The Pin Factory Blog

No, no prizes are won for shouting that Chavez is what's wrong with Venezuela. He's one thing that is but the malaise goes deeper than that. For he's not the first bad economic planner to have power in the country. A new paper tries to discuss what that deeper, underlying , problem is:

They find that the exceptional growth episode was due to a combination of plain old capital accumulation along with total factor productivity growth originating in the booming oil industry and its foreign direct investment transferring know-how to locals. The following collapse shows the undoing of this but with a very different origin. A severe misallocation of resources lead to a drop in total factor productivity, which then triggered capital loss. And how did the government manage to create the mess? First, it steered the economy away from oil, which may be a good idea for diversification. But the second error was to favor heavy industries, a common development mistake.

So there we have it: the sort of disaster that can happen from trying to grow the economy through localisation, infant industry protection and government planning.

For, as you can see, when foreign companies were investing in the country they were bringing with them the new and interesting ways of doing things, those higher productivity ways, which increase the wealth of the country. Note that these new ways only have to be a few percentage points more efficient than the local ways to more than cover the dividends and profits flowing out again.

But then, as so often in Latin America, there comes the idea that a country should be self-sufficient. So local industry is protected: meaning that those new ways discovered elsewhere don't take hold as the foreigners aren't allowed to bring them in. Result? stagnation of the economy.

It is possible to, in theory, suggest a way in which protecting local industries will make a country richer. But given that it's a big wide world out there, with all sorts of people in all sorts of places designing and inventing more efficient ways of doing things, deliberately cutting yourself off from those new ways leads to relative decline, not a growth in relative wealth.

Tax Freedom Day 2011 came on May 30, three days later than in 2010. That means that for the first 149 days of the year, Britons were earning for the taxman. Only on May 30 did they start earning for themselves.

But even this alarming figure understates the heavy financial burden imposed by the British state. If the government had to finance all its spending through taxes, rather than relying on borrowing, Tax Freedom Day would not have come until today, July 1.

To put it another way, the government would have to take every penny earned in the United Kingdom from January 1 to June 30 – a full six months – in order to balance the books for the year at current levels of spending.

What’s our money being spent on? If Britons were funding all public spending through taxes, they would have to work 50 days to cover the cost of benefits, tax credits and pensions, and a further 8 days to cover personal social services. Paying for healthcare would take them 32 days. Education would take 23.

Shockingly, Britons would have to work a full 11 days to finance debt interest payments – that’s longer than they’d have to work to pay for defence (10 days) or law and order (9 days).

How big is the funding gap? The gap between Tax Freedom Day based on tax revenues – the traditional figure – and Tax Freedom Day based on government spending now stands at 32 days. That is a smaller gap than in 2009 (37 days) and in 2010 (40 days) thanks to the government’s efforts to reduce the budget deficit. But as recently as 2001, there was no gap at all – then, the government could fund all its spending commitments through taxes, without having to borrow money.

What’s going to happen over the next five years? Assuming that the coalition governments delivers on its promise to reduce spending, then Tax Freedom Day based on government spending will continue to come earlier in the year, and the gap between it and Tax Freedom Day based on tax revenues will continue to get smaller. Based on Office of Budget Responsibility forecasts:

• In 2012, Tax Freedom Day will be May 30 based on tax revenue and June 23 based on government spending – a gap of 24 days.
• In 2013, it will be May 31 based on tax revenue and June 16 based on government spending – a gap of 16 days.
• In 2014, it will be June 1 based on tax revenue and June 11 based on government spending – a gap of 10 days.
• In 2015, it will be May 31 based on tax revenue and June 6 based on government spending – a gap of 6 days.

No doubt the actual figures will turn out different from that – government forecasts are rarely correct a year in advance, let alone five. But I do think these figures provide an interesting indication of what is to come. The tax burden will get worse, but only marginally, and government borrowing will be reduced, but not eliminated. 

