It's time to end big government's grip on our prisons

Ben Gummer MP has an interesting article in the Daily Telegraph today calling for reform in the UK’s prison system. We have twice as many men and women incarcerated in England and Wales as there were in the mid-1990s. In short, our prisons aren’t working. Spending on prisons has continued to rise to close to £4bn, while reoffending rates have stayed the same. Ben Gummer argues that now is the time, during this period of austerity, to finally address the issue and bring real reform to the penal system.

In his article, Ben Gummer argues for:

‘…the need to re-connect victims and communities with sentencing, to make punishment more local and purposeful, and to remove as far as possible the impersonal and failing bureaucracy of the state. For many criminals, prison is just another welfare dependency, and we might challenge its over-use on those grounds alone.’

He also points out that prisons often fail to rehabilitate prisoners and treat the root causes of criminal behaviour. Bad prisons’ ‘failure to tackle mental health, profound psychological disorder, drug and alcohol addiction and moral vacuity, is in itself a crime on society’s part. We put people behind walls and then forget about them. That is wrong.’

Ben Gummer raises some important issues in his article. Unfortunately for far too long it has been implicitly accepted that sending people to prison is an effective way of tackling crime. A fascinating paper released by the Howard League for Penal Reform this week undermines this assumption, showing that prison’s effect in deterring people from committing crime can be overestimated, while reconviction statistics highlight the failure of the penal system to reintegrate convicts in society.

A one-size-fits-all approach to the penal system isn’t working. The state doesn't have the knowledge necessary to determine a single ideal imprisonment system, despite the highly centralized nature of our criminal justice system.

As the ASI's Sam Bowman argued in an event with the Howard League this week, we should learn from free markets. Central government cannot run prisons and criminal justice any better than it can run hospitals and schools. It is only through experimentation and a more localised approach to punishment that we can discover effective ways to solve our current prison problem. 

Blame bailouts for huge budget deficits

Among Keynesian economists there is a resilient opinion on how the current large budget deficits shouldn’t be thought of as a serious problem to the economy, since they are ultimately a result of a depressed economy. Here's Paul Krugman:

“It’s true that right now we have a large federal budget deficit. But that deficit is mainly the result of a depressed economy — and you’re actually supposed to run deficits in a depressed economy to help support overall demand. The deficit will come down as the economy recovers: Revenue will rise while some categories of spending, such as unemployment benefits, will fall.”

Disregard for a moment the key issue regarding this type of opinion - which is that in a depression a government is supposed to run large deficits in order to jump-start a recovery. Let's for now focus only on the argument that a deficit is a result of a depressed economy. What Krugman and the like have in mind when they make this claim is the following; because of the crisis and the credit crunch many businesses fail and consequentially unemployment rises. This creates pressures on the budget deficit, since revenues fall as many businesses are bankrupt and are not paying taxes (on both profits and employee taxes), and on the other hand many new unemployed put pressure on the expenditure side, as the government has to pay out more unemployment benefits. This is all true. All the combined effects of the credit crunch will almost always result in an increased budget deficit. But they will never be so big to make the deficit rise above 10% of GDP as it did in the UK, Ireland or Spain (to mention only a few). Something else was at hand here.

This 'something else' was large government bailouts of fallen banks.

Ireland, Spain, UK, and of course the US all had problems with the bursting of the housing bubble, a consequential rapid decline of the construction sector and altogether a huge impact on personal wealth. This however wasn't enough to cause a huge budget deficit. Its persistence is a result of a depressed economy, but the initial cause of unsustainable public finances in Ireland, Spain, UK and USA were large government bank bailouts. The three European countries are usually the argument Keynesians use to attack the euro austerity, since all of these countries had stable public finances before the crisis (Greece is a case by itself), while now austerity is hurting their recovery prospects.

