The tax system is the biggest barrier to growth


Outside of academic papers that too rarely see the light of day, most "research" is unremarkable in its optimism about the state of entrepreneurship in the UK. That’s why the RSA’s Growing Pains: How the UK became a nation of “micropreneurs” caught my eye. It paints a stark picture. The UK, according to the report, has become a nation of micro businesses, while the proportion of high-growth businesses has plummeted: “UK businesses are becoming increasingly micro in size – reducing the overall potential for economic output and future growth, and increasing the economy’s reliance on a relatively small number of larger businesses.”

Since 2000, the proportion of businesses classified as micro (0-9 employees), as a share of all UK businesses has grown from 94.3 per cent of all private sector companies to 95.4%. This represents an additional 1.4 million micro firms and an increase over the same period of 43%.

“At the same time, the proportion of high-growth enterprises has declined sharply, falling by more than a fifth in the majority of regions since 2005.”

Although the number of high-growth firms is expected to rise over the coming years, the report cautions optimism: “performance is expected to remain below 2005 levels in all regions except London”.

So how can we solve the problem? According the entrepreneurs, the tax system (44%) is the biggest barrier to growth – ahead of a lack of bank lending (38%) and the cost of running a business (36%).

Another problem highlighted by the report is that entrepreneurs don't know what the government is up to:

“Around three-quarters (73%) of small business leaders also say the Government must make it easier for SMEs to access the right information and support for growth. While several of the Government’s recent incentives to support SMEs are designed to address the top-cited barriers, perhaps this information is not reaching the people who need it the most.”

Two polices are put forward in the conclusion to help entrepreneurs. First, “continued reform of the apprenticeship scheme could help micro firms to grow out of this business size category”. Second, “more tax relief like the National Insurance holiday could also pay real dividends.” It would be worth exploring the former in detail (something I plan to work on), but I don’t think another NI holiday goes nearly far enough: Employers' National Insurance should be scrapped entirely. And no just for small businesses.

Being an entrepreneur is tough. As the report points out, “the majority (55%) of new businesses don’t survive beyond five years.” Scrapping Employers' NI is the logical place to start.

Philip Salter is director of The Entrepreneurs Network.

'Global Inequality as a Consequence of Human Diversity'

EDIT: A version of this review was published in the journal Intelligence and can be found here. Over the past few days I read Tatu Vanhanen's new book, Global Inequality as a Consequence of Human Diversity published by the Ulster Institute for Social Research. Though I am broadly open to the arguments he makes therein, it is not a good book and I cannot recommend it. I have not read IQ and the Wealth of Nations the 2002 book he published with Richard Lynn, but I suspect the theses are very similar.

His argument runs that the existing explanations for the variation in living conditions between nations are either hard to falsify (like Jared Diamond's and Jeffrey Sachs'), excessively narrative, explain too little of the variation, or beg the question (like Daron Acemoglu & James Robinson's).

He advances an alternative explanation: since (a) human evolution has been recent and extensive enough to produce substantial morphological differences (consider how different Koreans, Somalians and Papua New Guineans look); and (b) we have a large literature suggesting that lots of traits, especially cognitive ability (measured well, he believes, by IQ) are substantially genetic, we shouldn't assume all human populations are genetically similar in intelligence. Since we know that intelligence is important for social success within populations we should not be surprised if it controls success across populations.

Quoting Pilar Ossorio, he says:

According to contemporary geneticists, any two unrelated humans are about 99.8% or 99.9% genetically identical, but because 'the human genome contains approximately 3bn nucleotides (DNA building blocks), a 0.1% or 0.2% difference translates into millions of sites at which two people will have a different nucleotide.'

He constructs an 'Index of Global Inequality' (IGI) out of six measures of societal success: gross national income at purchasing power parity; the share of the population in tertiary education; under-five mortality; life expectancy; sanitation facilities; and an index of democracy. He finds, with a simple regression, that around three quarters of a country's IGI is explained by its average IQ. Further, most of the outliers have special explanations for why they depart from the curve, the biggest four being: oil, caribbean tourism, history of socialism and civil wars.

