Overcoming the public choice dilemma

With the death of James Buchanan, it is interesting to reflect on some implications of public choice theory. Public choice theory presents a powerful explanation of why democracies tend towards government expansions that are difficult to reverse. As Dr Butler succinctly puts it: 'small groups with sharply focused interests have more influence in decision-making than much larger groups with more diffused concerns, such as taxpayers.'

Buchanan and the public choice school stress the importance of constitutional restraints on the size of government. Indeed, many Americans revere their Constitution’s ability to check the growth of government. Some of the Founding Fathers understood the public choice-style implications of large government and the tendency towards it, even if they did not express these fears in the same language.

But American constitutionalism has not been entirely successful in restraining the growth of government. For all its merits in guaranteeing enunciated political liberties, over time the US has seen such significant erosion of many of the economic liberties of the US that in many respects it is not greatly different from European 'social democracies' in terms of government spending or economic regulation. 

Fortunately, it is not inevitable that large government will favour special interests. Public choice assumptions account for only part of the rationale for collective action. There are significant variations between and within different polities in relation to particular levels of government activity. There have been points when large group interests have coalesced to prevent further exploitation by special interests. Without siding with critics of Public Choice, it is important to recognise that its explanatory power is not total.

I would argue, following Robert Higgs (his fascinating lecture series is well worth a listen), that ideology also presents a major explanatory factor that runs counter to 'instrumental' interests.  In the US, this would suggest that the growth of government and the 'failure' of the Constitution has been caused as much by the development of new ideologies such as Socialism, Progressivism, Keynesianism and so on as by pure instrumental interests (particularly because the results of such ideologies often run counter to the instrumental interests of many of those who support them). By the same token, the American Revolution itself emanated from a Whiggish culture and ideology which was imbued with a scepticism of powerful government and a desire for liberty. Ideology, as much as interest, also explains say, the abolition of the slave trade or Thatcherism.

Those advocating a smaller state should, therefore, take some heart that public choice theory does not provide a remorseless logic of concentrated special interests overpowering the general interest.

Public choice presents a powerful ideological reason to oppose big government and rent-seeking, and ideas about how to do so. But, alongside public choice critiques of government, we must also promulgate an ideology of a free society and limited government. As Higgs points out, prevailing ideologies can be shifted, sometimes rapidly.

balance.jpg

Why Paul Krugman shouldn't be US Treasury Secretary

The Guardian has endorsed Paul Krugman for the US Treasury Secretary job. The initiative began with actor Danny Glover’s online petition. The Guardian's case for Krugman begins:

Krugman has been right about the major problems facing our economy, where many other economists and much of the business press have been wrong. [For example]: he wrote about the housing bubble before it collapsed and caused the Great Recession.

So have many others – earlier and more accurately than Krugman. As for Krugman's predictive powers on the housing bubble, here he is in 2002:

The basic point is that the recession of 2001 wasn't a typical postwar slump, brought on when an inflation-fighting Fed raises interest rates and easily ended by a snapback in housing and consumer spending when the Fed brings rates back down again. This was a prewar-style recession, a morning after brought on by irrational exuberance. To fight this recession the Fed needs more than a snapback; it needs soaring household spending to offset moribund business investment. And to do that, as Paul McCulley of Pimco put it, Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble.

Of course, we hear similar arguments today: that the government needs to create a spending boom to offset the lack of private sector investment. The more things change, the more they stay the same.

Krugman claims that he was taken out of context. He meant that the only good Greenspan could have done was to create a bubble. He was right. After all, the housing bubble did lead to a recovery. Up until 2007, that is.

Going back to the endorsement:

[Krugman] has forecast and explained that large budget deficits and trillions of dollars of "quantitative easing" (money creation) would not cause inflation or long-term interest rates to rise; and that the "confidence fairies" would not reward governments that pursued austerity in the face of recession.