Claiming that American, British, Spanish or Irish troubles began with austerity is simply misleading. Their troubles began with what was an application of a typical textbook Keynesian solution to a crisis = bailouts and large stimuli. This triggered their public debt to rise and their deficits to widen. Bankruptcies of small businesses and rising unemployment couldn't have single-handedly risen the deficit above 10% of GDP, or the debt-to-GDP close to (or above) 100%. It they did, this would have occurred in a much longer time span. But clear evidence (which Keynesians like to call upon) points out that large budget deficits and booming public debts arose immediately as a result of bailouts and stimuli in 2008 and 2009:

Source: IMF; World Economic Outlook 2012

As shown in the graphs, all four countries started experiencing troubles as an immediate reaction to government bank bailouts and fiscal stimuli policies. They all had low and sustainable debt-to-GDP levels (Spain and Ireland below 40% and 30% respectively, UK around 45%, and the US around 60%), which in a few years escalated to close to 90% for the UK, over a 100% for the US, 70% for Spain and close to 120% for Ireland (which is a four-fold increase of debt for this country in only three years). As for the budget deficit, Spain and Ireland had a surplus prior to the crisis, while the UK and the US both had relatively small deficits. After 2008/2009 their deficit-spending bailout solution yielded its first results. Have in mind that in neither of these countries austerity didn't kick in until late 2010. After it did however it did little to improve the state of public finances and still hasn't stopped the rise of public debts in none of the four examples.

After the evident failure of this approach that caused the unsustainability of their public finances, European countries started to combat the deficit via tax hikes and selective budget cuts, instead of focusing on lowering the tax burden, relaxing the regulatory environment, and applying a broad set of institutional reforms aimed at clearing the instabilities of the labour and capital markets.

They made two big mistakes - application of immediate Keynesian policies thought to work in the short run (reminder, this is 2013, five years after the crisis had started - the short run is over), followed by a selective and wrong application of (let's call them) neoclassical policies.

The obvious failure of the stimulus deficit-spending solution, particularly with its effect on public finances, should be sufficient evidence not to call for these types of solutions for quite some time.

Summary

Bailouts of banks are to blame for the huge budget deficits of Western nations, says Vuk Vukovic.

Article: Blame bailouts for huge budget deficits

Among Keynesian economists there is a resilient opinion on how the current large budget deficits shouldn’t be thought of as a serious problem to the economy, since they are ultimately a result of a depressed economy. Here's Paul Krugman:

“It’s true that right now we have a large federal budget deficit. But that deficit is mainly the result of a depressed economy — and you’re actually supposed to run deficits in a depressed economy to help support overall demand. The deficit will come down as the economy recovers: Revenue will rise while some categories of spending, such as unemployment benefits, will fall.”

Disregard for a moment the key issue regarding this type of opinion - which is that in a depression a government is supposed to run large deficits in order to jump-start a recovery. Let's for now focus only on the argument that a deficit is a result of a depressed economy. What Krugman and the like have in mind when they make this claim is the following; because of the crisis and the credit crunch many businesses fail and consequentially unemployment rises. This creates pressures on the budget deficit, since revenues fall as many businesses are bankrupt and are not paying taxes (on both profits and employee taxes), and on the other hand many new unemployed put pressure on the expenditure side, as the government has to pay out more unemployment benefits.

This is all true. All the combined effects of the credit crunch will almost always result in an increased budget deficit. But they will never be so big to make the deficit rise above 10% of GDP as it did in the UK, Ireland or Spain (to mention only a few). Something else was at hand here.

This 'something else' was large government bailouts of fallen banks.

Continue reading.

Chart of the week: European household savings rates

Household savings rates are unchanged or headed in the wrong direction. That is bad news for the euro area.

What does the chart show: The chart shows household savings rates as % of disposable income up to Q3 2012, by country.

Why is the chart interesting: Within the euro area, as globally, part of the cause of the Great Recession was an imbalance between excess savers and excess spenders. This needs to rebalance – spenders need to save more and savers need to spend more. But, the chart shows that savings in Spain and Italy are on a downward trend, whereas in Germany, France and the Netherlands they are broadly flat. This implies that the underlying problems in the euro area are far from solved.

Chart and comments provided by Stein Brothers (UK), www.steinbrothers.co.uk

There’ll be no transparency in the NHS while the lawyers circle above

Complain about anything in an NHS hospital and you will face a wall of unknowing. Not sympathy, not a recognition of the mistake and certainly not an apology.  This has nothing to do with a lack of care or humanity by NHS staff and everything to do with the scale of legal costs and fines faced by the NHS.  The sums are now huge (£15bn in 2010 according to the Daily Telegraph, 3rd August) and rising fast, thus draining the funds that should be spent on front line care.

