Ten very good things 3: Profit
The third in my series is profits, much-maligned but essential for progress.
3. Profits
The role of profit is much misunderstood. Some denounce profits as if they represent money that rightfully belongs to others, but profits are the reason for the wealth-creation that has so benefited the world. We postpone consumption so that we can enjoy more of it later. There would be no reason to do so otherwise. By using wealth to create more wealth in the future we can have access to more choices and opportunities. The prospect of making a profit leads us to invest, and the investment creates new products and processes and new efficiencies. Profit is the difference between the cost of the inputs that go to create something and the price that others will freely pay for it.
Sometimes people are envious of high profits and think them somehow unfair. In fact the high profits encourage others to enter and start up in competition, which in turn benefits the consumer by increasing choice. Moreover high profits motivate others to start up new ventures in the hope of doing likewise. Thus profit is the incentive for increased economic output, as well as for the introduction of new products onto the market.
Profits do not represent wealth taken from others, but wealth created by added value and exchange. Without profits there would be no reason to forego present consumption by investing. Profits thus make us look to the future and what we might achieve in it, and lift our eyes above the present gratification that would prevail otherwise. Profits are the incentive which sets people on the road to economic expansion and the self-betterment which it makes possible.
Marxists erroneously suppose that profit represents exploitation, a price higher than the labour cost of producing goods. They err in supposing that value derives from labour costs. In fact it derives from demand, and is in the mind of the person contemplating the object, not in the object itself. It is because we value things differently that we trade. The investor hopes that people will value the goods produced more than the price that will be asked for them, and that this will be more than it costs to produce them. Profit benefits people rather than exploiting them, and it does so by making available new goods that they value and are willing to buy.
Ten very good things 2: Bankruptcy
For the second of the very good things that tend to receive a bad press, I highlight bankruptcy.
2. Bankruptcy
When an individual or firm goes bankrupt, a legal process is instigated to discharge debts that cannot be repaid. In former times such debtors might have been put into a debtors' prison and languished there for years. The process weighs assets against liabilities and allows the debts to be discharged at some fraction of their nominal value, leaving the debtor free of the burden, albeit subject to rules of financial behaviour and with a blemish on their credit record which can last for years.
While bankruptcy undoubtedly involves some social stigma that most people would seek to avoid, it does have advantages to society as well as to the individuals it releases from debt. A discharged bankrupt is no longer burdened by the debt, and is free to work again and to earn money without it all being consumed in repayments. If he or she went bankrupt as a result of a failed business enterprise, they become free, after the passage of time, to try again. Some highly successful business people have failed to get it right the first time, and have experienced bankruptcy on the road to eventual success.
Most lenders who extend loans to business know that risks are higher among 'subprime' candidates, and set their repayment terms sufficiently high to cover the losses from those who go bankrupt. While failure might be devastating and distressing for the individual, however, it has economic and social benefits. Failure enables capital and assets to be redeployed from businesses that have not worked towards new ventures that show more promise. It is the financial equivalent of clearing out the less hardy plants and animals and leaving their ecosphere available for the hardier strains.
The economist Joseph Schumpeter spoke of the "creative destruction" wrought by innovative ideas and businesses that led to the demise of established ones. Bankruptcy is part of the process by which failing firms close down and are replaced by newer and more successful ones. Although governments might try to reduce bankruptcies and failures by propping up firms in trouble, they do the economy and the prospects for future growth no favours by doing so. The failure of some is an important ingredient in the success of others.
Tax freedom for the poor!
Not slow to capitalise on this ‘leak’, the Spectator’s blog drew attention to a Centre for Policy Studies report published by Lord Maurice Saatchi and Peter Warburton in 2001, Poor People! Stop Paying Tax!, that itself recommended £10,000 at which the low-paid began to pay. For the think tank that Margaret Thatcher and Keith Joseph built, it is absurd that the State ‘even taxes people who can’t afford to pay tax at all.’ But insult is added to injury:
Governments put up tax, which reduces individual incomes and creates more dependence on the state. And citizens claim more state benefits to compensate. And so it goes on until the government is claiming billions of pounds a year in taxes from citizens who also claim billions of pounds a year in benefits from the government.
This political duel over who is truly the friend of the poor should set off a policy debate on taxes in general; namely, is it better for taxes to be wide and shallow — that is, paid by everyone, allowing for overall rates to be low — or narrow and deep — again, paid by the wealthy few who are considered able to pay them and, necessarily, rather high?