Of course inflation and long-term interest rates are low: the environment is uncertain and growth in the West is stagnant. Investors are looking for safe havens like US, UK or German bonds. That will change once we begin to recover. As for inflation expectations, we are still waiting to see how the Fed-induced monetary "bomb" will affect us in our next boom years – however far away they are.

And gee – I wonder why the confidence fairies are not rewarding tax increases, postponement of structural reforms, and a highly uncertain political environment? (Think Eurozone; think debt ceiling.)

Krugman has written extensively about the stupidity of the last few years of economic policy in Europe, which has been a major drag on the whole world economy. The treasury secretary would have only limited influence on Europe through the IMF, but in developing countries the US treasury department pretty much is the IMF.

Well, yes – Paul Krugman was opposed to the "stupidity" of Europe's economic policies, but from the wrong side. He opposed reforms to welfare states but was strongly in favour of large stimulus spending to "end this depression now". This is the same reasoning behind the UK's enormous budget deficit, unsustainable public finances, and current kick-the-can-down-the-road policies.

If Paul Krugman had been Treasury Secretary in 2002, would he have supported Greenspan in initiating the housing bubble or would he have opposed it? These are the decisions a Treasury Secretary has to cope with every single day. Krugman’s record does not suggest that he would make the right decisions.

Finally, can I make a suggestion for the US Treasury Secretary, since we're apparently allowing anyone to make important nominations? I nominate Ron Paul. He served his last day in Congress the other day so he's available. Maybe a famous fan like Kelly Clarkson should start a petition.

On the death of James Buchanan

We are sorry to report the death of James M Buchanan, the US academic who, with colleague Gordon Tullock, was the leader of the so-called Public Choice School of economists.

Public Choice theory applied the methods of economics to the theory and practice of politics and government – with extremely important results which give us important insights into the nature of democratic decision-making. Just as self-interest motivates people's private commercial choices, so does it affect their communal decisions. People also act 'economically' as voters, lobby groups, politicians and officials, aiming to maximise the outcome they personally desire, for minimum effort. Consequently the well-developed tools of economics – such as profit and loss, price and efficiency – can be used to analyse politics too.

Collective decision-making is necessary because there are some large projects that we cannot undertake alone. There is also the 'public goods' problem – that certain useful things, such as defence, will be under-provided by markets because non-payers can simply 'free ride' on the efforts of others.

But Buchanan and Tullock showed that such 'market failure' does not necessarily mean that government can do things better. There is 'government failure' too. Political decision-making is not a dispassionate pursuit of the 'public interest' but a struggle between different, competing personal and group interests. In this struggle for the supremacy of different values, small groups with sharply focused interests have more influence in decision-making than much larger groups with more diffused concerns, such as taxpayers.

Buchanan believed that strong constitutional restraints were needed in order to ensure that the 'silent majority' could not be exploited by coalitions of vested interests using political power over them. The commonly adopted rules in democracy is that 51% of the population decide the policy – even if the other 49% are vehemently opposed, as in the old joke that 'democracy is two wolves and a sheep deciding what to have for dinner'. Simple majority decisions are easier to make than ones requiring unanimity or higher majorities, but they do have this downside cost in terms of personal liberty. And the fear is that if producers are exploited too much by others, they will simply quit the productive sector and the whole society will suffer in terms of economic prosperity. Buchanan maintained that proper constitution can set the rules by which different sorts of decisions are to be made, and therefore can balance the interest of individuals and society as a whole.

Buchanan received the 1986 Nobel Memorial Prize in Economic Sciences for his work on Public Choice theory and was a life member of the Mont Pelerin Society, among many other awards and distinctions.

james-buchanan-1.jpg

William Beveridge's violin

By now almost everyone has heard that Child Benefit is going to be means-tested. We’ve also heard the middle class has responded to the move with “outrage.” We might also have heard the world’s smallest violin somewhere in the background of a BBC interview where a married mother complains of the manifest injustice that her six-figure income is structured so that her state aid will be taken away, whereas other families' six-figure incomes are not. She is not alone. Tonight, parents everywhere will cry out for Leviathan's intercession, hoping government will hearken to them in the spirit of fairness and equality… and, perhaps, with a little cash.

