Economic Nonsense: 28. Capitalism brought about the financial crisis and should be replaced

Opinions differ on the causes of the financial crisis; some economists suggest it happened because of a combination of several causes. In the US sub-prime mortgages were involved, in that mortgages had been given to some who were poor repayment risks. When these were bundled into other securities, an unknown risk was being marketed, with some institutions heavily over-extended with potentially bad debts. It should be pointed out that it was US government policy to extend home ownership to low income people. The two agencies Freddie Mac and Fannie Mae were both encouraged to do this. The process of 'red-lining,' drawing lines around city zones inside which no mortgages would be given, was outlawed. It might also be noted that most of those who received mortgages, including low income people, continued to pay their mortgages payments and successfully became home owners. Only a tiny proportion were defaulters. It was the unquantifiable nature of the risk that caused problems.

Others have pointed out that the Federal Reserve Bank made a policy of cheap credit. They did this to weather crises and prevent economic downturns. The Bank of England did some of the same. When money was cheap, so was risk, and the message encouraged financial institutions to undertake riskier ventures. It was as if all the traffic lights were stuck on green, and everyone pressed ahead at speed.

The lesson is that governments and central banks were at fault, as were reckless traders taking huge risks to bring greater returns. It was not capitalism itself that brought about the crisis, but rather the inappropriate behaviour of some of the parties involved, including government. Neither was it regulation. With the possible exception of the pharmaceutical industry, the financial sector was among the most tightly regulated in the world. It was unsuitable regulation that sent the wrong messages and brought about wrong behaviour.

Capitalism has not been replaced and almost certainly will not be replaced, in that no-one has found a better way of generating wealth or of improving living standards over the long term. It experiences shocks and crises from time to time, and it is partly a learning process. After each crisis it is modified to prevent the same happening again. But there may well be new and different crises in the future, and new ways will have to be found to deal with them.

One tax hike I'll be hoping for in the Budget (and some cuts as well)

Back home in Ireland, it’s said that asking for directions will often get you the reply, “I wouldn’t start from here.” We might say the same thing about the UK’s tax code. Nobody drawing up a tax system for the country would create anything like what we have right now, and when it comes to reform – well, I wouldn’t start from here. One example, which I talked about on the Today Programme this morning, is VAT. VAT is usually considered to be one of the least bad taxes around: in theory, it doesn’t discourage production, it isn’t very regressive, and it doesn’t distort the economy.

I say “in theory” because in practice the UK’s VAT system is a mess. It is riddled with exemptions (I am including zero-rated and reduced-rated goods in this) that distort people’s spending, which means that resources are being wasted, because people are buying relatively more of the untaxed goods and less of the taxed ones than they would be if the playing field was level.

The usual argument for these exemptions is that they are needed to reduce the burden on the poor. This is a powerful argument but it is wrong.

Many of the exempted items are unlikely to benefit the poor anyway – financial services, the construction of new dwellings, domestic passenger transport – but even for things like children’s clothes and food the argument is wrong. Although poor people spend a greater fraction of their budgets on exempted items like these, total spending on these goods rises with income, so most of the forgone revenue is actually from the rich.

The extra money raised could easily offset the extra cost to the poor by reducing income taxes on them (including national insurance contributions) or by raising the Universal Credit payment level. We could actually offset the extra cost to almost everyone, but except for people on low pay I think there are better taxes we could cut with the money left over.

The IFS estimated in 2010 that scrapping all VAT exemptions would raise an extra £26-28bn, based on 2010-11 numbers. Conservatively, rounding that up to £30bn to account for the larger economy, and spending half on boosting the incomes of the poor, we have £15bn left to play with. We’ve suggested scrapping capital gains tax to boost investment and using the rest to reduce the deficit.

In simplifying VAT we can make one important tax much less destructive without hurting the poor and use the money left over to cut taxes that are even worse.

Politically, this might not deliver good headlines, but if it was done at the start of the next Parliament the boost to people’s living standards by the next election could, improbably, make raising taxes on food and children’s clothes a real winner.

