Is democracy killing Indian growth?

Lord Desai, former LSE prof and expert on Marxian economics, seems to have lost any faith he once had in the ability of governments to manage an economic system. Talking of his home country, India, at an Adam Smith Lecture in Edinburgh (organised by the Asia Scotland Institute), he complained that the country's growth was being held back by 'policy paralysis'. After some major reforms in 1991 and opening up to world trade, India has been growing at 8% or so until the last couple of years, when the rate has fallen to 5% – something that UK Chancellor George Osborne would dream of, but not great for a large, developing economy. Inflation, meanwhile, has hit double digits. Interest rates have been raised to over 9% in the attempt to control it. Public spending is high, and the current account is in deficit. A third of government revenue goes on debt repayment.

India has had coalitions for quarter of a century, which does not help. Nor does the fact that the Congress Party has been dominated by the Ghandi family for all that time. In a country where two-thirds of the population are under 35, one would expect to see a less patriarchal (or occasionally matriarchal) form of politics. The BJP, for its part, is more ideological and its candidate for PM is a popular outsider. But both parties are statist and neither is fiscally responsible: cronyism and corruption is rife, and with two-thirds of the population getting food subsidies in one form or another, India's welfare state spending is getting even harder to rein back.

And, for a time after 1991, it was all going so well. Perhaps the difference between India and China is that India is a democracy. So Indian politicians are always keen to make promises and give favours to electors at the expense of other people, including future generations who are yet unborn and so cannot complain. No surprise then that its welfare state and public spending are expanding – and, though the economy is still growing, the wealth-creation engine is starting to slow. China, less troubled by such things, might well become wealthy before democratic pressures for redistribution start to do the same. Fine institution though democracy is, it works only if the powers of government, and the potential exploitation of wealth-creators, are strictly limited.

We spot the Laffer Curve in the wild again


A little point about the Laffer Curve that isn't usually properly appreciated. There is no Laffer Curve.

Rather, there are a series of Laffer Curves. Different taxes, in different societies at different times will always have their own shapes and peaks. We normally think about the curve with respect to income taxation and economic growth. Sometimes the gross weight of all taxation and growth. But there's a Laffer Curve in consumption taxation too:

After a hefty cigarette tax increase took effect July 1, tobacco tax revenues dropped $29 million or 21 percent short of projections, accounting for almost half of the shortfall in other taxes.

It is indeed possible to ramp up taxes sufficiently to reduce tax revenues. Therefore there really is a Laffer Curve. Even if for only this one tax in this one circumstance.

Which means that when we trun to our more nomral idea, that link between income taxation and revenue scollected, we do indeed know that there is an extant curve: we've just got to work out that peak.

Or, if we're rather more clever than that, work out what is that growth maximising rate for that is what is going to make a better world for our children.

At heart here though my point is simple. There are those who deny the very existence of even Laffer effects: we now know that they exist and can prove so with this simple example. Thus we can dismiss entirely the views of those who deny this simple and basic truth.

Ireland prepares to leave the bailout, after a policy of spending cuts and tax increases rather than the fiscal stimulus that some urged upon it

It's reported that the Republic of Ireland will leave the 85bn euro bailout package it undertook when its banks collapsed in 2010 by December this year.  Prime Minister Enda Kenny says that Ireland's 4.8% deficit next year will be well ahead of its 5.1% target.

This was done without the massive fiscal stimulus advocated by neo-Keynesians.  It was done by austerity.  The initial plan was for spending cuts to outweigh tax increases by 2:1, though the outcome has been more like 1:1. Ireland has cut child benefit, unemployment insurance, some health services and the capital budget for new buildings and roads.  Tax increases have seen a Universal Social Charge imposed as a surcharge on income tax, starting at 10,000 euros and ranging from 2% to 7%.  There have been increases in property taxes, effective income taxes and PRSI (their equivalent of National Insurance), and in VAT, plus a big increase in wine duty.