The refrain is a familiar one, and reminds me of a time I went down to Occupy London Stock Exchange – the cleaner, British version of Occupy Wall Street. I attended a talk there once on the subject of work, and the attendees – about twenty of them –  began the session by stating their employment, only to follow with aggressive complaining about how their work represented their abject mistreatment by the “system." “The terms of my employment are unfair,” said one; “my work is not valued,” said another, an unpaid intern in an art gallery. “I am not paid enough for what I do,” said a third. 

A range of employment – builder, cleaner, lecturer, doctor, student, protester (really?), freelance writer, freelance landscape architect – was represented. But the solution which the twenty of them agreed in council was not, as one might think, to go out and find another job, or to change careers to one which provided steadier work than freelance journalism, art internships or landscape design in central London. Instead, it was agreed that their labour should be withdrawn for a day on 30 November (even those who were self-employed): they would go on strike and seek a political solution in the longer term.

None of which, of course, does anything to solve the particular problem each of them faced: that their incomes were unsatisfactory compensation, in their eyes, for the marginal disutility of their labour.

Life is hard, goods and services are expensive, and competition in the labour market is ferocious. Nonetheless, except in cases of egregious civil rights violations, politics is almost never the best answer for improving one’s lot, particularly when one wants to make meaningful improvement on a middle-class financial position in a developed industrial state.

We each possess a degree of influence over our own lives which is far greater than that of any redistributive policy. What job to accept, what job to keep, what job to quit -- whether we can afford to have children, and how many. What these choices have in common is that they are ours alone. So should be the consequences. Viewed this way, spending life begging the government to save you is merely a waste. But asking your fellows to subsidise your expensive decisions — especially when you can afford to shoulder the burden yourself — is simply rotten. 

worlds-smallest-violin.jpg

Cutting the Gordian knot on pensions

The UK Labour party wants to end higher-rate tax relief on pension contributions, arguing that current reliefs are a subsidy to higher earners. As I argued on Monday, they are not – they simply defer tax on that part of a person's income that they defer drawing, and put into a pension investment instead. But what should the right policy on pensions be?

The straight libertarian argument is that governments have no business trying to encourage savings, whether through tax deferral, outright subsidy, or anything else. To do so distorts the market and puts the values of the authorities ahead of the values of the general public.

But of course we are not living in a libertarian paradise. The fact is that we have a large state welfare apparatus, with something like one-eighth of government spending going on transfer payments. And unless people are encouraged to make provision for their retirement, some (or perhaps many, given the natural human tendency to value present income more than future income) will consciously choose not to save while they are in work and rely on state welfare once they have retired. There is, therefore, a case for subsidising pension contributions as a way of incentivising people to provide for their own income in retirement, rather than relying on state benefits.

If that is so, then the state has no business encouraging people to save more than they need to save in order to keep themselves off the welfare rolls. That would suggest that any state encouragement of pension contributions should be limited. Once you have saved enough to prevent yourself being a charge on the welfare system in retirement, you should receive no further tax relief.

It also suggests that you should indeed convert the bulk of your pension pot into an annuity, providing you with a regular retirement income – or that you draw down your pension pot at a steady rate. Otherwise there would be 'double dipping' - people using the tax relief to accumulate pension pots that they then spend liberally, before declaring themselves impoverished and then relying on state welfare.

Again, though, practicality may intervene. It may be complicated to grant tax relief to some contributors rather than others; there is a bureaucratic cost to checking how much people have actually saved. Likewise, annuity rates may fluctuate considerably, perhaps leaving people with much lower pension income than they anticipated. And drawdown arrangements can be hard for people to understand and for the tax authorities to police.