We might not want to start from here to get our sensible tax system, but this is one reform that could be a good step in the right direction.

The dark history of the minimum wage

We read today that the national minimum wage will increase by 20p an hour to £6.70 from October, and that this will benefit more than 1.4 million workers. What we hardly ever hear from politicians is how many people will feel the costs of this increase, in addition to the people who are already being hurt by having a minimum wage law in the first place. The problem with state-enforced minimum wage laws is pretty standard economic text book stuff: the minimum wage makes it harder for low-skilled workers to get a foot on the labour market ladder, it unfairly loads the burden on firms that employ low-wage earners (a burden that could be avoided by simply reducing the tax low-earners pay, or taking them out of tax altogether), and as a result it often causes inflation of prices and reduction in staff as firms try to recoup their losses.

With the announcement today, and with the Budget looming, I was very interested to stumble upon an article this week by Jeffrey Tucker about a Eugenics Plot Behind the Minimum Wage, in which we find out that in the early 20th century some eugenicists tried to introduce the minimum wage as a means of getting some of the lesser able people out of the employment market. Here are some relevant quotes that are bound to shock:

A careful look at its history shows that the minimum wage was originally conceived as part of a eugenics strategy — an attempt to engineer a master race through public policy designed to cleanse the citizenry of undesirables. To that end, the state would have to bring about the isolation, sterilization, and extermination of nonprivileged populations.

It was during this period and for this reason that we saw the first trial runs of the minimum wage in Massachusetts in 1912. The new law pertained only to women and children as a measure to disemploy them and other “social dependents” from the labor force. Even though the measure was small and not well enforced, it did indeed reduce employment among the targeted groups.

Leonard documents an alarming series of academic articles and books appearing between the 1890s and the 1920s that were remarkably explicit about a variety of legislative attempts to squeeze people out of the work force. These articles were not written by marginal figures or radicals but by the leaders of the profession, the authors of the great textbooks, and the opinion leaders who shaped public policy.

“Progressive economists, like their neoclassical critics,” Leonard explains, “believed that binding minimum wages would cause job losses. However, the progressive economists also believed that the job loss induced by minimum wages was a social benefit, as it performed the eugenic service ridding the labor force of the ‘unemployable.’”

So when we hear politicians make minimum wage commitments in the run-up to the election, bear in mind that those that preceded them were always fully aware that wage floors precluded people from the labour market, and that they were once deliberately implemented to expunge the demographic landscape of those they thought inferior citizens that were unworthy of earning a living. That they so readily endorse a policy that places a barrier to employment for so many people tells you just about all you need to know about the extent to which winning votes matters far more than aiding people’s job prospects.

I hope that, in my lifetime, politicians and social commentators begin to get the simple message that if you artificially remove the lower rungs on the labour ladder, you make it difficult (often impossible) for people to climb it, or in some cases, get on it at all.

Everything is consistent with the gender difference model

I think science works by proposing models and checking if data falsifies them. A popular model of gender in labour markets is that women and men are on average the same, but that they face discriminatory institutions and employers which lead to them having different outcomes.

Lots of data, on its face, seems to contradict this model: papers suggest that a man and a woman with the same job have the same pay; women earn (very slightly) more than men aged 20-40; women get promoted more aggressively than men if they don't leave the workforce; that women don't seem to rate discrimination the most important thing blocking their progress themselves.

But the model can be modified: let's say men and women are cultured by society into doing different jobs, that qualified women aren't promoted equally; that women earn more but only because they do more education; that so many women are pressured out that the ones remaining are actually much better than the remaining men so they are still under-promoted; that women don't want to speak out or that discrimination is hidden so they don't notice it.