One statistic that has been largely missing from the media’s coverage of the pension debate this week has been life expectancy. Men can expect to live to 78, women to 82. That means that men can expect to live, on average, 17 years after the age of 65; women can expect to live another twenty years. The BBC reported in March that the average life span globally has doubled in the last 200 years, and that British life expectancy gains two years per decade.

According to the Guardian the average pension is £3,900 but a teacher who retries at 60 after working for forty years will have an index-linked pension of £24,000.

On average a public sector worked is being asked to contribute 3% more to their pension. This is not because of the deficit, but because pension schemes in the public sector are unfunded: like a pyramid scheme it pays up from the wide base of current workers to the small pinnacle of index-linked retirees. The problem is that the base and the pinnacle are not as proportionate as they are in a real pyramid.

The union leaders have been all over the radio and television talking about the most vulnerable being asked to pay more; but the Telegraph reports this:

Workers who earn less than £15,000 will not be asked to contribute any more. Those earning less than £18,000 will have extra contributions capped at 1.5pc.

Then there is the question of whether, as two teachers claimed on Sky News today, the workers are being asked to pay off the deficit whilst the bankers and the rich get off. The Telegraph reports the findings of Hargreaves Lansdown:

Take a public sector worker who starts on a salary of £20,000, sees their pay rise by 4.5pc a year and works for 40 years. According to Hargreaves, they will have an annual pension of £19,920 based on a career average scheme. This compares to just £7,960 a year that a private sector worker will get from a defined contribution scheme based on 10pc contributions.

Another stat that seems to have been underplayed is the reform made to the basic state pension, the triple lock. It will be upgraded in line with either inflation (CPI) earnings or by 2.5%, whichever is the largest.

The final fact comes from the economics editor at the Independent and makes the point about as plainly as it can be made:

Only…10 per cent of private-sector staff, are covered by [final salary pensions]. By contrast, about 80 per cent of public-sector workers still have traditional pensions.

Adam Smith had an insight that elegantly answers the question:

The practice of funding [i.e. borrowing to pay for government spending] has gradually enfeebled every state that has adopted it...where national debts have accumulated to a certain degree there is scarce I believe a single instance of them having been fairly and completely paid.

He, of course, was writing about England. And with the UK government now repaying its creditors in devalued, inflated sterling, he seems to be right there, too.

Over on ConservativeHome yesterday, Sajid Javid MP argued that the Britain should cap its national debt. Next month, he’ll be introducing a National Debt Cap Bill in the House of Commons to this effect. Bravo, Sajid!

I’m a big fan of the idea. The simple truth is that you can’t trust government to be fiscally responsible. Political imperatives mean they will almost always prioritize the short-term over the future. In spending terms, what’s a little more debt if it lets you carry on with the bread and circuses? The result is that governments tend to adopt a buy-now, pay-later attitude. All the incentives point in that direction.

That’s why rules are important. You need to impose limits on governments; you can’t just rely on their discretion. And a debt cap is the perfect place to start. But I’d like to see much more besides. Indeed, I’d like to see the government introduce a fully-fledged Economic Responsibility Act, like the one Eamonn outlined in this briefing paper.

As Sajid suggests in his ConHome piece, we should cap the national debt at 40 percent of GDP. We’re a little over 60 percent at the moment, so this cap should start as a binding legal target for, say, ten years hence – with clearly defined checkpoints along the way. Once we got there, the government’s hands would be tied.

We should cap the budget deficit – at 3 percent of GDP – and the overall size of the state – at one-third of GDP. Again, these should begin as legally binding targets, to be achieved by a specified date. We should also have clear rules on what the government can borrow for (capital investment) and what it can’t (current spending), and ensure that all government is transparent and ‘on-the-books’.

Finally, we should limit the government’s ability to raise taxes arbitrarily. I’d say that any tax rise not specifically detailed in a governing party’s general election manifesto should have to be approved in a referendum. That, taken together the deficit limit, would make it very difficult for future governments to ramp up spending the way Gordon Brown did.

