Tackle the root causes of slavery and human trafficking
On the BBC’s Today programme last Thursday, it was reported that vulnerable individuals from the UK are being trafficked within the EU to work as forced labour. The predictable response was to ask an EU official what the government response to such a problem should be which was outlined as information-sharing, enforcement, inter-governmental co-operation via the European Convention on Action Against Trafficking and so on.
A similar position can be found in this report from the Joseph Rowntree Foundation from 2007, looking at trafficking and slavery into the UK. This report suggests that appropriate policy recommendations should be based around governmental solutions; public awareness campaigns, tougher regulation of gangmasters, a more rigorous enforcement of the 2004 Immigration and Asylum Act provisions against trafficking and so forth.
Unfortunately, most of these proposed actions focus upon symptomatic treatment and do not tackle the underlying causes of human trafficking and slavery. The JRF report recognises that many of the problems are integral to the issue of migration. In terms of the countries of origin, there is little that can reasonably be said without entering into a discussion of development economics (barriers to trade and migration and the stultifying effects of aid are for a different discussion). It is clear, however, that UK immigration policy – by tying visas to specific jobs – enhances the ability of unscrupulous employers to coerce the victims. Tougher enforcement is unlikely to be very effective given its failures thus far; as the JRF observes, there have been very few prosecutions for trafficking. Comparison with the drugs trade would suggest that tougher enforcement merely drives up prices and further enriches the traffickers without having any noticeable impact on supply, amongst other harmful effects.
Eliminating the causes of human trafficking would be far more effective in these circumstances. The JRF report argues that the UK’s labour markets are the most flexible in Europe and it is the demand for cheap seasonal and temporary labour that creates demand for forced labour. Supermarket monopsony forces suppliers to drive down costs and employ the cheapest possible labour. Whilst the UK’s labour market may be more flexible than some, it is still highly inflexible in absolute terms. Temporary labour is favoured because of the bureaucratic costs of employing permanent labourers. Attempts to impose the same costs on temporary labourers will also further encourage a resort to illegal labour unencumbered by regulation. Similarly, the minimum wage creates an incentive to employ bonded labour either to avoid paying such wage rates or because of the reduction in supply of labour that minimum wages and bureaucracy imposes. Further, while it is a complex issue, the supermarket monopsony can hardly be explained in terms of a free market as the supermarkets receive various state-imposed economies of scale and barriers to competition which they would not receive in a free market.
One major aspect of the problem is the sex trade. Unlike the grey area of seasonal labour the sex trade is illegal. This creates the ideal incentives for trafficking and exploitation, and it is one of the strongest arguments for legalisation of prostitution. Instead, in an absurd piece of wrong-headedness, politicians like Harriet Harman advocate exactly the opposite. Sex workers themselves recognise the folly of this argument. It must also be pointed out that a slave is someone denied control over their body – which is what, in effect, prohibition of prostitution is doing. Criminalisation also makes it easier to engage minors in the sex trade as customers have fewer means of ensuring the legitimate nature of the business they are dealing with.
Of course, trafficking is not a simple phenomenon. In the case of forced marriage there is a case for state intervention because the slavery is an end in itself and is not a market-related phenomenon as such. These cases are rather more limited in number, however. It is also typical of interventionism in that it seeks to remedy one unintended consequence of interventionism with another, rather than removing the initial intervention. In other words, the government is enabling and incentivising a negative behaviour that it then seeks to remedy with further investment of resources, but it is amazing when everyone is surprised that such an approach fails. Thus it is liberalisation of labour markets and migration, not further state interventionism, which would mitigate against human trafficking.
Let us hope that the euro and the EU do collapse
Now yes, agreed, I am known for my euroscepticism, both of the very EU system and of the currency, thinking them both thoroughly bad ideas from start to finish. But I'd like to point out that there are those not as entirely crankish as I am on the subject who think that the toppling of one or both wouldn't be so bad: could even be desirable.
The claim that the downfall of the euro and the EU would produce chaos and war may be interpreted to be just a strategy necessary to get support for helping the highly indebted nations such as Greece, Portugal, Spain, or Italy with ever more financial support. However, conversations I have had with persons from various European countries suggest that many people really believe that Europe will disintegrate and that wars are looming if the EU dissolves. I hold this view to be seriously mistaken.
Good, just to get that out of the way.