But I wonder whether the model can contort itself enough to fit around these stylised facts:

• Srivastava & Sherman (2015) find that employees working under female managers do not experience smaller gender wage gaps.
• Charles (2011) finds that more gender egalitarian countries often have more sex-segregated occupations.
• Cech (2013) finds that both men and women enter fields that fit with their self-expressed characteristics, net of their beliefs about gender (i.e. even after taking those beliefs into account and controlling for them).
• Charles & Bradley (2009) found that people's curricular field choices are more sex-typed in more developed, egalitarian countries.
• Ceci, Ginther, Kahn & Williams (2014) found (among a huge number of other things) that the higher the average quantitative GRE score in a field, the fewer women were awarded PhDs in it.
• A 2015 ILO report found that women rate direct firm discrimination among the least important barriers in the way of their success in management.
• Gagliarducci & Paserman (2014) found that female-managed firms did worse on practically every measure, but that this was just because they managed different kinds of firms to men.
• Lippa, Collaer & Peters (2010) found that the more gender equal a country, the bigger the gap in mental rotational tasks (a key measure of visuospatial skills) between girls and boys.
• McGee, McGee & Pan (2014) found that male-female differences in competitiveness explain more of the gender wage gap in the NLSY97 (national longitudinal survey of youth that started in 1997) than in the NLSY79.
• Bertrand, Black, Jensen & Lleras-Muney (2014) found that the Norwegian law requiring all publicly traded firms' boards to be 40% or more female had no knock-on effects for women in general.
• Finally Schmitt, Realo, Voracek & Alli (2008) found that men and women differ across the world in personality, but most in developed countries where women have more rights and freedoms.

I bet you can make a model that fits, but that doesn't make it plausible.

The problem with Owen Jones

Young Owen is telling us all that we only mock the more idiot lefties because such mockery obscures the very important message that said lefties are trying to get over. Presumably that one about the necessity of smashing capitalism and sticking it to the man. Sadly he doesn't quite make his case: for he's sadly bereft of a basic understanding of how the media works. Yes, it's entirely true that everyone's screaming with laughter while discussing two kitchens Ed. But this isn't because the capitalist media pig dogs are pushing the story:

It is Vine who initiated this latest assault on Ed’s character. The drab kitchen was apparently sufficient grounds to suggest he and his wife are like “aliens”; Justine is compared to “the late Mr Spock”. But then Ed’s ever helpful friend Jenni Russell revealed that it was in fact, just a “functional kitchenette ... for tea and quick snacks”. And so the kitchen – sink and all – was thrown at Ed, or “two kitchens” Miliband as he is now to be known.

Why do I bother. Why do any of us bother. Try saying “political debate in Britain” without sniggering. It’s not about issues or people and their needs. It’s a mixture of the privileged scapegoating the largely voiceless – immigrants, people in poverty generally – and puerile character assassination.

The modus operandi of the right is to target anyone vaguely leftish and make the debate about them, rather than what they believe. I’ve written this before, but if you believe in social justice, they will find any reason to trash you. If you’re too poor, they’ll accuse you of envy; too rich, of hypocrisy; too young, of naivety; too old, of being a dinosaur. Above all, the right obsessively hunts anything that can be twisted into hypocrisy. If you think poverty is basically a bad thing and something needs to be done about it, then you have to live in a shed and forage for berries, otherwise you are a hypocritical champagne socialist.

In a market economy (no, this is nothing at all to do with capitalism or any other form of ism) an organisation prospers by delivering what its customers want. They therefore spend quite a lot of time and effort trying to divine what said customers want: so that they can offer it, of course. And with newspapers and the media more generally what people want (sa numerous academic studies have confirmed) is to have their extant prejudices stroked.

Purely hypothetically, if the working class of this country were possessed of some robustly conservative views on sex, gender and immigration, just as examples you understand, then the newspaper (s) that attempted to appeal to the working class of the country would have robustly conservative views on sex, gender and immigration. The newspaper do not form such views, they chase them.

And one of the things that we British do truly hate is hypocrisy. Thus the newspapers point to and urge us to laugh at examples of it, for we enjoy doing so. This isn't a right/left issue: it's just how a market works.

Which is why the newspapers are making hay with two kitchens Ed. Because we care very little about "the issues or people and their needs" and hugely about mocking the would be ruling class. And if you don't in fact know this about the media, that they chase prejudices not form them, then it really might be a good idea not to write about this subject that one is ill informed upon.