Establishing the framework of income tax policy
In the predominant social democratic environment of current debate, the arguments for the latter option are well-rehearsed, and are usually couched in terms of making the well-to-do ‘pay their fair share’, if not in the less-benign tone of ‘soaking the rich’. But the rationale for the former position is less well-known — certainly among the leftist intelligentsia — and so deserves a short hearing. One reason is based on shared solidarity; as Saatchi and Warburton note, ‘One of the arguments that is frequently aired is that the payment of income tax or council tax, even at a low level, is a mark of civic responsibility: an acknowledgement of the cost of government services.’ Or as Madsen Pirie has written, ‘Simple taxes ... make clear the duties of citizenship, and allow people to feel that they are partners with government, making the sacrifices required to enable society to function, and knowing what that involves on their part.’ To quote the Prime Minister and his Chancellor, ‘We’re all in this together.’
Another reason is based on subtle factors of containing the growth of the State and its entitlement culture: Citizens are more aware of abuse of the public treasury and State-aggrandisement if they bear a portion of the tax burden, less concerned if they personally bear none of the costs — especially so if they are among the recipients. ‘As long as it is admitted that the law may be diverted from its true purpose,’ cautioned Frédéric Bastiat in The Law, ‘— that it may violate property instead of protecting it — then everyone will want to participate in making the law, either to protect himself against plunder or to use it for plunder.’ The aim, then, according to this interpretation of comprehensive income taxes, is to make all citizens conscientious taxpayers, and therefore make everyone invested in good government.
Yet another, a bit esoteric in nature, posits that various business interests gain unfairly from the selective practice of ‘tax expenditures’ — a feature spawned from crony capitalism (or ‘corporatism’) — and that if such loopholes were removed, then a truly competitive free market economy would exist, with subsequent lower tax rates for all.
The socio-economic virtues of income-tax freedom for the poor
The first taxation policy — wide and shallow — has much to recommend it, though with respect to the subject of personal income taxes, the alternative position — narrow and deep — may be preferable: Taking those who are low-paid off the income tax register serves the greater common good.
Low earners still must pay any number of direct and indirect taxes, whether consumption taxes, property taxes, or National Insurance. They, like all other British taxpayers, know of sacrifice and social solidarity, and thus it cannot be argued they are oblivious of the costs of government to them. They certainly meet the standard as set forth by Adam Smith in The Wealth of Nations: ‘The subjects of every state ought to contribute toward the support of the government, as nearly as possible, in proportion to their respective abilities; that is, in proportion to the revenue which they respectively enjoy under the protection of the state (V.ii.b.3).’
Nor is raising the income threshold necessarily a complete loss to government revenues. Allowing the low-paid to keep more of their salaries is an incentive for increased productivity (which declines when despair and despondency hit the unemployed); furthermore, these new-found earnings may be saved or spent — both which serve businesses either looking for investment or sales opportunities. Other benefits outlined by Tom Clougherty include eliminating the ‘benefits trap’ and reducing the size of the ‘tax wedge’.
Raising the income threshold by removing the low-paid from the tax rolls also removes many from the welfare rolls, too. ‘The most effective way of giving extra income to low earners is not through a cumbersome system of credits and allowances, but by not taxing them in the first place,’ wrote Pirie (who envisions a slightly higher benchmark). ‘If their money is not taken by government, it does not need a complex bureaucracy to give some of it back to them.’
Some of those earning less than half the average wage find themselves needing benefits only because part of their money is taken in tax. If the threshold at which income tax is levied were raised to half the average wage (which is almost the same as the minimum wage, about £12,000 a year), those earning less than that would not pay it at all. Only income earned above the £12,000 level would come under income tax. This would not only be simpler and more efficient than the present welfare system, it would end most its poverty traps. There would always be an incentive to earn more, for no additional income would bring with it a reduction in benefits. Even above £12,000, people would only pay the basic rate on each pound earned above it, and none at all on the first £12.000. The incentive would always be there to earn more if people could.
Bastiat foresaw the adverse consequences of these traps: ‘The present-day delusion is an attempt to enrich everyone at the expense of everyone else; to make plunder universal under the pretence of organising it.’ Tax-credit and tax-benefit policies, however well-intentioned, have become perverted and often serve as barriers to advancement and independence for those whom they were intended to help.