In and of itself, this argument is somewhat interesting and somewhat suggestive. What is surprising is that this is almost the entirety of the book, fairly laboriously spread over 170-odd pages. It makes almost no attempt to deal with the evidence against it. For example, it's true that within Western groups IQ is highly heritable (i.e. most of the variation between individual is due to genetic factors) and largely unaffected by environment. It's also true that within poorer societies a large fraction of IQ is down to genes, but this fraction is lower, because there are many more of the big downside factors that can really stunt cognitive development (principally malnutrition). And it's much less clear that the difference in IQ across the world, where environments are extremely heterogeneous, are down to genetics.

It's not that it's impossible they are and there is rock solid evidence for the alternative. But Vanhanen doesn't even attempt to provide evidence for his view that IQ is practically entirely genetic, even across strikingly different environments. One flaw of the book is that once he has stated that the evidence suggests IQ is mainly genetic within populations, he begins assuming the link between IQ and development across populations purely represents human diversity-caused differences, with only the unexplained residual environmental. This is not representative of the stronger stuff I've read in the area.

This leads into another puzzling issue with the book: the fact it fails to deal with any of this existing literature. There are better ways to test whether institutions, geography or human diversity is driving differences in development and he doesn't really attempt any of them! For example, a 2011 paper found that effectively random variation in institutions had no effect on the economic outcomes of a given African ethnic group. The literature is large and the debate is still raging, and Vanhanen's 'side' might end up being judged right, but his approach adds basically nothing to the question of whether IQ causes development or development causes IQ.

I suppose I can't really blame the book for its cheapness, the relatively frequent typos, the ugly and unclear charts and tables, but these certainly reinforce the overall feeling of lightweight pointlessness you get when you read it. And I can't stress enough the importance of human capital theorists being epistemically cautious in their claims, given how controversial their conclusions are. People, working on sound principles, often devalue a perspective when they hear a weak argument in its favour ('if that's the best they've got...'), and I think Vanhanen's new book will only weaken the case for considering human diversity when looking at global inequality.

The ECB is fiddling while Europe burns


If not quite burning yet, the eurozone is kindling. For once, most people agree why: money is very tight. The central bank's interest rate is low, yes, but this is not a good measure of the stance of monetary policy. What matters is the interest rate relative to the 'natural' interest rate - ie, what it would be in a free market. It's difficult to know what this natural rate is (as Hayek would tell us) but we can look at things like nominal GDP and inflation to help us guess. Both are way, way below levels that the market is used to. Deflation is back on the menu.

As Scott points out, whatever you think about the American or British economies since 2008, the Eurozone looks like a case study in central bank failure:

The eurozone was already in recession in July 2008, and eurozone interest rates were relative high, and then the ECB raised them further.  How is tight money not the cause of the subsequent NGDP collapse?  Is there any mainstream AS/AD or IS/LM model that would exonerate the ECB?  I get that people are skeptical of my argument when the US was at the zero bound.  But the ECB wasn’t even close to the zero bound in 2008.  I get that people don’t like NGDP growth as an indicator of monetary policy, and want “concrete steppes.”  Well the ECB raised rates in 2008.  The ECB is standing over the body with a revolver in its hand.  The body has a bullet wound.  The revolver is still smoking.  And still most economists don’t believe it.  ”My goodness, a central bank would never cause a recession, that only happened in the bad old days, the 1930s.”

. . . And then three years later they do it again.  Rates were already above the zero bound in early 2011, and then the ECB raised them again.  Twice.  The ECB is now a serial killer.  They had marched down the hall to another office, and shot another worker.  Again they are again caught with a gun in their hand.  Still smoking.

Meanwhile the economics profession is like Inspector Clouseau, looking for ways a sovereign debt crisis could have cause the second dip, even though the US did much more austerity after 2011 than the eurozone.  Real GDP in the eurozone is now lower than in 2007, and we are to believe this is due to a housing bubble in the US, and turmoil in the Ukraine?  If the situation in Europe were not so tragic this would be comical.

There is a point here. Economic news, by its nature, tends to emphasise interesting, tangible, 'real' events over things like central bank policy changes (let alone the absence of changes).