While unemployment has fallen, this is mainly down to emigration.  Even so, those leaving tend to acquire new skills abroad, remit funds home, and will probably return when the economy has picked up sufficiently.  Unemployment is about 13.5%, which, while high, is nothing like the levels seen in other bailout countries.

There are still problems, with the economy hovering in and out of recession and a mortgage arrears crisis that has 1 in 8 mortgage holders more than three months behind on payments.  Still, bad banks are being wound down and the future looks quite promising.  It was done by fiscal responsibility rather than fake stimulus, and Ireland firmly and bravely refused to give up its low corporation tax policy despite great pressure to do so, and thus remains an attractive location for business and expansion.


Does the Nobel kill the Robin Hood Tax?

So, that Nobel award then. What's the political lesson we should draw from this?

Myself I would say that it kills the Robin Hood Tax, aka the Financial Transactions Tax (FTT) stone dead.

The 2013 Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel was awarded jointly to Eugene F. Fama, Lars Peter Hansen and Robert J. Shiller "for their empirical analysis of asset prices".

Along the way Fama and Shiller proved two things. Firstly, the effficient markets hypothesis itself. Which is simply that markets are efficient at processing the information about what prices should be in that market. Shiller then went on to emphasise that it is speculation itself that produces some of that efficiency. Specifically he pointed out that in the US housing market there's no real way to speculate on falling prices. You cannot short houses for example. This meant that those people who thought there was a bubble could not influence prices: for there was no method of their putting their money where their thoughts were. And it is that money following thought which produces the efficiency of the information processing by the market. So much so that Shiller's idea is to introduce futures and options markets for housing to aid in preventing futher bubbles.

Now think of what the FTT people are arguing. That speculation is a bad idea, that we must discourage it through taxation. This is, in the eyes of the above theory, of course entire nonsense. For if speculation is what moves to return prices to their "correct" level, then we want more of it not less.

You can of course still believe in the FTT if you wish. But it's worth pointing out that the Nobel Committee has just declared that the scientific consensus is that you're wrong.

Does the existence of intangible goods mean we shouldn't maximise wealth?

The proposal I made last week—that we abolish parliamentary democracy and turn over decision-making to a a set of betting/prediction markets—faces a number of serious objections. In this post I will deal with the objection that national wealth in principle misses out several important contributions to welfare like liberty, love or other intangibles. I have four further serious objections, which I will attempt to tackle in a third and final piece.

What makes us happy, and helps or allows us to satisfy our desires and preferences, may not be wealth alone. A millionaire who desires only a dishwasher is no better off for all her wealth if she is unable to buy one. A world in which dishwashers are harder to get hold of—perhaps due to a ban—is worse than one in which they are widely available, for a given amount of wealth.

But introducing "for a given amount of wealth" might be begging the question. Our measure of wealth, to be a good one,  will include some correction for changes in prices (like the official measure). Even under our current system of drug prohibition there are measures of illegal substance prices. Similarly, if we banned dishwashers, perhaps in some bizarre return of the lump of labour fallacy, they might still exist, albeit underground and more costly. In this way the measure would show an expected dip in real wealth in the prediction market for the national wealth effects of dishwasher banning.

And many other restrictions on liberty that we'd have independent reasons against would also depress our wealth, e.g. racist employment regulations, restrictions on travel. Even something like the ability to marry could be factored in—if people want to have marriages, they will have a higher demand for housing in areas where marriages are allowed. However this faces a lot of difficulties in a world where so many goods are unpriced and thus we cannot measure all of these effects. And it's unclear whether all of the cost to an individual of, for example, restrictions on marriage would be fully capitalised into house prices. So there might be some reason to expect a wealth maximising state to be less liberal than the ideal happiness-maximising state would be.

Further, typically unmeasured goods like love—which many people see as one of the most important—may not be measured by any element of the wealth markets. While current parliamentary systems don't necessarily directly consider what effect policies will have on aggregate love in the country, were it to be significantly effected by a (proposed) policy they would be able to factor it in. But a pure national wealth-driven system would not.

