The Pin Factory Blog

Along with insights from the Austrian economists, public choice economics is one of the cornerstones of many libertarians' economic worldviews. In today's episode of Economics is Fun, Madsen explains why public choice is so important. He equates public choice with the principal/agent issue in companies, namely that our representatives tend to grind their own axes instead of ours.

There's a rather odd idea common among lefty and greenish types about markets and their scale. Partially based on the ideas of Karl Polanyi, the thought is that if we restrict our trade, the market we deal in, to those we know and with whom we have a web of mutual obligations then somehow everything will be fairer. More lovely even.

The problem with this is that, well, it just doesn't seem to be true:

Large-scale societies in which strangers regularly engage in mutually beneficial transactions are puzzling. The evolutionary mechanisms associated with kinship and reciprocity, which underpin much of primate sociality, do not readily extend to large unrelated groups. Theory suggests that the evolution of such societies may have required norms and institutions that sustain fairness in ephemeral exchanges. If that is true, then engagement in larger-scale institutions, such as markets and world religions, should be associated with greater fairness, and larger communities should punish unfairness more. Using three behavioral experiments administered across 15 diverse populations, we show that market integration (measured as the percentage of purchased calories) positively covaries with fairness while community size positively covaries with punishment.

In fact, it's not just not true it's the very opposite of the truth.

As endless repeats of those experiments about how people will punish cheaters, even at cost to themselves, show fairness isn't something innate, it's something societally drummed into us by the responses of others to unfairness. And for large scale exchange societies to work we need more of that drumming into us and thus a greater appreciation of and desire for fairness. They just don't work without that so in those that do work we see more, not less, fairness.

All of which means, of course, that those promoting this idea of small scale society promoting fairness will immediately change tack and promote global markets as the way to increase fairness in society. Won't they? Anyone?

The absence of their doing so in the face of changed facts could be taken to mean that they never actually believed their own argument in the first place.

I was really rather shocked to see this statement for it's such an inversion of the truth.

It is beyond question that every industry should be aiming for a workforce that is inclusive, non-discriminatory and accurately reflects the demographics of its market. As many companies are quick to acknowledge, this doesn't just make moral sense, it makes business sense.

It's an entire mockery of the most basic economic explanation of how wealth is created. Which is, as Our Adam pointed out, through the division and specialisation of labour and the trade in the resultant production. The implication of this is that far from our wanting the workforce of any particular industry to reflect the demographics of its market we want said workforce to be entirely different from the customers.

The point is most obvious at the extremes: we don't get babies to make nappies nor the crippled elderly install chairlifts. And it would be a very odd prostitute indeed who reflected the gender characteristics of her customer base (his, perhaps, her, no).

But when we abandon such extremes we're still in fact trying to do precisely the opposite of making the workforce the same as or reflect the characteristics of the customer base. Bakers employ people who both can and are willing to bake bread: bread is purchased from bakers by those who either cannot or do not wish to bake bread. And I'm certainly entirely happy that those who make airplanes are not as cackhanded as I am.

So it isn't just that we shouldn't worry about the demographics of the workforce, something that the impersonal activities of the market allow us to ignore. It's that the very functioning of the market, the very division and specialisation of labour that brings the market into existence as a means of distributing production, insists that far from wanting the workforce to be the same as the customers we're actually insisting that they must be different.

It's entirely true that certain forms of difference are not important: skin colour never, genitalia in only very specific circumstances and so on. But the idea that the workforce must reflect the customers is simply arrant, absolute, nonsense. For the entire point of the whole enterprise is that the skills, needs and desires of the two groups are different.

50p Tax – It should go. It doesn't raise any money and it damages Britain's economic competitiveness. Dropping the 50p rate to 45p would be ineffective and wet. Any tax over 40p – to which national insurance must be added too – will produce lower long-term returns for the Treasury as investors conclude that Britain does not welcome them. Changing the rate to a new figure simple sends out the signal that Britain's tax system is in turmoil – while what investors want it stability. Reducing it all the way to 40p will send out a clear signal that Britain is open for business again.

We released a report last year calling for the 50p rate to be scrapped and arguing that it would lower tax revenue. Our director, Dr Eamonn Butler, recently wrote about this in the Mail on Sunday.

Mansion tax - There is a case for wholesale reform of Britain's land/property taxes, but the mansion tax is the wrong way to go. Tax policy should be driven by economics, not envy-fuelled class warfare. This taxing of wealth is essentially theft.