Of course that can be deeply misleading. The stance of money affects the whole economy (at least the whole economy that does business in nominal terms, which is pretty much everything except for gilt markets), and the Eurozone is experiencing exactly the sort of problems that the likes of Milton Friedman predicted that tight money would create.

Overall, the Euro looks like the most harmful institution in the world, except perhaps for ISIS or the North Korean govt. It may be unsaveable in the sense that it will never really be an optimal currency area, but looser policy (which free banking would provide) would probably alleviate many of the Eurozone's biggest problems. Instead, what Europe has is the NHS of money – big, clunking and unresponsive to demand.

And the ECB seems wilfully misguided about what it needs to do. The only argument against this is that surely—surely—Draghi and co know what they're doing. Well, what if they don't?

Another exercise in rewriting economic history


It is just so fun watching people rearranging the historical deckchairs to make sure that their tribe looks good and that the tribe of their opponents can be portrayed as those nasty, 'orrible, people over there. And so it is with this latest from Ha Joon Chang:

First, let’s look at the origins of the deficit. Contrary to the Conservative portrayal of it as a spendthrift party, Labour kept the budget in balance averaged over its first six years in office between 1997 and 2002. Between 2003 and 2007 the deficit rose, but at 3.2% of GDP a year it was manageable.

Quite: in those first few years Blair and Brown held to the spending limits that had been suggested by the previous, outgoing, Tory government. On the basis that if anyone thought they were the spendthrift Labour party of old then they wouldn't get elected. So there was, in there, a period of a public sector surplus. It's only after the second election that they ripped up that idea of fiscal restraint and became that Labour party of old again. So "balance" over the six years is actually a couple of years of Tory policy then spend, spend, spend.

And a deficit of 3.2% a year might be manageable: except of course it wasn't, was it? But more importantly it is a grave violation of the precepts of Keynesian economics to be having a deficit of any sort at that point in the economic cycle. If we are to take Keynesian demand management seriously (we don't, but let us do so arguendo) then yes, there should be fiscal expansion in the slumps. But the counterpart to that is that in the boom there should be restraint: a surplus, not a deficit. This is not to pay off the previous debt, it's not to create the borrowing room to provide the firepower for that next slump. It's because demand management means that you temper the booms as well as the busts. Given that the middle part of the Brown/Blair Terror was in fact the tail end of the longest modern peacetime boom then the public accounts should have been healthily in surplus. In order to temper that boom.

Chang is doing an edit to history here, to show that his tribe is better than the other one. Given the circumstances of the time Labour really were sailor-type drunken loons going on a spree with the nation's chequebook and don't let anybody tell you different.

The mansion tax is theft, a bit at a time

Labour's mansion tax was already starting to unravel even before Shadow Chancellor Ed Balls tried to save it with a few palliatives today. When you have left-wing Labour MP Diane Abbott complaining that the mansion tax would be little more than a tax on Londoners, and when other MPs and candidates nursing slim majorities are worrying that the tax might hit their own voters, and not just rich Tories, you know it's time to throw in the towel.

Strange, is it not, how politicians never ask how they could cut their own spending, but only think about how they can raise taxes from other people. Mr Balls reckons he can raise £1.2bn from the tax, which he says would come in handy for the NHS, he reckons (though the emerging black hole in the NHS budget is much larger than that). How does he know? He says much of the tax would come from foreigners with big houses in London, but does not seem to know how many of them there are. No, as usual, it will be the Great British public who foot most of the bill, and not just the rich. Tens of thousands of homes in London will be caught by it, for example, where the average price in a 'prime area' will probably hit the £2m mansion tax threshold by the time of the 2015 election. And 'prime' includes areas like Battersea and Clapham, not just swanky Kensington and Chelsea.

There are already plenty of taxes on property. Not only is there the council tax, but there is stamp duty when you buy a house and inheritance tax when you give it to your kids. Now the plan is to add another, of perhaps £4,000 a year.

We all know what will happen. The tax will be imposed on properties of £2m, and over the years, thanks to (politician-created) inflation and (politician-created) planning restrictions, the cost of property will rise. More and more properties will be hit by the 'mansion' tax (yes, including broom cupboards in Kensington), just as more and more people now pay the 40% higher rate of income tax, which was originally targeted at the wealthy but is now paid by people like teachers and police officers.