Curbing a ravenous government of its revenue dependency
Need it be said that a preference for personal income taxes that are narrow and deep is not an endorsement for wild abandon? (And by ‘deep’, what is connoted are taxes which are ‘deeper’ in comparison to those applied to the poor.) Smith anticipated Laffer Curve findings which suggest that higher taxes do not unquestioningly entail enhanced revenue streams (see quotation below) — not to mention the moral issues involved with the gratuitous confiscation of private property. Both Pirie and Clougherty, as well as Saatchi and Warburton, emphasise that a significant cause for generating ever-more revenue to fund expenditures has been the unprecedented growth of the Welfare State — of which tax reallocations form a part.
Though it has become a cliché among conservative circles, it is no less true that most Western democracies don’t suffer from too few taxes, but rather from too much spending.
These effects of over-government affect all taxpayers and, along with providing tax relief for the poor, should constitute a major reform of government policy. Smith’s eighteenth-century standard for taxation is as relevant now as then:
Every tax ought to be so contrived as both to take out and to keep out of the pockets of the people as little as possible, over and above what it brings into the publick treasury of the state. A tax may either take out or keep out of the pockets of the people a great deal more than it brings into the publick treasury, in [that] ... it may obstruct the industry of the people, and discourage them from applying to certain branches of business which might give maintenance and employment to great multitudes. [...] It is in some one or other of these ... ways that taxes are frequently so much more burdensome to the people than they are beneficial to the sovereign (V.ii.b.6).
Tax freedom for the poor!
Establishing a higher threshold for personal income tax was under much discussion last month — a precursor for conference season debate. Under the banner of ‘Fairer Tax in Tough Times’, the Liberal Democrats presented plans to increase the scheduled threshold of £9,205 to a suggested rise of £10,000.
Not slow to capitalise on this ‘leak’, the Spectator’s blog drew attention to a Centre for Policy Studies report published by Lord Maurice Saatchi and Peter Warburton in 2001, Poor People! Stop Paying Tax!, that itself recommended £10,000 at which the low-paid began to pay. For the think tank that Margaret Thatcher and Keith Joseph built, it is absurd that the State ‘even taxes people who can’t afford to pay tax at all.’ But insult is added to injury:
Governments put up tax, which reduces individual incomes and creates more dependence on the state. And citizens claim more state benefits to compensate. And so it goes on until the government is claiming billions of pounds a year in taxes from citizens who also claim billions of pounds a year in benefits from the government.
This political duel over who is truly the friend of the poor should set off a policy debate on taxes in general; namely, is it better for taxes to be wide and shallow — that is, paid by everyone, allowing for overall rates to be low — or narrow and deep — again, paid by the wealthy few who are considered able to pay them and, necessarily, rather high?
Ten very good things: Advertising
Some things that are good and beneficial are frequently disparaged because they are misunderstood. I have selected a few such things to put the case in favour, pointing out the good that they do. These points will be familiar to many of our readers, of course, but they might equip other people with arguments that can defend these ideas against critics.
1. Advertising
Some suggest that advertising is wasteful, diverting resources into promoting goods that might otherwise be used to lower the price. It has even been claimed that advertising is coercive, tricking a gullible public into buying goods and services by bombarding them with positive images instead of trying to sell on the basis of quality.
In fact advertising is informative. It tells the public what goods are available, in what varieties and at what prices. It is a very competitive industry, with creative minds vying with each other to find new and attractive ways of appealing to what the public is looking for, and of emphasizing the merits that people seek in the goods they buy.
Advertising is often used to promote new or improved products by announcing the edge they have over their rivals. It is self-regulated, not permitting ads that try to sell goods by making people feel inadequate or inferior without them. Instead they have to stress the positive aspects of their products.
Some intangible associations add value to products by creating an image for the product that enhances the enjoyment of it. Malt whisky in India is promoted as an aspirational product, so the young Indians who sip it enjoy not only the whisky, but the feeling that they are headed for success. And long after the whisky has gone, the memory of that feeling might endure. When some products are bought, the purchaser buys into a lifestyle linked to them by advertising, and enjoys the intangible associations they bring.
Sports companies are sometimes criticized for promoting expensive brands that young people are encouraged to buy into. But the fact is that many teenagers are still discovering who they are, and the brands help them to assert an identity linked to their associations.
Far from being wasteful, advertising promotes competition, and that keeps prices keen and quality high; and the images created for products enhance the value of those goods to the purchaser.