Personal Allowances - We are in favour of raising the personal allowance and have been arguing for this for years. Indeed, we would go further and ensure that people earning the minimum wage or less did not pay income tax at all.

Pensions - Further restrictions on contributing to private pensions would be a misstep by the Chancellor. Firstly, savers have already been hit hard by policies like QE. Secondly, given the demographic pressures of an ageing population, the government should be encouraging people to save more not less. Thirdly, savings create capital pools for investment, which drives economic growth – again, we need more savings, not less.

Sin taxes - Sin taxes are regressive: they hit the poorest hardest. Moreover, the revenue from existing sin taxes already far exceeds the costs to society of tobacco, alcohol, and so on. Any further taxation is just about money – whatever the government claims.

100 year or Perpetual Bonds - You would have to be mad to buy a 100 year or perpetual gilt, from this government or anyone else. The only way this could ever work is the government forced people to buy them (the most likely target of such a policy is the banks). But that's just a covert way to write off debt via inflation. It would be a dishonest cop-out, and another step along the road to permanently high debt and low growth.  

General Anti-Avoidance Rule - The best way to ensure people pay their fair share of tax is to radically simplify the tax system by removing complex reliefs, allowances, and loopholes. Doing that would also allow you to lower headline rates. A 'general anti-avoidance rule' on the other hand, leaves far too much to bureaucratic discretion. It is a recipe for uncertainty, arbitrariness, and corruption. Our paper critiquing the GAAR can be viewed here.

The Guardian reports today that George Osborne is "poised" to scrap the 50p tax in this Wednesday's budget:

Government sources say that from the outset the chancellor has seen a cut in the 50p rate as the headline-grabbing measure of the budget, and views it as the simplest single step he can take to show his commitment to an enterprise economy... The chancellor has, sources say, been intellectually persuaded of the case for a cut in the top rate, a move that will endear him to the Tory right.

There's no point in counting unhatched chickens, but if this is true, it is superb news. For one thing, the 50p tax hasn't even done the job its supporters claimed it would — it seems to have lowered tax revenue. The Institute for Fiscal Studies (the gold standard for this sort of thing) says this, as does the Treasury itself. Absurdly, the 50p tax rate's defenders justify it on moral grounds, as if high taxes are a necessary punishment for the crime of creating a lot of wealth.

Mind you, reducing the government's tax income is a good thing. The problem is that the 50p tax does that by making everyone else poorer. As our report last year showed, the 50p rate is a drag on growth. The 50p tax base is very small, at around 320,000 people, or 1% of the total number of taxpayers. But those 50p taxpayers are also extremely productive and valuable: that 1% pays around 28% of total tax revenue.

Squeezing a narrow base of highly wealthy people is a dangerous game. As our report showed, the 50p rate was driving high income earners abroad and into early retirement. Who can blame them? If the government was taking more than half of my income (when other taxes are taken into account) and I could afford to throw in the towel to spend more time with my family and friends, I would too. The upshot of that is that the rest of us lose their talent for wealth creation. No wonder job creation is so weak right now — the 50p tax smothers precisely the people we're depending on to start and invest in new businesses.

Getting rid of the 50p rate is critically important to revive growth in the UK. If the Guardian's report turns out to be true, I'll be happy (and not just because we at the Adam Smith Institute called it last year). It'll mean better prospects for everyone.

Oh, and there was one other part of that report that caught my eye: "In return for supporting the measure the Lib Dems are pressing for a large increase in the personal allowance for those in work." If coalition means Tory-led tax cuts for the rich and Lib Dem-led tax cuts for the poor, then who knows? Maybe the future isn't as gloomy as we think.

The excellent new site Libertarianism.org has put together this discussion with David D. Friedman on his book The Machinery of Freedom. It's a fascinating discussion of a topic many refuse to consider — whether the institutions virtually everyone, including libertarians, consider the preserve of the state, could instead be carried out by private organizations as well or better than the state. Friedman discusses private courts and police, as well as, for me, the toughest question of national defence. Has private supply of these goods ever worked well in history, or are these what we need a state to provide?

Some find this kind of discussion esoteric or utopian. Indeed, the sort of anarcho-capitalist who insists that it is wrong for a state to exist because it necessitates some violence can be frustrating. But conflating arguments made by the likes of Friedman with this kind of puritanism is silly. It's quite reasonable to ask whether the things that make markets superior to the state in some areas, like organizing people's economic activity, might also make markets better than the state in other areas, like providing law. And it's intellectually valuable: just as an understanding of how a free market would work is a useful starting point in real-world economic analysis, an understanding of how a stateless society might work can help us understand the state-heavy world we live in.