And our tax (and subsidy) system is already highly progressive. Wealthier people pay higher taxes of many kinds, while poorer areas get subsidies through the local government finance system.

The mansion tax is theft, a bit at a time. There will be many people who happen to live in large houses but have little or nothing in the way of income (such as those on pensions) with which to pay the tax. Perhaps the house was their childhood home and they can't face moving. Moving is a strain even for the most robust of us. Ed Balls says, well maybe poorer people could defer the tax until they sell the house or pass it on after their death. But that makes the tax even more complicated - it is going to need a means test and a lot of extra bureaucracy, more lines on the tax form and all the stuff that has already got us in such an overtaxed bureaucratic pickle. This is a tax we could well do without.

Equal pay for equal work


A recent speech by Andy Haldane, the Bank of England's chief economist, sheds a good deal of light on the cost of living crisis and the union-led "Britain Needs a Payrise" campaign. Haldane points out how grim the recent situation has been for real wages in the UK economy:

Growth in real wages has been negative for all bar three of the past 74 months. The cumulative fall in real wages since their pre-recession peak is around 10%. As best we can tell, the length and depth of this fall is unprecedented since at least the mid-1800s.

But is this because employers have suddenly become selfish capitalists, whereas before they were paying workers out of the good of their heart? Or is something else at play?

Productivity – GDP per hour worked – was broadly unchanged in the year to 2014 Q2, leaving it around 15% below its pre-crisis trend level. The level of productivity is no higher than it was six years ago. This is the so-called “productivity puzzle”. Productivity has not flat-lined for that long in any period since the 1880s, other than following demobilisation after the World Wars.

We usually think that wages and productivity will be pretty closely related. Employers are unlikely to consistently pay above productivity, because they'd lose money. But equally, they'll be unable to consistently pay far below productivity (less the share needed to rent the capital involved) because in a reasonably competitive market firms will compete their workers away with more attractive job offers.

We might think this is particularly true at the low wage end of the market, because much less of low-skilled workers productivity is job specific. An accountant makes a very poor lawyer, and a civil engineer is not qualified to write code, but a worker in McDonalds will be similarly good at Burger King, or for that matter Waterstones, JR Wetherspoon, Lidl or most other relatively low-skilled areas.

So basic economic models suggest pay will track productivity. And what do we see on the macro level?

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The deficit in pay tracks the deficit in productivity. Of course, the situation for public sector workers is a bit different—we actually measure their productivity mainly by inputs. If their pay goes up, their measured productivity goes up. It's hard to see how else we would do it. But the overall picture suggests that the real pay decline is down to a real productivity decline. We haven't moved away from equal pay for equal work—we've just had a big horrible recession and a sluggish recovery!

R&D's great but why a target for spending on it?


R&D's just lovely, it is, after all, how we develop the new technologies that are such an important part of economic growth. But we do hesitate a little bit when people start to say that we should have targets for spending upon something, whether it be R&D, poverty alleviation or education:

A "bold strategy” is needed to remedy weaknesses in Britain’s supply chain, according to the CBI, in a push to create 500,000 new jobs and boost the economy by £30bn.

The CBI feels a long-term target of 3pc of gross domestic product for public and private sector spending on research and development would underpin a turnaround over the next decade.

It's all a bit never mind the quality, feel the width, isn't it? For it's not actually true that devoting more resources to something is desirable: what we want is more output of whatever it is from the resources that we do devote to that thing. We could describe this as being almost Stalinist: don't worry about how good each car is but just weigh how much steel we put into each one! Or, another way of making the same point is that GDP, the thing we use to measure economic growth, is actually measuring value added in the economy. Except when we come to talking about government of course. There we've no idea what the value added is so we just assume that the output is worth the value of the resources devoted to producing it.

That's not an assumption that holds true in the real world of course: and so it is and would be with R&D spending. How much we spend on it isn't the interesting or important point: how much cool new stuff and shiny shiny we get from spending on R&D is.