The reality is that transparency by the hospital (or whatever) will simply provide evidence for the ensuing law suit.  If patients and their relatives are given more information about their treatment, then that too can be used in evidence.

Harold Wilson is to blame.  When the NHS was set up, patients could not sue and everything was more open.   Those are the days of caring we look back on with a warm glow.  The reason they could not sue is because there is no contract between NHS and patient: the patient does not directly pay for NHS services, the state does.  So the patient had none of the usual customer’s rights.  Harold Wilson was lobbied by patients’ representatives saying this was unfair and they were entitled to recompense when things went wrong.  The law changed and the patient became the customer with a right to sue for damages.

The unintended consequences are now plain: lawyers instruct NHS staff not to admit liability, or indeed anything.  The costs to the NHS are not just the lawsuits but lawyer interference in management at all levels.  Sweep the cock-ups under the surgical gowns and no one will learn from mistakes or even know about them.

I had personal experience of this when a famous London hospital nearly killed my uncle by not following standard hygiene procedure during his operation. The infection was serious and kept him in hospital for quite a while. My uncle did not want to make a fuss, still less sue, but I insisted on having a discussion with the surgeon.  I hit a brick wall.  Most people would have given up but eventually, after giving assurances that we would not sue, we met.  He was accompanied by a young man whom I took to be a lawyer.  He tried to write everything down until, by now quite cross, I reminded them that we were not suing.  The meeting was entirely to ensure the surgeon understood what had happened, since we had no reason to believe he did, and to press him on how these things could be avoided in future.  I got some satisfaction on the former and none on the latter which was, in fairness, not strictly my business.  There was no apology.

The idea that mistreated patients deserve some recompense is now so ingrained that we are unlikely to revert to the pre-Wilson era.  But the present system is lose-lose: it contributes to the problems such as those now exposed at Mid Staffs whilst simultaneously destroying the NHS budget and the costs are escalating.  Following Mid Staffs all sides are issuing platitudes about transparency but, with the lawyers circling the sky like vultures, it will not happen.

One solution is to have a menu of damages that an ombudsman can award once the facts have been transparently exposed.  In the event the hospital, or the patient’s representative, is less than open, the damages are doubled or eliminated following the more arduous investigation.  Any hospital playing the odds, i.e. getting doubled too often, would be required to discipline, and possibly sack, the manager most responsible for the lack of transparency.  In this solution, no lawyers would be allowed to participate on either side.

Racial inequality in the US criminal justice system

Reviewing the LSE Growth Commission

The London School of Economics' much-vaunted "Growth Commission" has finally released its report, after a year of discussion, debate and work. Unfortunately, the policies it advocates are unoriginal and underwhelming.

They focus on three areas of long-term investment, into human capital, infrastructure and innovation. All of these factors are, of course, conducive to growth. However, beyond that obvious, aggregated view, the authors fail to answer the question of which investment is right for growth; which human capital; which institutions are most conducive to growth.

For example, human capital is not some homogenous gloop to be imparted into the grey matter of students, but can be subdivided into a whole host of different skills and capabilities. Some of these skills will be conducive to productivity growth and innovation. Others will be useless. While improving school autonomy is admirable, the largest contribution of this report is to slap the term "flexible ecology" onto policies already being pursued. At no point do they explain that school autonomy is important because freer interactions allow employers and universities to demand and get the types of human capital that they need, rather than what a top-down state system foists upon them.

Similarly, physical capital in the form of infrastructure is not some magical panacea. While they identify the planning system as a key barrier to private infrastructure investment, the report's authors bizarrely recommend the creation of three new Quangos, one of which is a bank, and to automatically pay more for any infrastructure projects. Perhaps they might have stopped to consider that the implication of a faulty planning system is to reform it, rather than to add more bureaucracy, and pour even more money on the problem. The report's proposals again focus on merely increasing investment, with little regard for quality and sustainability.

