The Recession: Causes and Cures

• The recession was neither unforeseeable nor inexplicable. On the contrary, it was the direct and unavoidable result of the credit-fuelled boom that preceded it.
• Governments and their central banks contributed to the boom by: (1) keeping interest rates too low for too long, allowing asset-price bubbles to build; (2) giving implicit guarantees to the banks and other borrowers; (3) failing in their functions of prudential supervision and financial market regulation; and (4) by encouraging borrowing by those least able to afford it.
• These mistakes originated in a misunderstanding by central bankers and Treasury officials on both sides of the Atlantic of the nature of the economic cycle, and in their consequent hubristic belief that they had solved the problem of how to prevent recessions.
• The only way to avoid a recession is to restrain the antecedent boom. However, once a recession is under way, there may be ways to mitigate its worst effects and bring it more quickly to an end. The key is to re-establish a climate of business confidence.
• The best way to do that is to set a long-term course for lower corporate and personal tax rates, and stick to it. In the medium term, higher taxes can only be limited by reducing government expenditure, not by borrowing. Large-scale borrowing does not inspire confidence, because it gives rise to an expectation of future tax rises which discourages investment.
• In contrast, the three principal measures that have been adopted by the US and UK Governments to mitigate the recession are of marginal benefit and may prove harmful. These are: injecting taxpayers' money into the banks, artificially expanding the money supply, and attempting to provide a 'fiscal stimulus'.
• While one can understand why Governments felt the need to bail out certain institutions when they did, attempting to bail out all the banks is unwise. An orderly liquidation of the insolvent banks would have left sound banks in a stronger market position, allowing them to expand their lending to creditworthy borrowers more rapidly. No financial institution should be allowed to believe it is too big to fail.
• Expanding excessively the supply of money is unlikely to have a positive impact. In the long-term, it poses an inflationary threat which may be difficult for central banks to counter.
• The prescription of an across-the-board fiscal stimulus as a remedy is equally misconceived. The present recession is not the result of a deficiency in aggregate demand which was growing steadily until the summer of 2007. Nor is the recession's impact evenly distributed across the economy. There may be a case for targeted assistance to alleviate hardship and ease adjustment, but government must be careful not to support unsuccessful firms at the expense of successful ones.
• A notable feature of the boom was the misalignment of incentives in financial markets, which encouraged excessive risk-taking. This is largely attributable to the persistent failure of institutional shareholders to hold directors and senior managers to account. This may perhaps be the biggest flaw in the operation of Western market economies at the present time, and needs to be addressed by legislation.
• The present crisis has cast into doubt the ability of national governments to control the supply of money and credit. In the short term, new monetary and fiscal policies will have to be formulated. If these don’t work, then in the longer term some form of commodity reserve system for currencies may need to be considered.
   

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In our latest publication, The Recession: Causes and Cures, economist David Simpson examines the current recession and the government's responses to it. I'd highly recommend reading the whole thing if you have time (PDF available here) – the analysis of the financial crisis is one of the best I've read – but for now you can click read more for the executive summary.

EU make me sick

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A flabbergasted European Union has for the past 12 months been telling Ireland that the "No" they returned in the referendum of 2008 was not "their final answer". Today the EU announced that concessions had been granted to the Irish in areas covering military neutrality, taxes and abortion. Or in political terms: the voters of Ireland have been offered a bribe to vote 'yes' so that the planned federalization of Europe can continue unabated. As for the rest of the European nations who have already ratified the treaty, there are no special favours or opt-out areas on offer.

If a single 'no' to a EU treaty can grant you negotiable policy areas imagine what the UK could have achieved had we been able to express ourselves freely and openly on how we felt towards the EU and the Lisbon Treaty. But this quite clearly shows that there are areas of public policy that have once again been handed over meekly by parliament to the control of Brussels/Strasbourg. If the Irish felt those areas were of national importance and are enough to swing the vote to a 'yes' what are we going to regret losing control over?

Rather than continuing the charade of European elections every 5 years, with an ever-decreasing turnout, we should finally hold the referendum that has been continually promised us. We are now 36 years into a partnership with our neighbours which has hardly ever been beneficial. Thirty-four years have passed since we last held this contract to account, it is time for a re-assessment especially in light of what Ireland have protected and what we no longer have control over. In the meantime we shall have to hope that the Irish see past the bribery and realize that there is no benefit to further integration. Should they vote 'no' it could finally open the door to a referendum in this country.