Of course, it is true that – constitutionally speaking – Parliament cannot bind its successors, so these rules could always be changed at a later date. But the very existence of the rules, and the need to explicitly repeal or amend them, would act as a powerful counter-incentive against ever-larger government.

But that’s all some way off. For now, good luck to Sajid Javid and his National Debt Cap Bill.

Philipp Bagus is an associate professor at Universidad Rey Juan Carlos in Madrid. He is the author of The Tragedy of the Euro. Visit his personal website here. 

Police and rioters are clashing in the streets of Athens as the Greek government approves further austerity measures. Indeed there are conflicts over austerity measures all over Europe. At the root of these conflicts lies an interventionist banking system, credit expansion and the perverse setup of the European Monetary System as described in my book The Tragedy of the Euro.

During the 2000s artificially low interest rates lead to an impressive boom, asset price bubbles and malinvestments. Real resources were wasted in building houses that no one wants at bubble prices, in the overexpansion of certain industries and in countries such as Greece in maintaining and expanding an immense public sector.

When Lehman Brothers collapsed governments came to the rescue of industries such as the automotive sectors and, of course, of the banking industry. The losses of these sectors were, thus, partially transferred to the governments. Government deficits and debts soared. The result is the sovereign debt crisis.

Now, European governments like the Greek one are on the border of default. If Greece would be allowed to default, its banks holding Greek government debts and experiencing a run would go bust. In a European banking crisis, French, German and British banks could go insolvent.

While society in general is already poorer due to the malinvestment of the artificial boom, the burden of the losses has not been finally assigned. And losses have not disappeared. They were partially shifted from banks and companies to governments.

Who will be the final bearer of these past losses? Will banks, that bought government bonds, finally be the bearer of losses because governments default on their bonds? Will governments suffer the losses as they lose in power when they are forced to auction off public resources and reduce their spending? Or will taxpayers bear the losses? And finally, which countries’ taxpayers will bear the losses? A huge struggle has started in the Eurozone on how to split the losses between governments, banks and tax payers in the periphery and the core.

The fastest and cleanest solution would be that the responsible actors bear the losses themselves: governments and banks. They would have to default. Banks have lent to irresponsible governments or granted loans flowing into asset price bubbles. Their shareholders would lose everything. Unsurprisingly, politicians and bankers suggest that this would lead to chaos and trigger a long depression. They want taxpayers to pay their bill, at least partially.

Yet, in the case of non-intervention, the world would not come to an end. More realistically, there would be a short and sharp crisis and a fast adjustment. Economically unsustainable business models in the financial sector would disappear. Sounder banks could raise new capital and creditors could agree to a debt to equity swap if a bank´s business model was judged sound.

The alternative is that the past losses are not realized at once but stretched through a long crisis and put on the shoulders of innocent parties. Banks could be sustained with unrealized losses similar to Japanese zombie banks. Taxpayers and users of the single currency could be made reliable for losses. The Eurozone would then stagnate for years.

Through the bailout of irresponsible banks and governments, irresponsible behavior is encouraged. Past malinvestments are not dismantled and new ones are added. A taxpayer bailout reduces the pressure on the Greek government to sell its assets and cut its spending – i.e. malinvestments are not liquidated and continue. Similarly, banks can maintain their support for irresponsible government and prevent the fast liquidation of malinvestments such as unsold housing units. Ordinary people in the Eurozone then suffer through price inflation and a greater tax burden, as well as a long, drawn out crisis.

By contrast, ordinary Europeans would strongly benefit from a liquidation of malinvestments following a Greek default and a European banking crisis. This would not be the end of the world, but the beginning of a short, efficient adjustment process and the just distribution of the burden of losses.