Economic Nonsense: 27. Outsourcing harms the economy

Outsourcing involves the contracting out of a business process to an outside party, and usually involves something that the business could do, and maybe previously did do, in house. Far from harming the economy, it is usually beneficial, sometimes to an extraordinary degree. It can be domestic outsourcing where firms within the same country provide services to a business under contract, or offshore outsourcing, where part of the activities of a business are performed abroad.

Domestic outsourcing has many advantages. It enables greater specialization, in that it allows a firm to concentrate on its core function, and to have certain functions performed by outside firms that specialize in those areas. By specializing they often acquire the expertise to perform the activity better than the firm could have done itself, and at a competitive price. The firm itself need not meet the capital and overhead costs of performing the activity in-house, but simply pay for the services from others.

Offshore outsourcing is usually done to achieve cost savings. It enables a firm to employ lower cost foreign labour, and thus achieve lower prices for its own products. Many electronic devices such as mobile phones and music players have their assembly outsourced to cheaper countries. This enables the goods to be sold more cheaply in advanced economies, saving customers money to spend on other things. It thus boosts economic activity and makes both countries richer. The poorer country has its workers enter the global labour market and be paid wages, while the richer country receives lower cost goods.

Outsourcing can be beneficial to government when it uses the services of outside contractors to perform some of its functions. Ministers and civil servants are not necessarily (and not usually) particularly good at business, so it can make sense to hire outsiders who are better at it and who have a record of experience at it.

Logical Fallacies: 18. We must do something

https://www.youtube.com/watch?v=J_tnXrK8Zmk  

The latest logical fallacy examined by Madsen Pirie is the idea that 'we must do something'.

You can pre-order the new edition of Dr. Madsen Pirie's How to Win Every Argument here

High top tax rates drive away inventors

There are plenty of reasons we might want moderately high top tax rates. If we do them cleverly (e.g. taxing consumption, not income, and definitely not capital or transactions) they can raise the revenue we may need for redistribution and goods everyone seems to believe only the government can provide, while not causing too many efficiency costs.

But there are also lots of reasons we might not want tax rates to go up too high. Eventually we pass the top of the Laffer Curve (it probably peaks when marginal rates + national insurance + benefit withdrawal + the tax rate effects of VAT + so on are roughly 60%, so about now) so we can cut rates and raise revenue—everyone benefits. Higher taxes means lower growth.

Another is that today's top 1% most skilled people are less rooted than ever before, and seem willing to work in Hong Kong, New York, Geneva, Paris, Los Angeles or wherever things are better. This means that changes in top tax rates can have substantial impacts. A new paper shows that this applies not just to bankers (witness the flood of French financiers to London) but also to top inventors.

"Taxation and the International Mobility of Inventors" (pdf), from Ufuk Akcigit, Salom Baslandze and Stefanie Stantcheva, finds that:

This paper studies the effect of top tax rates on inventors’ mobility since 1977. We put special emphasis on “superstar” inventors, those with the most and most valuable patents. We use panel data on inventors from the United States and European Patent Offices to track inventors’ locations over time and combine it with international effective top tax rate data. We construct a detailed set of proxies for inventors’ counterfactual incomes in each possible destination country including, among others, measures of patent quality and technological fit with each potential destination. We find that superstar top 1% inventors are significantly affected by top tax rates when deciding where to locate.

The elasticity of the number of domestic inventors to the net-of-tax rate is relatively small, between 0.04 and 0.06, while the elasticity of the number of foreign inventors is much larger, around 1.3. The elasticities to top net-of-tax rates decline as one moves down the quality distribution of inventors. Inventors who work in multinational companies are more likely to take advantage of tax differentials. On the other hand, if the company of an inventor has a higher share of its research activity in a given country, the inventor is less sensitive to the tax rate in that country.

The paper comes with some fascinating charts, showing just how many useful patents come from the most productive inventors.