This is certainly a difficult objection for the model of government, but it isn't necessarily fatal. After all we know there are devastating problems with the current system, including distorted incentive structures, but even more than that public ignorance. We'd want evidence that not only would maximising expected wealth tend to cut the amount of aggregate love in society—it would do so to an extent that outweighed the improvements in policymaking down to an unbiased, properly incentivised and dispassionately rational decision-making system.

We'd need particularly robust evidence to overturn the strong established empirical connections between wealth and happiness (which presumably takes into account the effect of love on happiness). This means the love objection is not telling on our account without much further exploration. As suggested above, there remains the objection that some liberty contributes to happiness without contributing to wealth, or being fully accounted for in wealth measures, and this stands, and should be weighed against the other benefits gained from the wealth-maximising state. And the wealth-maximising state may well be more liberal than current parliamentary arrangements, given what we know about free markets and long-term growth.

Privatisation, nationalisation and jobs

Just as the UK government sells the bulk of Royal Mail, the Scottish government prepares to nationalise Prestwick Airport. The current owners, the New Zealand company Infratil, have done their best in marketing the place, but cannot make it pay. An hour out of Glasgow, it has been losing custom to Glasgow Airport, which is minutes from the centre and has benefited from recent road improvements. Prestwick is also very dependent on one customer, Ryanair, which has cut its flights and is famously keen on forcing down airport charges. So it seems that the Airport will be sold to Holyrood for £1. That's a very bad deal. Firstly, Prestwick loses money, secondly there is no obvious way of making it pay, and thirdly, an expert private operator will make a better fist of it than politicians.

The reason for the nationalisation is to protect jobs. There are various high-tech and aviation businesses that need a runway, and they and the airport employ a large number of the local population. Debating this on Radio Scotland, I was faced with the usual argument: 'the private sector makes profits, then when things don't pay any more they walk away and leave the public with the bill for sorting out the mess'.

Give me strength. Who do you suppose provides all the taxes that the government uses to 'sort out the mess' in the first place? Answer: the private companies that make profits and pay taxes on them, the companies that supply them and do the same, and all the people who work for all those commercial enterprises and pay tax on their wages and still more taxes when they save or spend those wages. Business should stick to making money and government should stick to civics. Neither of them is much good at doing the other's job.

And is it a 'mess' anyway, or simply the workings of a changing world? Jobs should go where the demand is, rather than outdated industries and infrastructure being preserved in the aspic of taxpayer funding. If the Scottish government were not so keen to intervene – with an eye to elections, politicians always like to look 'pro-active' – what would happen to Prestwick? Maybe the companies that depend on its runway would find cheaper ways of keeping it working. Maybe the jobs would simply move to somewhere better connected. Maybe the land would be sold for some far more productive purpose that would produce even more, genuine, industry and employment.

Once Holyrood has nationalised Prestwick, it is going to be faced with calls to do the same for the much larger, failing oil facility, Grangemouth. And whatever superannuated loss-maker follows that. It is beginning to sound like the 1940s. Maybe it can preserve jobs though: after Independence, Scotland could always market itself as a Museum of Socialism.

It's amazing how Will Hutton misses the point again

It's entirely astonishing to find that Will Hutton has missed the point again. Here he's talking about education, the costs and returns to it. And he manages to use as examples the very facts that prove his argument wrong.

Although the proposition was that there would be a range of fees, few universities charge less than £9,000 a year. Indeed, average fees are about £8,400. Accommodation and living costs have to be paid for on top, so that almost whatever university a student attends or whatever the degree taken, he or she will end up with about £45,000 of debt.

OK, £45k of debt. It's a lot I agree. But is it worth it?

There are insufficient jobs that pay enough to allow even a fraction of each year's 340,000 students to escape the trap. The average salary is £26,500. Only about 10% of the population earn more than £41,000. Even allowing for the fact that wages usually rise faster than prices (though they have not since 2006), it follows that many, perhaps even the majority of, students will struggle to fully pay back their debt.