Greece, Spain, and reality
As riots accompany new austerity measures in Greece and Spain, the euro is plunged into uncertainty again. Sanguine observers might predict that there will be three such crises in the next year, and that there will be three emergency summits held, and three announcements of new measures to deal with the problem. On each occasion markets will respond favourably for a very short time, then gloom and uncertainty will return. Those same observers might predict a further three such sequences in the following year, and three more in the year after that. And so on.
Oliver Smith in the Telegraph reports informed opinion suggesting that a Greek exit from the euro is now inevitable. Greece would become a very cheap tourist destination with a devalued drachma, and the tourist industry would experience a boom. Investment would come in to build hotels and restaurants, and employment would rise. This process could and should have started two years ago. If it had, recovery would by now be visible.
It is also true of Spain. The only solution for them is to quit the euro so that the peseta can find a level that reflects Spain's true position and enables exports to rise and economic growth to take hold.
The economic case for exit might be overwhelming, but it is entirely subordinated to the political case that the European juggernaut must not falter for an instant in its drive to 'ever closer union.' This gives a strong likelihood that the crises, the summits and the responses will continue for years, along with the civil unrest and misery that accompanies them. This is where we came in.
No one should ever get benefits of more than £10,000 a year
The current government has announced that no family will get more than median income in benefits each year. I'm afraid that they're still being hopelessly over-generous here. And I would call into evidence the Baron Skidelsky to prove it to them as well. No one should ever be able to garner benefits of more than £10,000 a year. For as the Noble Lord tells us:
The case against making increased GDP per capita the overriding policy objective is that it doesn’t deliver the increased happiness or welfare if promises. In 1974, the economist Richard Easterlin published a famous paper, “Does Economic Growth Improve the Human Lot?”. The answer, he concluded, after correlating per capita incomes and self-reported happiness levels across a number of countries is probably “no”. In a refinement dating from 1995, Easterlin found no relationship between income and happiness above an average per capita income level of between $15,000 and $20,000. Other findings confirm Easterlin.
Well, there we have it. Over $15,000 a year you just don't get any happier. This is usually applied to the idea that people who do make more than that £10,000 a year can have chunks of cash nicked from them to be given to those with less with no loss of human happiness. And let us do our ideological enemies the honour of exploring their own argument. Which is, as we can see, that more than £10,000 a year doesn't make you any happier.
Thus, while those with more than this might have room to lose some income in order to make others happier, those who already have £10,000 a year won't be made any happier by gaining more. Nor will anyone receiving benefits of £10,001 be made happier, indeed, someone currently earning £9,990 currently will be made maximally happy by being provided with only another £10.
That is, that our argument that money doesn't make you happy provides an absolute cap on how much it is that the welfare state should try to supply to the poor. We have in fact reached Nirvana: we know how much money to move around, the maximum amount of money that can possibly be usefully applied to making people happier. And that amount isn't £10,000 per person per year. It is only the amount by which each person receives less than £10,000 through their market activities. Or, compared to what is currently spent, virtually nothing.
All we have to do is rejig the system so that everyone's income is topped up to that £10,000 a year level (and why yes, this would include housing benefit, it would even include services in kind like education and the NHS) and we are all as happy as can possibly be.
The only reason this could not possibly be true is if that you don't get happier having more money isn't true. So which idea do the redistributionists want to give up? For it is either more than £10k doesn't make you happier therefore no one needs more welfare than to provide them with £10k or, if more than £10k does make you happier then, well, more than £10k does make you happier.
Can we please kill the idea that Adair Turner or Robert Skidelsky are economists?
Robert Skidelsky has another of his pieces about how being richer just doesn't make people happier. In it he quotes Adair Truner on a point which really should put to rest the idea that either of them are economists. For it really is a dreadful mistake:
More radical is Turner’s attack on our way of measuring wealth. GDP measures the volume of marketed output, not its quality. But it is the improvement in quality which is chiefly important for satisfaction.
GDP is not the volume of marketed output at all. It is the value of total output at market prices. That valuation at market prices means that we're linking that output to the satisfaction that consumers get from it. No, it's not the total value they do derive from it for there is such a thing as the consumer surplus (people purchase things at market prices because they value them more than the market price).
It's actually the other people, the Soviets, who measured economic output by volume. So many tonnes of cement, so many kilos of copper, so many kilometres of transport provided. We measure economic output by the value of it. Which does, as I say, link economic output to the satisfaction derived from it in a way that purely measuring by volume does not. For the value ascribed to production by market prices does bear some relationship to the satisfaction derived by consumers.