Inevitably, such considerations make pensions complicated – and that complexity must discourage people from paying in to pension plans. A simple regime has much going for it – say a straight pound-for-pound matching by government of everything you put into a pension – up to a total or annual limit, calculated to be enough to keep folk off the welfare rolls in retirement. Easy. The only trouble is, you can't just tear up the existing pension contracts that people have, as pensions are inherently long-term commitments. And there are lots of those different arrangements, because the pension rules have been changed many times in the past. Which means that pensions will continue to confuse the general public. Annoying, but true.

Welfare cuts might save money, but where's the growth?

Following the benefits cap debate today, I can’t help but think that, yet again, the government has missed the point. Yes, the cap will save some money. Virtually everything the government spends money on needs to be cut. But where are the pro-growth policies? Where are the jobs that people on welfare are supposed to take? And where is the wholesale reform of the state that would allow the really big cuts to be made?

The country is broke. Government debt has topped £1 trillion. This year, we will have borrowed another £108.5 billion, only down £13 billion from the year before. The deficit reduction plan has only just begun, and we'll keep borrowing until 2018 at the earliest. 

At a little under £3bn/year, the savings from capping the rise in benefits at 1% in cash terms (a real-terms cut, in other words) are better than nothing. But let’s not kid ourselves – they will be painful, especially since the fastest-rising prices are for things like food and home heating. Because we tax low-income workers and then give it back to them in the form of ‘tax credits’ (which are really just a cash transfer payment), many people who are in work will be affected.

On the other hand, public sector pay has been capped at the same rate, and it would be perverse for benefits to rise faster than Whitehall cleaners' pay. And this is no ordinary recession – the deficit is staggeringly big, and the global economy is moribund. Cuts really do need to be made, and I haven't heard any alternatives from the people opposing these ones.

As I wrote last week, the government has singularly failed to make the big reforms that would make public spending cuts work by promoting growth. There has been essentially no deregulation of enterprise; no simplification of the tax code to produce a revenue-neutral tax cut (for everyone who can’t afford a Westminster lobbyist, at least); no real, pro-construction reforms to the planning system; and no sense on immigration.

The principle of universal benefits is, thankfully, being chipped away, but as long as the health and pensions systems remain as they are there will not be any way to avoid people on £24,000/year paying for the healthcare and retirement of people who have earned three times that.

So long as the tax threshold is so low, the government’s claims to be ‘making work pay’ are a joke. Full-time minimum wage workers pay nearly £1,600/year in tax, which is then topped up by more welfare money (the mis-named ‘tax credits’, which will now be capped!). How different would today’s debate be if we weren’t taking low-income workers’ money away with one hand and giving it back as welfare with the other?

But these things are difficult. It’s easy not to touch business regulation, to keep immigrants out and leave reform of the welfare state to some other sods. Welfare cuts are very popular with voters, and it’s easy to see why. So, another frustrating day – some cuts, yes, but none of the reforms needed to grow the economy and make them work.

1940's_Child_Ration_Book.jpg

Is it possible to have a rational debate about housing?

Various financial pundits in Britain's newspapers have been warning that house prices won't be rising any time soon. This is seen as bad news for the British economy, which has been quite largely driven by the wealth that people have in their homes, encouraging them to spend, spend, spend.

UK average house prices are well below their pre-2007 peak and have been flat for the last two years. Indeed, average prices actually fell 1% in 2011. So UK householders aren't feeling as well off as they used to. They are hanging onto their cash instead of spending it, prompting general economic gloom.

In the boom years, people put money into property. Now, in the bust phase of the cycle, people have more pressing needs than buying grand houses. And mortgages are tighter: the banks are being more choosy, having had their fingers burnt earlier. Lenders they are asking for higher deposits which – at today's low interest rates – first-time buyers are finding it hard to save. How different from when the banks were offering 110% mortgages. And no wonder the housing market is down, with home ownership its lowest in a quarter century.