Will doesn't think that the extra earnings of those graduates, for most of them at least, make up for the debt costs they've got to pay back.

OK, let's agree so far. What is therefore the solution?

For Hutton it is that everyone should be taxed more so as to pay those fees on behalf of the students rather than making them borrow to pay them themselves.

Unfortunately, those facts that he's using lead us to entirely the opposite conclusion. If we've got a cost that is higher than the benefit then this is a signal that we should stop doing this thing. Hutton is indeed arguing that the cost of a university education is higher, for many to most people, than the benefit that comes from having one. This is true whoever is paying the bills. Therefore we would rather like to have fewer people going to university.

But that leaves us with another problem. For some people university is definitely worth it. For others not. So how do we select those for whom it is and those for whom it is not?

Well, actually, that's one of the things that a price structure does for us. We make clear the costs of something and people will decide themselves whether they're willing to pay that price. That is, whether it is worth it for them. Whether Media Studies from an ex-technical college is worth £45,000 isn't something that you, I or Hutton should be deciding. It's something that people considering doing Media Studies at an ex-tech should be deciding. So too with English at Cambridge or physics at King's.

Do also note that once we have prices clear we don't have to assume that people will then decide purely on the financial return: Everyone will ascribe some value to the 3 years of uni, some might even ascribe value to the intellectual stimulation, whatever the degree.

But the important point here is the basic one. Hutton is arguing that university does not make sense in terms of value added for most students. He therefore proposes subsidy for those students. Which is ridiculous. If the activity is not value adding we don't want more of it, we want less of it.

Blatherings and facts about the tax gap

HMRC's just released their estimates of the tax gap. What should be paid under the law of the land against what is actually paid. And as a result we've got Richard Murphy shouting that HMRC's estimations are all wet for he's the guy with the real facts.

Now I am actually under a promise to Madsen not to mention Murphy too much here but he's given us a perfect example of why the numbers differ: because the definitions do. Here's Murphy on corporation tax revenues:

Instead let me just highlight some of the absurd anomalies in this year’s report that I have noted so far. Let’s take corporate tax avoidance for a start. According to HMRC in 2011-12, they year to which this report relates UK tax avoidance in that year was just £4 billion and was split down as follows: (chart excluded-Ed)Now this report in the Mail on Sunday in April 2012 – covering the same year as a result – gave an estimate (and in my opinion a fair one) of the tax avoidance of just a few giant tech companies: (chart excluded) That’s, as they note, £685 million lost to five companies. Microsoft and Yahoo are not in there. And there are, we know, plenty more playing such tricks. But apparently the total lost is just £1.5 billion. Actually, that’s because none of these losses to tech companies is in HMRC’s figures. They may have been in David Cameron’s sight lines when attacking tax avoidance but HMRC refuses top recognise they do anything wrong. And that’s ludicrous.

Now what he's talking about is of course the way in which various tech companies sell into the UK from Ireland or Luxembourg, paying their corporation tax there. Murphy is claiming that the tax on this money that is paid (or not paid) in Ireland is thus tax avoidance from the UK tax system. What he's missing is that it isn't. Here's HMRC on the subject:

In broad terms, companies are required to pay corporation tax in the country where they carry on the economic activity that generates their profits, not where their customers are located.

Hmm, so where the customers are is not the determinant of where the tax liability is. Not even in theory: in fact theory, that spirit of the law, operates exactly the other way around. That people are selling to UK based firms or consumers does not, in any manner, create a tax liability in the UK. It is entirely other and very different criteria that decide that question. And as HMRC goes on to state:

Non-resident trading companies which do not have a branch in the UK, but have UK customers, will therefore pay tax on the profits arising from those customers in the country where the company is resident, according to the tax law in that country. The profits will not be taxed in the UK. This is not tax avoidance: it is simply the way that corporation tax works.