Incidentally, a roughly-typeset (but still very readable) version of Friedman's book is available online. He's hoping to do a third edition of the book, if the peculiarities of copyright law don't stop him from doing so.

For many years, the boundary between acceptable and unacceptable plans to reduce a UK tax bill has been depicted by tax “avoidance” versus tax “evasion”, the former being acceptable and the latter not.

The General Anti-Avoidance Rule (GAAR) report (commissioned by the Government in December 2010 and published in November 2011) has chosen to up-the-ante by using avoidance for unacceptability, and combining it with “abuse” (i.e. “egregious” tax planning) thus dropping off “evasion” altogether.  The document refers more than 40 times to “avoidance”, 18 times to “abuse”, 5 times to “egregious”, and 60 times to “reasonable”.

Apart from some unnecessary changes to current terminology, this may not matter were it not for the clear views of the author, Graham Aaronson QC: “My own approach … is based on the premise that the levying of tax is the principal means by which the state pays for the services and facilities which it provides for its citizens”.

This sentence, together with a belief that tax rates should be progressive according to income or wealth, encapsulates the whole ethos of the report. There is no question or worry as to who decides on what and how large these “services and facilities” are to be.  There is no evidence that Mr. Aaronson understands that all taxes reduce aggregate living standards – irrespective of whether or not collection costs exceed tax revenue – as they often do in respect of higher rate taxes for the “wealthy”.

Read this article.

Market failure: the justification for so many wrongheaded interventions in the market, but usually not failures at all, or caused by an absence of property rights if they are. Madsen talks about fairness and why it doesn't make sense to expect markets — amoral but efficient — to produce "fair" results. Government failure, he says, is something we should fear much more than market failure.

Buy the book.

It's a double-whammy today: growth and market failure. In this video, Madsen discusses how and why an economy grows — why we are better today than Julius Caesar was in his day. Maybe the most commonly-stated goal of politicians, far too few of them realize what growth really is.

Next week the Chancellor will deliver a much-anticipated budget. With calls for tax cuts, tax rises and regulatory reform, the line between politics and economics will be a difficult one to tread. However, many commentators and politicians seem to be in agreement on one thing: that ‘infrastructure investment’ would be a boost to the economy, reinvigorating the construction sector and adding to the nation's productivity. Hence we have projects such as HS2 and £6 billion announced in the last year’s autumn statement for roads and other rail projects. These measures are supposed to create jobs in the short- and the long-term whilst bringing the country's transport infrastructure into the 21st century. In the US, too, President Obama has been keen to point to ‘shovel ready jobs’ available through government infrastructure spending.

We should all be worried when politicians start spouting platitudes about the highly unrealistic benefits of these projects. The great myth of the success Roosevelt’s New Deal no doubt lingers in the minds of policy makers. But the truth about government infrastructure is wildly different from the conventional wisdom.

It is a fallacy to believe that the government can allocate resources effectively to meet future economic needs, instead of entrepreneurs. What advocates of state infrastructure spending fail to grasp is that government cannot suddenly acquire the knowledge as to which parts of the UK’s infrastructure either needs repair, replacement or, indeed, which new projects should be undertaken. The economy is dynamic and never static. The government cannot predict what it will look like in 30 years time, whether there will be an increase of manufacturing jobs in the northeast or high tech in the midlands. This is simply not possible to anticipate into the next twenty or thirty years.

The argument commonly made for infrastructure spending is that it will have a kind of Keynesian multiplier effect. Private construction firms will be employed, idle resources will be put to use and money will start to circulate through the economy as people spend their newly earned wages. But this, again, is untrue. Government infrastructure drains the economy of resources and, even in the short term, stops resources from being used elsewhere. These decisions are difficult even for the private sector, which relies on price signals. Sometimes the private sector fails, sometimes it succeeds, but because it is the investor's money that is on the line it has a reason to act rationally. Government lacks the information to act wisely, and the incentives to act prudently.

In Japan, large government infrastructure projects have failed to lift the country out if its low growth high debt slump. In the UK, many cities have built tramlines, which have almost universally turned out to be loss makers and failed to promote growth.

Entrepreneurs, not state bureaucrats, will be best to judge whether a particular project is worth the risk. The history of white elephant infrastructure projects is one that seems to repeat itself with each new administration. Let us hope that the politicians fail to match their rhetoric with our money.