The government's first solution is to keep interest rates rock-bottom – so when you do borrow it is cheap to do so. But that just keeps people in houses that in normal times they couldn't afford. As and when interest rates do edge up, so will defaults. The second plan is to subsidise mortgage risk. But there has been scant take-up, as uncertainty is still preventing people to stake their fortune on buying a new house. And it is the people who can afford to borrow anyway that have been helped, not first-timers.

However, a good Austrian economist would look below the averages and observe some profound diversities in the UK housing market, which blanket policies are not going to change. While most of the country reports falling house prices, London prices are edging up. That is surely not surprising when only 18,000 new houses were built in London a year ago, despite a population increase of 100,000. Londoners are being squashed into smaller and smaller homes when they actually need new ones.

Planning policy is restricting supply, while demand is soaring. Not just natural population rise, but immigration, and plenty of rich foreigners looking for somewhere safe to invest their money rather than trusting to put it in their local banks. (Think Greece, Italy, Portugal...) That is why, in the swanker parts of central London, prices are not just rising but booming.

And yet my housing-minister friend Nick Boles MP got roundly beaten up for suggesting even a small amount of new development in the 'green belt', though in the age of factory-agriculture, the 'green belt' is more like inaccessible prairie than bucolic haven. There are so many vested interests, built up as a result of decades of housing and planning policy, that I fear this is yet another issue on which rational debate is nigh impossible.

london-accomodation-student.jpg

More eyes on the bleeding hearts

The RSA has blogged about the Bleeding Heart Libertarians, who I’ve also written about in the past. The RSA give a fair outline of what the bleeding hearts believe:

BHL doesn’t, like most libertarian thought, believe that social justice is a natural by-product of market and non-state relationships which are themselves justified by other values, most notably the freedom of the individual. Instead, BHL believes that such relationships are only worthwhile to the extent to which they actively promote social justice and the well-being of the poor.  One leading BHL thinker, Matt Zwolinski, has suggested, for example, that unlike most other libertarians, BHLers would either reject or modify their prioritisation of market and non-state relationships if it could be shown that they do not benefit the poor and most vulnerable.

I take a more straightforwardly consequentialist view. If I discovered that the libertarian institutions I wanted (a “night watchman” state, perhaps with a modest safety net, although I doubt that would be necessary) were not the best way of allowing people to satisfy their preferences, I’d want whatever institutions did do that. That’s all any political ideology should offer – the best means to allowing people to do whatever they want to do.

The article is a little bit off-base when it contrasts Bleeding Heart Libertarians with common or garden libertarians:

They share the libertarian suspicion of the big state on economic issues and are critical of high tax, interventionist policies, ‘crony capitalism’ and the loose money policies of the Federal Reserve.

However, unlike some of the loudest elements in the Tea Party (or indeed in UKIP) who might share these economic views, they are also  supportive of civil liberties in the form of gay rights, anti-racism, internet freedom, legalising marijuana use, feminism and more open immigration.

They are also highly critical of American foreign policy opposing the ‘war on terror’, military action against Iran and other forms of intervention. (Although it must be reiterated here that BHL remains a dialogue of diverse views rather than a manifesto to which all sign up.)

Most of those things seem like pretty integral parts of the standard libertarian agenda to me, not the wacky innovations of the Bleeding Hearts. I’d certainly do a double take if I met a libertarian who was against liberalizing drug and immigration laws, but enthusiastic about more foreign intervention. (I don’t necessarily blame the RSA’s author for this, mind you – the number of old-fashioned conservatives who call themselves libertarians without any support for free people or, indeed, free markets is truly depressing.)

What sets the Bleeding Hearts apart from normal libertarians is their belief that social justice of the kind outlined by John Rawls is an important value which libertarian institutions are good at achieving. Matt Zwolinski briefly outlined this argument in this video. (Jacob Levy disagrees about the importance of social justice — some of the reasons he gives are why I prefer old-fashioned 'utility' to 'social justice'.)

In any case, it’s good to see more mainstream interest in libertarianism, particularly when it’s fair minded. With the right degree of open-mindedness, optimism, and confidence in the power of liberty to improve people’s lives, libertarians might have a uniquely appealing idea on their hands.