The visit of the Chinese premier Wen Jiabao to the UK this week naturally makes one ponder the role of China in the world economy. After years of China selling us cheap clothing and electronics, British and American consumers are getting used to paying a lot more for their imports as their currencies slide gracefully towards oblivion, thanks to quantitative easing. In China, meanwhile, the expansion of the cities and the movement of people off the land is turning the economy more middle class – more interested to supply its own needs rather than be cheap producers for the rest of the world.

British and, particularly, American influence in world affairs has been given a knock by the financial crisis. China was already catching up fast, in terms of overall GDP at least, if not per-capita. The crisis is just hastening the eclipse of the West. The old G8 hardly matters these days, it is the G20 that pushes the world economic agenda. Indeed, the emerging economies of Brazil, Russia, India, China, Mexico, Indonesia and Turkey are becoming a power in themselves. And Europe is of course embroiled in its own crisis, thanks not so much to the banking crisis as to the inconsistencies of the single currency.

On the other hand, the West's self-inflicted hurt is not really good news for China. It has its own problems. Its decades-long manipulation of the exchange rate has produced a lot of them. Inflation is alarmingly high. Growth has slowed as China's customers, like America, have been spending less. Commodity prices are rising again as other parts of the world recover. It has a terrible demographic problems, with its ageing population and one-child policy. And when you go to China and see millions of them jabbering into their mobile phones, you wonder how the central administrators in Beijing think they can resist the rise of democracy. Sure, China is growing, more of its population are being taken out of poverty, its muscle in world affairs is getting stronger. But it would be a lot stronger still if it maintained more sensible economic policies, rather than its politicians thinking that they can defy economic laws of gravity. If China really goes capitalist, we had better all watch out.

I breakfasted yesterday with Felipe Larrain, the finance minister of Chile. One of the interesting points that came up is why the countries with the most developed economies in South America don't have more of a say in world affairs. Their combined GDP does, after all, match up to China's and overtakes India's – yet those to countries have a much greater presence.

I guess the answer is that countries like (to take them in order of GDP per capita) Uraguay, Chile, Brazil, Venezuela, Argentina, Costa Rica and Peru are all very different places. They have different histories and different historical links to other countries. Brazil even has a different language. It seems to have been hard enough for them even to establish free trade between them. Although Chile has free trade agreements with 59 countries, other countries put astonishing tariffs on their trade to keep out competitors.

But free trade in goods probably has to come before anything else. Then maybe the free movement of capital. The free movement of people – that is, immigration – is always treated with suspicion, in any part of the world. But it becomes feasible, almost natural, once you are locked into close trading relationships with other countries. South America is still a long way off that. And Brazil, he country which dominates the region on account of its vast area and vast population, is hardly a free-market paradise. It is more keen to go its own way in the world, rather than form alliances with the likes of market-oriented Chile. So the more market-driven economies of South America seem destined, for some decades at least, to punch below their weight in world affairs, while more coherent regions have undue influence.

Greece aims to raise €50bn from privatizations between now and 2015. Good luck. Since 2000, the country has already netted €10bn through privatization, but the new target means doing five times more, in half the time. And although many of the properties in the privatization list are already on offer, there have been no takers so far. Maybe it is not surprising that people are reluctant to invest in a country so corrupt, or in companies with such an appalling work culture. Meanwhile, other countries like Ireland and Portugal are trying to interest investors in their state businesses too. So it looks like a tough sell.

Among the companies on the privatization list are a telephone operator, shares in half a dozen banks, a couple of water companies, a gas company, train operators, airports (including defunct ones), a weapons contractor and regional ports and highways. No doubt there will be public resistance to all of these on the grounds that they are 'priceless national assets'. If only.

Meanwhile, the Greek government will be trying to sell off old Olympic venues, a state lottery, a horse-racing concession, a stake in a casino, a nickel mine, and thousands of acres of agricultural land. Which begs the question of why it owns these things in the first place. They are hardly matters of national security or prestige.