The report shows a lack of investment in research and development, along with a growing skills crisis, has weakened “foundation industries” such as plastics, metals and chemicals.

It is also calling for a change in research tax credits to help innovation and incentives to encourage more graduates to take science, technology, engineering and mathematics (STEM) degrees.

Creating a national materials strategy to protect and enhance critical supply chain sub-sectors and doubling the budget of Innovate UK are among other measures in the CBI programme.

It all does smack rather of that old industrial planning, doesn't it, where success is measured by resources consumed rather than the value of the output.

Finally, as an aside, encouraging more people to take STEM degrees is very simple indeed. The employers of those who graduate with STEM degrees should increase the wage they pay to those with STEM degrees. Rather than demand that the State subsidise the creation of a willing workforce.

The terrible error of Naomi Klein


Naomi Klein tells us that the polluter must pay. Something that is both logical and true. Then she tells us that the fossil fuel companies must be made to pay for the damage that they do. Also logical and true:

Up until the early 1980s, that was still a guiding principle of environmental law-making in North America. And the principle hasn’t totally disappeared – it’s the reason why Exxon and BP were forced to pick up large portions of the bills after the Valdez and Deepwater Horizon disasters.

We might quibble about whether the damage was quite what was described or paid for but the basic principle is entirely fair. However, here comes the error:

The astronomical profits these companies and their cohorts continue to earn from digging up and burning fossil fuels cannot continue to haemorrhage into private coffers. They must, instead, be harnessed to help roll out the clean technologies and infrastructure that will allow us to move beyond these dangerous energy sources, as well as to help us adapt to the heavy weather we have already locked in. A minimal carbon tax whose price tag can be passed on to consumers is no substitute for a real polluter-pays framework – not after decades of inaction has made the problem immeasurably worse (inaction secured, in part, by a climate denial movement funded by some of these same corporations).

Assume, for a moment, that CO2 emissions are indeed causing damage. So, who is responsible for those emissions? Who is the polluter here who must pay?

When I drive to the shops it is me making the decision to do so, me making the decision to emit CO2 in gaining my supply of comestibles. I am therefore the polluter. That's why, if there is to be a tax on polluters it should be upon me, the polluter. Which is the entire point of a carbon tax that can be passed on to the consumers. It is we consumers who are the polluters which is why we should have that tax which falls upon the polluters.

This is the most appalling and most basic error by Klein. We do not consume fossil fuels because Teh Eeevil Corporations force them upon us. We consume them because they provide us with things that we desire, transport, heat, light and so on. The fault, as it were, is not in our suppliers but in ourselves.

Of course, as many do around here, it's entirely possible to reject the entire thesis. But working within the logical structure of the IPCC we still end up with the result that a tax which falls upon consumers is the correct action: as every single economic report about the problem, from Stern through Nordhaus and the IPCC itself, has pointed out. Because it's the consumers who are the polluters and yes, the polluters should pay.

How food banks trump the welfare state


On the face of it, the figures are damning. Food banks in Britain helped over 900,000 people last year, up around a third over the year before. It seems Britain has a real problem with food poverty. Our benefits system just isn’t coping. But, like so many media headlines, the truth is a lot more subtle. Nearly all food banks in Britain are run by a single Christian charity, the Trussell Trust. In the last few years it has found a niche, sharpened its act, and opened a lot more. So not surprisingly, care professionals have been sending more people along. It may not be that the underlying problem is getting worse, just that it is being better served.

Nor is it the government’s benefit reforms that explain the rise. Food banks were growing long before the measures were passed in 2013, and many of the reforms have not even been implemented yet. And by merging scores of benefits into a far simpler universal benefit, the reforms should hopefully help ensure that people do not in fact fall through the gaps in the over-complicated welfare net.

The underlying problem that food banks help solve is not food poverty, any more than it is shoe poverty, clothes poverty, electricity poverty or water poverty. It is the temporary crises that people sometimes get into when they are unemployed or on low pay. Around 60% of food bank users are once-only users. They hit a crisis and can’t afford the groceries; that is why care workers refer them.