Lessons from Alderney

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Last week I was in Alderney, the most northerly of the Channel Islands and a wonderfully free place. It is controlled by an elected legislature with ten members and a President, acting as head of the government. Without the interference of party politics and career politicians they seem to have maintained a sense of sanity that has been lost in Westminster.

As part of the Channel Islands Alderney maintains a low tax status:

• No Value Added Tax.
• No tax on capital.
• No tax on inheritance.
• No tax on exempt companies carrying on business outside the islands-see section Trusts/ Company Law.
• No tax on trusts whose beneficiaries live outside the island.
• Low tax (only 20%) on profits of companies which carry on business in the island.
• Low tax (20%) and generous personal allowances on income of persons who live in the island.
• Preferential arrangements made for captive insurance companies based on the island.

This all means that smaller local businesses don’t have to struggle in order to pay their tax bills, which obviously is beneficial to all on the island. The absence of tax on capital attracts wealth from abroad, creating flows of income into the island that act as an investment for the community.

The island is not only competititve in its tax policy. The legislature also does not infer in people's social freedoms as in mainland UK. There are relaxed driving laws with no traffic lights or MOT tests. If you go into the pubs on the island people are free to smoke indoors at the bar – a far cry from the infringement on our freedoms that we have suffered here.

There was a really good quality of life on the island, this is shown by a high number of people retiring there after living and working in Britain and France. The government has not sought to meddle in every aspect of life and the community is better off for it – now why did I come back to Westminster again?

Voluntarism and coercion

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The "private sector" of the economy is, in fact, the voluntary sector; and...the "public sector" is, in fact, the coercive sector.

Henry Hazlitt

A certain sadness, yes, but really we should celebrate

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Ian Jack's got a nicely done piece over at The Guardian about the decline of the British milk producing industry. Yes, of course, there's a sadness at the idea that the very embodiment of Stout British Yeomanry, the independent farmer, is being driven out of business. I'm also a little surprised that mention isn't made of the way that the milk quota regime imposed by the EU is deliberately skewed against said Stout British Yeoman.

But there's one little line in there which is the reason we should really be celebrating.

Years of genetic engineering and dietary supplements mean increased milk yields and fewer cows;

Fewer cows of course means fewer farmers needed to tend to them. This is really the story of increasing efficiency, increasing productivity, in farming. Something that we really should be celebrating, for it's the key to this whole civilisation thing. A society where everyone has to work full time in the fields in order to keep that society fed is really not much of a society. In order to develop anything other than just that peasant farming, you know, things like libraries, the NHS, symphonies, jet travel, absolutely anything other than a pure subsistence lifestyle, it is necessary that farming become more productive. That one person working upon the land can produce the food for 2 people, or 49 (as it is in our own, with some 2% working upon the land) or even 1.001 people's food.

It is only if there is this sort of surplus production over and above the necessary food for those doing the labouring that we can develop and build a society of any real sort.

So while we might indeed be sentimental about the disappearance of part of Ye Olde Englande, we really ought to be celebrating the process which has been going on for some10,000 years now, the ever increasing producivity of farming. For it's to that that we owe the rest of this wonderful world we see around us.

Scotland's fiscal powers

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Last week the Calman Commission reported on extending fiscal devolution to Scotland. They suggested the following:

• Scotland would set its own income tax rates, with10p from the standard and upper rates being deducted by the UK Treasury.
• Stamp duty and land taxes could also be devolved to Scotland, along with landfill tax, air passenger duty and aggregates levy (whatever that is).
• The Barnett formula for allocating revenues would be kept, but Scotland's grant would be cut to reflect their new tax raising powers.

In short: a dog's breakfast. Like every other part of the devolution process, the Calman Commission's report is an almighty fudge, creating as many problems as it solves. If this was the best they could come up with, you have to wonder why they bothered at all.

The principle behind any reform should be a very simple one: each level of government should themselves be responsible for raising the revenue they spend. That would encourage fiscal responsibility and rational policymaking, and strengthen the accountability of politicians to their electorates. It would also lead to a great deal more autonomy at each level of government – a healthy antidote to Britain's relentless centralization.