Pensions tax relief is no stealth subsidy

The UK Labour Party’s plan to reduce the tax relief that higher-rate taxpayers can take when making private pension contributions (in order to fund job-creation programmes) is an intriguing one.

Labour finance spokesman Ed Balls argues that “When times are tough it cannot be right that we subsidise the pension contributions of the top two per cent of earners at more than double the rate of people on average earnings paying the basic rate of tax.” Under his plan, those earning £150,000 would be able to claim only 20% tax relief on their pension contributions – the same rate as a person on average earnings – rather than the 50% that top earners can claim now (which will fall to 45% in April as the top rate of tax is reduced).

What Mr Balls forgets, however, is that the tax relief available on contributions to private pension plans is not, in fact, a straight subsidy. It is, rather, deferred taxation. And that makes a big difference, since if taxation is being deferred, it should be deferred at the rate it is paid.

Confused? You should be. Pensions are absurdly complicated. But here is how the tax relief actually works. Decades ago, governments wanted to encourage people to make private pension contributions. This, they reasoned, would help keep them off the welfare rolls when they retired and no longer had a wage coming in. And it would encourage thrift and self-help. So they decided to defer the tax on pension contributions. In other words, if you took all your salary now, you would pay tax on it. If, however, you chose to defer taking part of your salary and instead invested it in a pension, then part of your tax would be deferred too. That is, people would be taxed only when they actually consumed their pay: postpone the consumption, and the tax is also postponed. They would not pay tax on income that they were not actually enjoying right now.

Thus a 20% income tax payer would not pay the 20% tax on contributions to a pension, until they actually started drawing that income. Likewise a 45% income tax payer would not pay the 45% tax until they did the same. It is not a differential subsidy for high earners, just a postponement of their tax on income that they have decided to put off enjoying.

Under this logic, reducing the tax relief on higher-rate earners amounts to confiscation. They defer consumption, but still get landed with 25% tax on income they have not yet drawn.

However much governments might like to tax people on income they do not draw, it doesn’t make it right.

pensions.jpg

Mr Cameron's fuzzy electioneering

UK Prime Minister David Cameron MP says that he fully intends to to fight the next election (in 2015) and serve another full term as Prime Minister – meaning that he will be Prime Minister until 2020. But you can't take what any politician says quite literally.

For a start, Mr Cameron's vision of staying in power until 2020 depends on the Conservatives winning the 2015 election. This is by no means certain. But evenif the Conservatives did win in 2015, what would the future hold? A narrow victory would still leave Mr Cameron in a weak position. There would be plenty of people jostling for his job, and a series of knife-edge parliamentary debate would do nothing to strengthen his hand. A strong victory should, you might think, make his leadership unassailable. But would it?

There would still be doubt. What does he say a year or two before the 2020 election? That he will step down at the end of his term and let someone else fight the election? Changing leaders just before an election is no way for a party to win – particularly if the leadership contest has been divisive. The public need time to get used to party leaders and know what they are voting for.

Nor could he say he would fight the election and then let someone take over. The public won't take kindly to voting for one person then getting another. Could he perhaps say that he will fight the election, serve a couple of years, then let someone else take over then? Once more, the public might well ask why they should elect someone who quits halfway through the job.

Mr Cameron's problem is faced by all Prime Ministers. For the party, the ideal is to go halfway through your term of office, so that your successor can get experience and public familiarity before fighting the subsequent election. But you can't say this. And if your colleagues take you at your word that you intend to carry on too long, they are quite likely to give you the push anyway, as Margaret Thatcher, despite winning three elections, found out.

The only option for any Prime Minister loyal to his or her party is duplicity. You have to tell the public that you will fight for a second term and see it out, but you have to make way for your successor before your time is up. In any case, seven and a half years is plenty for a Prime Minister. Any longer and, no matter how great you are, your accumulated baggage starts to weigh you down.