Around 30% of them have problems because their benefits payment has not arrived in time, or they are being penalised for not showing up at interview, or they have simply filled in a form wrongly. And you can blame that on our over-complicated, bureaucratic, distant and unfeeling state benefits system. We spend £94bn a year on it, a seventh of all government spending (and the government spends a lot). If we devolved the process to local communities and voluntary groups, it would work much better.

No government can do much about the fact that food prices have risen nearly 35% since 2007. Well, actually, they could stop subsidising biofuels, which has diverted huge amounts of agricultural produce out of human mouths and into gasoline tanks. And they could do something about the fact that other essentials have been soaring in price too. Government-mandated to renewable energy adds about 15% to the fuel bills of businesses and private sector organisations, plus about 6% on the gas bills and 11% on the electricity bills of domestic customers. That is why poorer people run out of cash and economise by going hungry.

Nearly everyone in Britain is well fed – some too much so – because Britain is a peaceful, trading nation with an established rule of law. Our farmers are not afraid to plant crops in case they are stolen by thugs or invading armies. Our traders bring produce to us from all over the world. If you want to see chronic poverty, look at countries that do not have this thriving market system.

Because this market system makes us a rich country, we can afford to help people who run into problems. The biggest philanthropic sector on the planet is that of America, the world’s richest country. In fact, America, Canada, New Zealand all have large food bank movements. That is because they are rich, and because they have a strong sense of community too. In Britain, too much of that sense of community has been crowded out by our state bureaucracy.

It is actually good to see charities taking on these problems. The state is inevitably large and lumbering. Private charities are much better at tackling individual human issues, like families who run out of cash from time to time.

Of course, the state could help in a very simple way. A large number of people referred to food banks are actually not those on benefits, but people on minimum wages. The government has pledged to take everyone on minimum wage out of tax, and about time too – it is absurd to tax people who are on the breadline. And yet we are still charging them and their employers another, hidden tax, namely National Insurance Contributions. Again, it’s crazy. If you want to help people in poverty­–and get people into the world’s best welfare programme, namely a paying job–you should be making work pay, which for many of the nation’s poorest, is appallingly not the case.

Yes, of course we're being lied to, why do you ask?


We're all wearily familiar with the ritual incantations that it's those nasty multinationals that dodge taxes in developing countries and that therefore little babies die. This is not, despite the frequency of those incantations, actually true. The extremely impressive researcher, Maya Forstater, has rather more of the truth for us here:

Nevertheless if current estimates are best we have to go on, they should at least be communicated clearly. One thing that becomes clear once you take away all the showmanship of the killer facts is that the estimates commonly used are simply not that much money. Global numbers in billions are hard to comprehend, but we can make honest and clear efforts to make sense of them on a country-by-country basis. According to the data that ONE sent me (which uses PWC data on national tax rates to estimate the tax revenue losses associated with GFI illicit flows estimates) it looks like most countries where aid contributes a significant proportion of government budgets have estimated trade related tax losses in the region of 15% or less of aid receipts. Not nothing, but not the grand problem-solving amounts we are led to believe.

If you look at what this amounts to on a per capita basis (based on the ONE data and my calculations), Bangladesh could raise $2.77 extra tax for each of its citizens, Ethiopia $6.81, India $9.31and China $4.14. That is dollars; single dollars. Per person. Per year.

We thoroughly recommend reading her whole piece in full. Maya's forte is to take these various reports from the various usual suspects and then drill down into the actual numbers and assumptions that they are making and test the veracity of them. An earlier success of hers was pointing out that estimates that Zambia had been diddled out of $10 billion in copper revenues was based on the pricing structure of 2 tonnes (yes, just two tonnes) of samples that had been sent out. Thus over-estimating the correct copper revenues by a factor of five (the very boring technical detail which I was able to help with subsequent to that article is that samples cost more than production lots. Largely because customs data on pricing (which is where the prices came from) includes the cost of transport in said customs pricing. So if you send someone 20 kg of copper as a sample through DHL the customs price for that 20 kg includes the DHL package costs. Which is, as we all know, rather higher per kg than the transport costs of 10,000 tonnes of copper on a ship).

It's important for us to recognise all of this: and Forstater's major point here is that these numbers we're being fed about the impact of tax losses on developing countries simply are not true.