So, the reason that HMRC does not include such numbers in its estimates of tax avoidance is that under the basic system of corporation tax, under both the spirit and letter of the law of this and most other nations, there's not any tax avoidance going on. This is the way that Parliament, the OECD and before them, the League of Nations (where the basic structure of international tax treaties come from) set the whole system up.

Murphy's numbers try to include such sums which is most odd for someone prclaimed as one of the nation's leading tax experts.

What is actually happening here is that Murphy thinks that settled law should not be as it is. Which is fine, of course, there's plenty of areas of life where I think settled law should not be as it is. I wouldn't be allied with a radical think tank if I didn't. But there is something important to therefore note about these tax gap estimates.

Murphy's numbers and thus, for they all run with them, those of the TUC, PCS, Unite, Polly, nef, Margaret, Lady Hodge and the rest of the rag tag groups that is the British left, estimate what the tax gap would be if the law were changed to conform to their prejudices and misconceptions about what settled tax law should be.

HMRC's numbers are based on what settled tax law actually is.

All of which does lead to a small amusement: those campaigning for tax law to be changed to reflect their prejudices are of course campaigning to increase the tax gap. For if the law were changed in the manner they desire then that tax gap would be closer to their figures: figures note which are larger than those under current tax law.

And it's very odd indeed to see lefties arguing that there should be even more uncollected tax around the place.

America's shutdown to a Briton's eyes

What to make of the Yanks and their budget? As Newt Gingrich pointed out in last Saturday’s FT, we might start by dialling down the hysteria: shutdowns are no novelty.

“Democratic Speaker, Tip O’Neill presided over twelve…government shutdowns…with presidents Jimmy Carter and Ronald Reagan, and even while Democrats controlled both Houses of Congress….No one in the O’Neill era saw shutdowns as catastrophic. They were irritating, complicated and frustrating but also part of the legislative process.”

The GOP is fussed about Obamacare, which no-one in the UK gets. Its main point is not to provide hospital care for indigents (something already provided under Medicaid and common-carrier obligations), but to oblige healthy youngsters to sign up so as to reduce costs by bringing them into the insurance pool. This makes some sense – it more or less happens elsewhere - but putting it like this explains why Americans see it as intrusive and the scheme is so unpopular.

More generally, the Tea Party is up in arms because the new obligations of Obamacare come at a time when the US (as pretty much universally) is testing the limits of what a government of free citizens can afford to take on. Hysteria is now extending to lefty commentators, who are calling apocalypse if the debt ceiling is not raised on 17 October, fearing without quite admitting it that the markets will bear down on the President. They have been joined by some big bondholders who ought to know. Now we hear that “constructive talks” are under way - on the ceiling at least. But recall that great changes in national direction only come with grubbiness and mess: think of Lloyd George threatening to pack the Lords after they turned down the Peoples’ Budget, Roosevelt menacing the Supreme Court over the New Deal, or Bevan getting the NHS past hold-out doctors by “stopping their mouths with gold”. That’s politics.

But is Obamacare a good thing? Hard for a Brit to say. US healthcare is costly by our standards, yielding outcomes which at their best are world-beating but not universal. Maybe they need more private “managed care” systems to reduce costs, but that is not the same as Federal intervention.

Back to the limits of government. King Charles I - the one who lost his head - had a legitimate gripe about the irresponsibility of his parliaments. They were bloody-minded, sent mixed signals (singe Papist beards; raise no new taxes) and generally messed him about something rotten (not to mention that losing the head thing). But they and their successors established the principle that the executive shall be controlled by the power of the purse, exercised by representatives of the taxpayers. The Tea Party is also bloody-minded and given to mixed signals. But it is fully seized of that most essential component of American DNA, snappily put by the Culpeper Minutemen, “Don’t tread on me!”

No doubt, the immediate outcome of this month’s stand-off will be the customary fudge. That’s politics too. But make no mistake: the Republicans in their confusion, the Tea Party zealots in their flyover-state gaucherie are onto something: where shall government find its limit? It’s not a trivial question and it won’t be answered in just one go.