What this adds up to is fiscal independence for Scotland. There are plenty of ways it could be done – see this excellent paper from Reform Scotland for a thorough examination – but my preferred option would be to have National Insurance and VAT set and collected by the UK government (to finance non-devolved matters like defence and social security), split North Sea Oil revenue 60/40 in Scotland's favour, and then leave everything else to the Scottish Parliament. The sums more or less work out.

Would such an arrangement undermine the Union? Maybe, but who cares? Besides, you could just as easily argue that fiscal autonomy for Scotland would weaken the nationalist case for independence, by addressing the resentment that is presently felt both sides of the border. Whichever way you look at it, fiscal autonomy is good policy.

The war on drugs is wrong

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Blog Review 1000

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Using Adam Smith to explain why a £6 tax per phone line to extend broadband is a bad idea. Although, to be honest, you could probably use Marx, Edward Lear or Barney the Dinosaur to explain why a £6 tax per phone line to extend broadband is a bad idea.

More Smith, this time about the difference between selfishness and rational self interest.

There's something not quite right about this idea of having a criminal trial without a jury.

What would you prefer to have? No Smokers or a Navy?

Worth remembering who helped get rid of the draft: that would have been enough for fame and glory, forget the Nobel and all the rest.

Yes, these plates in the road to use the cars to power the lights: it's perpetual motion flimflammery again.

And finally, crazed bailout economics.

And really finally, Netsmith bows out having reached the M mark. Been fun etc.

Toodle Pip!

Well, sort of Ms Phillips

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We shouldn't be all that surprised that the Head of Natural England thinks that we should, of course, be using natural methods to be dealing with problems such as climate change, coastal erosion and all the rest:

Protecting and working with nature makes economic sense and can be done now. Continuing to rely on undeveloped technologies as a safety net for climate change would be a disaster.

And as the statement stands itself I'm not sure I would argue all that much. But what is inherent in there is given that the necessary or required technologies are as yet undeveloped, therefore we must use only natural methods. Which is of course nonsense.

If we don't have tried and trusted technologies to do something that we wish to do then we'd better get on with developing them and then testing them so that we can trust them. This is after all how civilisation has advanced, someone spots a problem or a desire and then creates some technology to solve or satisfy it.

As an example that Ms. Phillips would probably agree with, we do not yet have a properly developed and economic method of turning the abundant sunlight we get into the electricty that we desire. Which is exactly why there are tens of thousands of people around the world working on developing, testing and thus allowing us to trust a system that would do just that. Solar PV at cheaper than coal, the thing we are promised is now only a few short years away.

So with any other such problem. If we've not developed the required technology as yet, better get on and do so really, rather than just throw up our hands and say that nature must take over.

I like tax competition

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My thanks to Cato's Dan Mitchell for drawing my attention to this comment by Finland's prime minister:

The overall tax rate will have to rise as well over the longer term. In some areas that can be done without much consultation between the countries. For example, property taxes or inheritance taxes can largely be determined at the national level without adverse economic consequences. But such taxes will not raise significant amounts of revenue. Only changes in value added tax, various excise taxes or taxes on earned and capital income can make a real difference. However, raising such taxes can have detrimental effects on economic activity. This is especially so when a country acts on its own: capital and people can respond by migrating to jurisdictions with lower rates. Deeper co-operation is therefore necessary if tax revenues are to be increased in a way that truly helps fiscal consolidation.

In other words, if we don't prevent tax competition, we won't be able to raise taxes as high as we want to. In order to make big government even bigger, we need to establish a tax cartel so people have no choice but to cough up. As Dan says, this idea is nothing short of an OPEC for politicians.

Still, at least the Finnish prime minister is being honest about his intentions, which is a lot more than you can say for Gordon Brown. He tries to tell people that we need to crack down on tax competition in order to make everyone's savings "much safer". And that, quite frankly, is laughable.

I favour tax competition for the same reason that most politicians oppose it: it puts a limit on how much of our income they can get away with stealing, and forces them to think about the effect that higher taxes are going to have on the economy. It's a blunt instrument, sure, but it's one of the few that taxpayers' have got. If anything, governments should be extending tax competition to different areas within countries, not attempting to curb it through international stitch-ups.