals and other wheezes. Like a raucous evening in the pub, it felt good at the time, but eventually the pain had to come. As the boom subsided, and mortgage holders and banks started to go bust, governments leapt in to prop them up. Unfortunately, it has now become clear that those governments are in just as much debt as the people they were trying to save.

If anyone tells you they know what is going to happen, don't believe them. That's what makes it so scary. Maybe the Euro will split apart under the pressure of the markets. Maybe it will all end in tiers – a Euro of sounder countries, and Club Med doing its own thing. The best solution – Euroland politicians realising the game is over and deconstructing the Euro peacefully – is the least likely.

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