If Greece's privatizations are aimed just to make money to fill a black hole, they will not work. For a start, the black hole is far too deep for €50bn to fill. And right now, with the market low and lots of other governments holding fire-sales too, it is not exactly the right time to get a good price for any business. And if privatization is to work, it needs to involve the whole population – and not just sell companies to China or some other wealthy overseas power, which would be deeply unpopular. But with the Greek public already complaining that their pockets are empty, the chance of getting a good price from them is vanishingly small.

The real objective in Greece should be to turn round loss-making state-owned monopolies and make them profit-making, tax-paying, competitive enterprises. Having a privatization deadline might help that process. In the UK, it was only the fact that nationalised industries like British Steel and British Airways knew that they would be privatized that made them squeeze out waste and make themselves into proper commercial companies. Once you have made a company fit, paid off its debts and cleaned up its accounts, then you can sell it. Not before. So the prospect of future privatization presents a real reform opportunity. And it sends the markets a message too that Greece is serious. Whether any of that will happen, though, I doubt. This is Greece, after all.

Last week Anna wrote a piece on ‘The fatal conceit of the Police National Database’. It raised concerns about plans to store the details of 10-15 million people in this database, on the basis that there are only 9.2 million people in the UK with criminal records. By implication, Anna wrote, up to 6 million people without criminal records would be on the database. And given the British government’s less-than-stellar track record with data security, this poses a worrying threat to privacy. I stand behind all of that.

However, the National Policing Improvement Agency (NPIA) has written in to say that Anna’s piece contained a factual error that they would like us to clarify. They say Jennie Cronin, director of the NPIA, never said that, “many of these people [the additional six million] are victims”. In fact, they say that victim data will only be held in a limited number of cases, where it relates to sexual offences for which a court can grant a sexual offences prevention order.

I’m happy to admit it when we get something wrong, and I apologize for us putting inaccurate words in Ms Cronin’s mouth.

The NPIA go on to say that holding such victim data is important because it will help the police to realize when vulnerable people are being repeatedly targeted and prompt them to provide additional protection. The example they cite is of a recent Police National Database (PND) search on a victim of domestic violence, which revealed a pattern of abusive relationships across the country. They say that now the police force in question is fully appraised of the situation, they are in a better position to protect her and to “help her to break the pattern of abusive relationships.” Similarly, they believe the victim data on the PND will help police to protect “children and young people being ‘groomed’ for prostitution and then trafficked across local police force borders”.

The NPIA also argue that they are justified to put the details of people who haven’t been convicted of any crime on the PND. They say that individual police forces already hold information on such people, and that all that is in question is sharing it between forces. They also say that Ian Huntley, the murderer of Holly Wells and Jessica Chapman, came to the attention of Humberside Police in relation to allegations of eight separate sexual offences between 1995 and 1999, was investigated in yet another, but was never convicted. They do not claim that the PND would have prevented the Soham murders, but do say it would help to prevent people like Huntley slipping through their net in future.

Now, the NPIA advance valid arguments on both victim data and sharing information on those who have not actually been convicted of any offence. And I think it is important that even those of us are deeply concerned about the over-extension of police powers and the inexorable rise of the database state acknowledge that such policy shifts are often driven by noble intentions.

But I’m still not sold on the whole thing. The trouble is that we’ve been here so many times before: we’re told that new police powers are needed to tackle terrorism, and before you know it they’re being used to arrest people for walking on cycle lanes or heckling at the Labour Party conference. We assume that the police will only arrest you for serious wrongdoing, and then we hear you can be banged up for dropping an apple core and prosecuted for overfilling your wheelie bin.

If I still believed that the police could be trusted to exercise their powers fairly, proportionately, and responsibly, I wouldn’t have to be writing this blog. But I don’t believe it, and many others feel the same way. Whatever the rights and wrongs of the Police National Database, the National Policing Improvement Agency has its work cut out to convince us we’re wrong about that.