The report is weakest on the most important aspect of economic growth: innovation. They identify a lack of capital for new entrepreneurs as the biggest problem. Predictably, their answer is to support current moves towards a government-run "Business Bank", to support new financial regulations, and for yet another Quango to be created to form industrial policy. Again, this is hardly original. All of this ignores the fact that government, and even supposedly sainted "independent" Quangocrats are notoriously bad at picking winners, and are likely to exacerbate any capital misallocations in the economy by diverting it away from viable innovations. The Commission's plan is basically to use taxpayer money to prop up unsustainable start-ups, towards an unclear and likely negligible impact on economic growth.

The LSE Growth Commission's report fails to see that institutions need to be conducive to choosing the right investment, not simply more of it. The value of an economy is only increased if people get what they actually demand. For all its imperfections, free exchange is still the best test of determining what people want, and which innovations are best at meeting those wants.

Ring-fencing is the wrong answer to the wrong question

The government is proposing to 'electrify' the ring fence around retail banking activities by warning them that they risk being forcibly broken up by the Bank of England if they try to get round the fence.

Ring-fencing is the wrong answer to the wrong question. Thanks largely to the rhetoric of Business Secretary Vince Cable, many people, including too many politicians who should know better, imagine that the financial crash occurred because of the failures of 'casino banks' – that is, the international investment banks. These, we have been told, crashed and brought down the retail banks that were attached to them. So to protect ordinary customers, we need to separate the two.

But as Miles Saltiel showed in an Adam Smith Institute report in 2011, it was not the investment banks that brought down the retail banks and threatened people's savings. The first banks to fail were the ex-building societies like Northern Rock that got out of their depth when they dropped their mutual status and started offering silly mortgage deals. Then it was the turn of the big banks who were buying mortgage assets – supposedly 'safe' retail-based business – that turned out to be rubbish.

Ultimately, it was politicians and regulators who caused the crash, by flooding the world with cheap credit and money for decades and then cutting back suddenly – as, again, John Redwood demonstrated in yet another Adam Smith Institute report. No wonder banks took risks that brought them down. And when the ex-building societies were offering 120% mortgages and other risky products, the regulators did nothing.

I certainly think that bank customers should know what the bank is doing with their money, so they can judge the risk they are prepared to take and balance safety against cost. But ring fencing does not cure any of the problems I have listed. What it might do is to deny the retail banks access to international capital, making retail banking more expensive for customers and continuing the problems faced by small businesses who cannot get loans. And since other countries have no plans to ring-fence their banks, Britain's financial sector will be setting itself at a self-imposed international disadvantage.

A dismal decade

One should 'Never make predictions, especially about the future'. However, it seems pretty certain to me that the next medium-term picture for the UK economy is bleak. There's nothing particularly novel here, but it's worth summarising the position.

From the fiscal perspective, the present government has made appalling progress with deficit-cutting: borrowing has increased, spending is still increasing and whilst growth-destroying taxes have risen the size of the state has not decreased. Apparently only 6% of the public realise that this is the case. Any hope of the UK being able to balance its budget let alone amortize any of its vast debt by running surpluses is years in the future. In the best-case scenario, an outright Conservative electoral  victory in 2015 might bring the time and the will needed to eliminate the deficit but this is unlikely even if that is the result.

Unfortunately, the present government has portrayed the present situation as one of austerity when it is not - what 'pain' is being felt is from the reallocation of spending from one Department to another and to increased interest payments. It might be that a sensible left-wing government actually finds it easier to cut the deficit, like New Zealand's Labour, as they avoid accusations of being Tory 'toffs' or some such nonsense. However, the present Labour Party seem committed to fiscal recklessness, not to mention the dire prospects such a government would have for deregulation and supply-side reform. All the while, the Lib Dems claim credit for 'restraining' the Conservatives from cutting government, as if this were positive. Essentially, the UK's fiscal position seems unlikely to improve any time soon and government will continue to spend around 45-50% of GDP, a position seriously deleterious for growth.

On the monetary front, we seem committed to a policy of inflationism and dis-saving and the incoming Bank of England Governor sounds even more committed to loose monetary policy than the present. Inflating the national debt away may take the burden from politicians in having to make real spending reductions, but it has serious impacts on saving and capital formation and thus future economic growth and risks the formation of new asset bubbles.

