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.

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.

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.

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.

Another silly idea crashes and burns

It wasn't long after the financial crisis that we had every lefty worth their name crawling out of the woodwork insisting that this just proved how wrongly banking was structured. We must move back to local banks. Banks which had local politicians on the boards so as to make sure that the wider interests of the community were considered. Other stakeholders, like the unions must be included. And we most certainly had to divorce any investment banking from retail banking

There were a number of problems with this set of ideas: for example, none of the banks that went down in the UK did so because of investment banking. It was the wholesale bank run (Northern Rock), corporate hubris (RBS) or plain and simple bad lending (HBOS, various building societies).

But let's leave that aside. Let's assume that we did indeed have a local banking system. One that didn't have anything at all to do with investment banking. No CDOs, no CDS, no "trading", just plain vanilla lending in their specific regions. And we'll bring on board the local worthies, the local politicians, the union chiefs. Heck, we'll even make them non-profit shall we? Perhaps they should be owned by charitable institutions?

What do we end up with? Actually, we end up with the Spanish banking system:

Bankia stands as a reminder that Spain's property bubble—and the banking crisis that is its aftermath—had its roots in the intertwining of government and finance. Until the crash, Spain's cajas were community institutions closely tied to regional governments, and bank boards and regulators were peopled by party insiders willing to overlook lenders' real-estate excesses. Spain will see more disasters like Bankia's until these links are fully wrung out.

Note that here in the UK a few banks went bust (and rightly so), a couple were rescued as too big to fail and the rest became illiquid but not insolvent. They needed temporary funding aid but that could be and was repaid. That's what happened with the capitalist shareholding investment and retail bank mixing national system in the UK.

In the Spanish localised, politically directed and not for shareholder profit system absolutely all of that banking system went resoundingly bankrupt. No, not just illiquid: bust. In such large numbers that it's bankrupting Spain itself. So that's another one of those trendy lefty ideas that crashes and burns then, eh?

Oh, by the way, the only three banks in Spain that are still standing are the shareholder owned, for profit, mixing investment and retail banking, national and international ones.

Reduced liquidity really does increase price volatility you know

One part of the drivel we hear (or hear being repeatedly asserted perhaps) about the financial transactions tax is that lots of trading increases price volatility. Thus the tax, by reducing liquidity, will reduce price volatility which would be a good thing. So tax the markets and Hurrah!

There is one slight problem with this idea. It's only a teensie problem to be sure. The teensie weensie problem being that there's absolutely no evidence whatsoever that it's true.

It's entirely possible to construct theories in which it is true: that's certain. Assume that everyone's a momentum investor, just following the herd, and it quite possibly would be true for example. But it is always necessary to benchmark such theories against the real world. As an example, I've always been quite taken with the theory that The Moon is made of green cheese. That has indeed been tested and no, Neil Armstrong was not able to consume regolith on a Jacobs Cream Cracker. So it is with this idea that increasing liquidity in a market increases price volatility: or the inverse, that reducing it would reduce such.

Eric Hunsader at Nanex presents us with a nice start to 2013 markets — a no less than an 8 per cent drop and subsequent clawback in natgas futures during early Thursday trade: That’ll teach you for not waiting for a bit more liquidity later in the day.

Interesting, isn't it? How actual facts often upset the wilder suppositions put forward by those who would tax us all more?

Indeed, there's almost certainly a Ph.D thesis in there for someone who wants to do it. Take 20 or 50 different markets (and cover different things, stocks, bonds, derivatives, commodites), in different countries, with different holiday periods. Compare and contrast price volatility in those markets with those holiday periods and reduced volumes and liquidity.

My bet is that we'll see increased price volatility in circumstances of reduced liquidity. And to supporters of financial transactions taxes (and the idiocy that is the Robin Hood Tax) if you're so sure of your claim, why haven't you done this analysis already to prove your point to us?

EU derision time

The EU Federalists have already written the script for the UK’s new relationship as an “associate member”.  We will be subject to all the regulations and costs of EU membership without any influence or voting rights.  That is roughly the deal Norway currently has.

So is this decision time as we choose between attractive alternatives or derision time as we crawl pathetically back into our hutch?

The Federalists believe the UK has little negotiating room and Cameron will be out of office before the talks get tough.  At the next election, UKIP will not be taking many, if any, Westminster seats but they will be drawing away the key marginal voters.  Any Lib Dems remaining will undermine negotiations. 

So is the EU now a lost cause?  If it was left to the FCO, it certainly would be.  Our diplomats have no blueprint of an EU, nor of an exit, that we would like, nor any plan to achieve either of them.