It seems pretty reasonable that there are benefits to the UK of having productive inventors in the UK rather than elsewhere—although it may not come out as a net benefit to the world unless there are network benefits to the kinds of big agglomerations of research activity that are building up around Oxford, Cambridge, Manchester and London. But even if that isn't true, it goes to show that people really do respond to incentives.

Re-examining London's misnamed green belt

The momentum is building up for a change in London's housing policy after the election. The ASI published "The Green Noose" by Tom Papworth in January, showing that over a third of protected Green Belt land is devoted to intensive farming, by no means pretty to look at or environmentally friendly, and which in fact generates net environmental costs. In February London First published "The Green Belt - A Place for Londoners?" giving the facts and figures on London's land, and showing that only 26% of London's Green Belt consists of environmentally protected land, parks, and public access land. They similarly showed that only 27.6% of London is covered by buildings, roads, paths and railways.

In today's City AM Mark Boleat, policy chairman at the City of London Corporation, makes similar points, quoting the London First report, and pointing out that "a full 60% of the Green Belt is private agricultural land."

The research done by bodies such as the Adam Smith Institute and London First contradicts the popular image of the Green Belt as green and pleasant land. Far from the daisy-strewn meadows and woods teeming with wildlife that the term suggests, much Green Belt land is farmland, with monoculture fields by no means friendly to wildlife or accessible to people.

The first step in re-evaluation might be to classify Green Belt land into the different types that comprise it. There is genuinely green land, the fields and woods that everyone likes. There is damaged or brownfield land, partly made up of abandoned buildings, gravel pits and the like. And there is farmland, much of which is not environmentally friendly.

The government that takes office after May's election could take the initiative to redress a chronic shortage of housing where it is needed by allowing building to take place on land of types two and three, while leaving the genuinely green land preserved. The opposition will be much diminished if it is understood that only damaged, distressed or intensively farmed land will be affected. And more to the point, the extra houses will bring down the costs of housing and make it available to more people.

ASI's Budget 2015 wishlist: A tax code that actually makes sense

Nobody designing the UK’s tax code from scratch would come up with one like the system we have now. Our taxes are complicated and inefficient and divert capital away from productive investments that would boost economic growth. This year, we’re hoping for a Budget that reforms the tax code in line with the best economics out there, reforming the worst taxes and cutting the tax burden on investment and the working poor: VAT: broaden the base and use the money to help the poor

The huge number of exemptions to VAT make the tax so inefficient that if we raised the rate to 20% on every good we could compensate every household and still have a few billion pounds left over. If, instead, we raised every good to the 20% flat rate, but compensated only households earning less than median income, we'd have billions left over to reduce the deficit. The money raised should be given back to people on low pay through tax credits and to create a higher national insurance contributions threshold, which would increase the incentive to work on the other end.

Capital Gains Tax: abolish it outright to boost growth

Capital Gains Tax (CGT) is an extremely inefficient tax on capital that reduces overall investment and raises just £5bn annually. CGT reduces investment, 'locks-in' capital to less productive investments and can be avoided by not investing in assets that will rise in price, so it is distortionary and ends up directing investment away from riskier assets like start-up business debt. Scrapping CGT would not cost a lot (and could be paid for with the money left over from the VAT broadening, above), and would boost investment and growth, boosting wages across the board.

Business rates & council tax: revalue with a view to eventually merge

Business rates & council tax are in theory some of the least bad taxes on the books. As long as the values they are levied on are kept up-to-date, they reduce economic activity much less than most taxes. But in the modern world house prices and land prices move rapidly and not uniformly. The North is currently being hammered—paying business rates far higher than their property deserves—the South is winning out with unfairly cheap payments. Council tax is even worse: the band system is out-of-date and should be replaced with a fluid penny in the pound system like rates, while the revaluation long postponed from 1993 should be done now and then kept constantly up-to-date. If Zoopla can get good estimates of property values then surely HMT can too. Eventually the two systems should be merged at the same rate, so that housing and business both go where they are most in demand.

For further comments or to arrange an interview, contact Kate Andrews, Head of Communications, at kate@old.adamsmith.org | 07584 778207.