Contrary to popular belief, the Thatcher-Major governments of the 1980s did not really reduce the size of the state but instead - in general - restrained its growth compared to the size of the economy. This economic growth was predicated on supply-side reform, particularly in privatisation and increased labour flexibility. The present government has tinkered but has not really delivered any substantial supply-side reform. What happened to the Great Reform Bill? Where is the slashing of Red Tape that we were promised? The 'bonfire of the quangos' was a flash in the pan and Big Government has continued whilst Big Society died.

Whilst I don't think a major economic or fiscal collapse is likely, it is not beyond the bounds of possibility. The Coalition government are not seriously pursuing any of the reforms necessary to bring about economic growth: a proper programme of major fiscal consolidation combined with sweeping supply side reform and underpinned by sound money. Labour's policies score even worse.  In brief, the next ten years and beyond seem to offer the UK prospect of mild (or perhaps more serious?) stagflation.

For the elucidation of the Tax Justice Network: yes, let's abolish corporation tax

The Tax Justice Network is patting itself on the back for having survived a decade of securing government grants. In their little self-congratulatory note they make this point:

Proponents of tax competition have never answered the crucial question of how far it should be allowed to go before it compromises the functioning of a viable and equitable tax regime. Taken to its logical extreme, unregulated tax competition will inevitably lead to a race to the bottom, meaning that governments will be forced to cut tax rates on corporate profits to zero and subsidise those companies choosing to invest in their countries.

I can't see that not charging tax is a subsidy but still: for the rest of it, yes, that actually is the point. Corporation tax is an extremely bad tax, for two very different reasons, and we'd all be much better off if the same revenue (assuming that we do indeed want to collect that same gargantuan amount of the economy to be spent through government) were raised in some other manner.

The first reason corporation tax is a bad tax is because of deadweight costs. All taxes destroy some economic activity. Things that would have been done in the absence of taxation are now no longer done in the presence of it. This is why we tax booze, fags and petrol: to reduce the amount of smoking, drinking and driving. But, as this OECD chart shows, different taxes have different deadweight costs. That is, some destroy more economic activity than others per £ of tax revenue raised. And corporation tax destroys more economic activity than almost any other form of tax (well, except for the entirely stupid Robin Hood Tax). Thus we would very much like people not to charge corporation tax but to get the necessary some other way: taxing land, property or consumption for example. This has nothing at all to do with whatever wonders will be financed with the tax collected: we are talking purely about how much destruction accompanies certain forms of taxation themselves.

Do note that a large part of the TJN's purported concern is with the poor countries. Exactly those we would want to be striving for the least destructive tax system possible. They really are grasping for all the economic growth they can get: thus corporation tax is doubly contra-indicated. Although, for some reason unknown to myself or anyone else sentient, they keep insisting that said poor countries should be charging more and more corporation tax.

The second reason why corporation tax is a bad idea is that it's a disguised tax. Yer averge schmoe in the street thinks that it's the companies paying it: when of course it isn't. It's some combination of shareholders and workers who do. What influences the balance there is how large the economy is (the smaller, the more the workers) and how open it is (the more open the more the workers). And again the TJN is insistent that it's got to be the developing economies that charge companies more corporation tax. Developing countries are by definition small ones. And given that we are talking about foreign capital being invested they're also, in the context of this argument at least, entirely open. Thus the burden of the corporation tax the TJN insists upon is really being carried almost entirely by the wages of the workers. Indeed, Joe Stiglitz once pointed out that this burden can be greater than 100% of the revenue raised.

So the TJN are stating that the corporates must be taxed more: when the sentient among us realise that actually the burden is upon the poorest of the poor: workers in developing nations.

The above being the double reasons why zero corporation tax, most especially in poor and developing nations, would be such a good idea. All of which leaves me slightly flabberghasted. The TJN has actually managed to get something right:

Taken to its logical extreme, unregulated tax competition will inevitably lead to a race to the bottom, meaning that governments will be forced to cut tax rates on corporate profits to zero

Yes, that's the point.

Corporation tax is a bad tax and we want less of it. Most especially in poor and developing nations.

That with a corporate tax rate of zero hundreds of thousands of highly paid accountants and lawyers will have to go and do something productive with their lives is just an added bonus.