What can we do?  Cameron needs to agree the seriousness of the issue with Milliband – forget Clegg.  The UK’s national interest needs a negotiating team and a strategy  that will survive the next election whatever the outcome.  The team should work in secret and bring together some of the more thoughtful MPs and MEPs, both Conservative and Labour, as well as the City – our most crucial economic interest.  Unfortunately it will also need diplomats, but retired ambassadors rather than serving civil servants, because it will be essential to know the extent to which we can bring other EU members along with us.

The team should be given a year, no more, to come up with an A and a B scenario to compare with scenario C, and plans to achieve A and B:
A. What is the best “staying in” deal we can reasonably expect to achieve?
B. What is the best “opting out” deal we can reasonably expect to achieve?
C. If we are blocked from both of those and continue to be dragged, whingeing, along, how will that look?

A referendum should be deferred until we are ready but that is easy.  If a premature referendum comes to the wrong answer, have another a year later.

We can win this campaign but not if we continue to deal with the EU in the manner we have for the last 40 years.  If we lose this campaign it will resemble our last Eurovision Song Contest entry: a tired old gent being derided by a bunch of countries with whom we have lost touch.

Opportunities for students this spring

2013 is shaping up to be a good year for young fans of liberty. Here are some opportunities available to them.

Free Books for Schools
In October we began sending out books for A‐Level students studying politics, economics and philosophy. By December we mailed out over 1,000 books to Sixth Form students. The books available are listed below, and we can provide up to three copies of each to your school.

Freedom 101 (Free PDF)
Freedom 101 gives answers to 101 common errors made by opponents of free markets and open societies.

A Beginner’s Guide to Liberty (Free PDF)
A short, accessible introduction to liberal ideas from free trade to banking to legalized drugs.

The Condensed Wealth of Nations (Free PDF)
An explanation of Adam Smith's The Wealth of Nations that uses Smith's own words and explains them for a modern audience, point-by-point, to allow his great ideas to shine through.

Win £500 in our Young Writer on Liberty Competition
If you’re under 21, there is still time to enter our writing competition before the closing date on February 1st. The first prize includes £500 and an internship at the Adam Smith Institute. You can find more information here.

Independent Seminar on the Open Society (ISOS) March Student Conference
The Independent Seminar on the Open Society (ISOS) is a free one-day seminar for sixth-formers, held in London twice a year. This March the conference will focus on free market economics. Topics covered will include:

Limits of knowledge
The benefits of trade
The fallacy of evidence-based policy
The private supply of public goods
Debate: Should we be able to sell our organs?

Students are welcome to attend independently, or with teachers. Refreshments will be provided.

If you are interested in finding out more about any of these, do contact us at info@old.adamsmith.org.

How not to start negotiations with the EU

David Cameron is expected to make his long awaited EU policy speech shortly.  We are told it will be radical and bold. The consequence, we are told again, will be a major renegotiation of our EU terms or departure with our head held high.  That choice will be for the UK to make on the basis of an in/out referendum.

Cameron is in the weakest negotiating position of any British Prime Minister since Edward Heath.  With her Bruges speech, Thatcher turned us from a respected contributor to a moaning Minnie, complaining at every step of the EU way and thereby alienating our friends.  Major dismantled what could have been a powerful trading partner for the EU leaving a rump EFTA today.  He led our potential allies into the arms of Brussels.  Now they want our money but not us.  Blair, to appease the unions, gave away John Major’s opt-outs and, to curry favour with new EU members, much of the Thatcher rebate. Brown handed City regulation over to Brussels.

So far Brussels has been helpful on Scottish independence because Spain is terrified that Catalonia will go the same way.  But if the Federalists can use Scottish independence as a further way to undermine the UK position, they surely will.

The track record of our City, regulators and civil servants has been weak.  Much of the EU treaty and regulatory wording has been drafted by our people.  They claim, naturally, that the treaties and regulations are better than they otherwise would have been. From the Federalist perspective these civil servants look remarkably like a Fifth Column, advancing the EU cause under British colours.

And finally consider the witlessness of our MPs. Have any have sat down and worked out what we are trying to achieve and how that can be done?  Bill Cash is thoughtful but no one listens to him any more. On fisheries, did we not sell most of our rights to Spanish fleets?  Will the courts allow us to repatriate those rights without compensation and will the compensation not be higher for an independent UK?

Our MPs and our media have further alienated Brussels and other member states by blaming them for UK intervention and undermining our sovereignty  when, for example, far more regulations have arisen from Whitehall and Westminster than ever came from Brussels.  Transparently, it has suited Whitehall to escape the odium that should be theirs.

In short, the UK will begin the negotiations with the worst possible background.