As a critique of announcing the tractor production statistics Turner and Skidelsky have a valid point. Given that we don't do that, have never done that and in fact as the 20th century proves we were right not to do that as a criticism of our current economy it's entirely incorrect. Fatuous even: so can we put to bed the idea that, given their seeming ignorance of the most basic points about our current economic system, either Turner or Skidelsky have anything very much interesting to say to us about how we should alter our current economic system?
Making a mockery of scientific ethics
Last week saw an outrageous abuse of scientific ethics which deserves wider coverage and denunciation in case it becomes widespread. French scientists based at Caen had a paper published in the journal "Food and Chemical Toxicology." The paper concerned the effects on rats who were fed supplements of the herbicide Roundup or a crop genetically modified to tolerate high levels of Roundup.
Unusually, as Arstechnica reports, journalists who wanted advance copies were obliged to sign an agreement not to show the findings to any outside experts before publication.
This unprecedented step meant that the usual process of peer review and assessment which is basic to science was thwarted. Usually scientific journalists contact outside experts in advance of publication to see what validity the new study has, and to comment on any weaknesses they might see.
In this case they were prevented from doing so, and the initial coverage lacked the analysis that customarily puts such papers in context. Following that initial coverage, the experts found much at fault in the survey.
"The authors used a strain of rats that is prone to tumors late in life. Every single experimental condition was compared to a single control group of only 10 rats, and some of the experimental groups were actually healthier than the controls. The authors didn't use a standard statistical analysis to determine whether any of the experimental groups had significantly different health problems."
Some of them were completely dismissive of any value the report might claim to have.
One called the work "a statistical fishing trip" while another said the lack of proper controls meant "these results are of no value." One report quoted a scientist at UC Davis as saying, "There is very little scientific credibility to this paper. The flaws in the test are just incredible to me."
The point is that the scientific authors deliberately prevented these flaws from being revealed at the time of publication. They had a field day of uncritical coverage, and violated all the ethics of scientific research to achieve that. The result is that for years to come anti-GM zealots will cite their findings without any of the criticism that undermined them.
As they say, a lie can be halfway round the world before truth gets its boots on.
Now that we're getting a government owned investment bank what is the effect of government ownership of banks?
Vince Cable seems to have got his idea of a state owned business investment bank approved. Which seems like a reasonable time to ask what the effects of such state ownership of banks and the banking system is. Or if you prefer, what is the effect of allowing politicians to direct bank lending?
Which is interesting because there's a new paper out which looks at just that. There are two possible views here. One is that politicians are wiser than the accumulated wisdom of the markets (or perhaps their incentives lead them to make better decisions about capital allocation) and that therefore state owned banking will make everyone better off. Given that the part of the Spanish banking system, the cajas, that is bust and near to bankrupting the entire country is that part that was controlled by politicians makes this a tough argument to make. But perhaps that's just Spanish politicians. The other view, the "political" view, is that politicians will use state owned banks to reward their friends and buy votes. This will lead to even worse capital allocation than the market manages and make the future poorer than it needs to be. Having looked around the world the paper tells us that:
We assemble data on government ownership of banks around the world. The data show that such ownership is large and pervasive, and higher in countries with low levels of per capita income, backward financial systems, interventionist and inefficient governments, and poor protection of property rights. Higher government ownership of banks in 1970 is associated with slower subsequent financial development and lower growth of per capita income and productivity. This evidence supports “political” theories of the effects of government ownership of firms.
Ah, OK. So state owned banking is a very bad idea then. Something that should be clear to everyone a priori, even to the politicians rubbing their hands with glee at the idea of being able to buy support and votes. For while you, you near omniscient and incorruptible politician you, might indeed know better than everyone else how to allocate capital the same isn't true of your political opponents. Obviously it could not be for if it were you wouldn't be in the other party than them. But at some point the turns of political fortune are going to mean that they are going to get control of that lending and capital allocation.
This logic works whichever party you belong to: even if you do think that money should be allocated to cooperatives in order to stop the capitalists grinding the poor into the dust at some point the other lot will get in and allocate that same funding to the capitalists to grind the poor into the dust.
Or, as the paper says, we don't want state allocation of credit because it will lead to our children being poorer than they would be without it. For politicians make even worse decisions than bankers do if you could believe such a possibility.