The individual countries in Europe will quickly form new treaties among themselves. Collaboration will be maintained in all those areas where it has worked well. Some countries will remain in a newly formed and smaller Eurozone, for which the appropriate treaties will be designed. A similar reconstitution will take place with respect to Schengen, which will then encompass different members. Only those countries that find it advantageous will join a new convention on the free movement of persons. In contrast, those nations that do not find such new treaties attractive, or that are not admitted to them by the other members, will not join.
The result will be a net of overlapping contracts between countries, which the various nations will join at will. These contracts will not be based on a vague notion of what ‘’Europe’ may mean, but rather on functional efficiency. Crucially, the individual treaties will be stable because they will be in the interest of each member.
What is being suggested is a multi-speed Europe, a contractual one or, if you prefer, a liberal conception of inter-state cooperation rather than the building of new over arching state. And it's a vision that I find very attractive indeed. I see no need or, no reason for, a new State of Europe while I can see the obvious benefits of cooperation across the continent.
But let's have that cooperation freely given, freely negotated and split out into its component parts. As Bruno Frey (for it is he) points out:
The essence of ‘Europe’ is variety and diversity rather than étatisme and bureaucracy.
So why in hell is anyone at all trying to constrain such variety and diversity under one set of rules and one set of rulers?
A couple of points on public choice theory
Mark Pennington has an interesting piece on public choice theory here. He's specifically looking at how it challenges certain lefty world views.
I do like his implication that public choice theory is the classically liberal refutation of Marxian class arguments. We don't doubt that it's possible, that it happens at times, that the State is captured for the good not of the citizenry but of those who have done the capturing. All we're pointing out is that it tends not to be a class that does this but individuals.
He also points to the way in which some simply deny the existence of public choice probems at all. All politicians, for example, are motivated by nothing more than public service. There are no economic motives here at all so that economics is irrelevant. Yes, I find that terribly convincing too.
My usual answer to these types is to start asking whether CEOs and bankers are worth millions per year. The answer that comes back is that no they're not and thus we can start talking about the principal/agent problem. Bosses are greedy b'tds ripping everyone off: it's not difficult to gain agreement along these lines.
But the principal/agent problem and public choice are really the same thing. When we offer over to someone else the right to control an asset (a company, the State), tell them to help themselves to our money, we face exactly the same problem of trying to make sure that they do all of that running of it for our benefit not their.
And to be a little Marxian about it, those who go into the civil service fast stream, those who go into Westminster politics, those who go into banking and those who go into business, they're all from pretty much the same narrow class here in the UK. If you believe the principal /agent problem it's very difficult indeed to see why you wouldn't believe the public choice one, for they're at times the same problem.
Euros and sense
In all the panicky talk of haircuts and economic Armageddon, it might be wise to step back and consider the two basic options: Euro or no Euro. The Euro is only a means not an end and preserving it at all costs makes little sense. With hindsight it might just look like an interesting experiment.
German leaders are keen on the Euro, even if their electors are not, because its weakness keeps German exports competitive, it lowers exchange costs and it is a step towards the United States of Europe governed from Berlin. To the extent that the current troubles lead to central, i.e. German, management of national finances throughout the Eurozone, the pain is worth the gain. There was a price for bringing East Germany in from the cold and there is now a price for fiscal union in the Eurozone. But there is a limit to the subsidies German electors will tolerate and Angela Merkel is walking a tightrope.
So the long term Euro retention option boils down to whether Germany is prepared to pay the costs of fiscal union in the Eurozone. The northern fiscally correct countries will play along albeit with some nervousness about the end game. The Mediterranean group will focus on how they can appear to be conforming to the rules whilst actually clearing the till each night. In other words the costs will not stop with the current round of negotiations.
Even Bismarck had to accept that there were limits to German expansion in his day and Germany may now decide the game is not worth the candle in which case the question becomes how to dismantle the Euro with least economic cost.
My friend Richard Warner, a banker from the days when bank bonuses were modest, has figured out that the solution is for the strongest currency to secede first, followed by the next and so on. His reasoning is that if the weakest, say Greece, leaves first, no one will believe the initial Euro:Drachma exchange rate and the drama will continue even though the Greeks can then hoist interest rates. We had a taste of that with the ERM. Double digit interest rates only scared the markets more.
On the other had, if Germany exits first the Euro:Deutschmark exchange rate would be regarded and fairly stable and the two currencies could settle at their own levels allowing the next most stable, the Netherlands perhaps, to exit next.
He has a point, don’t you think?
Sugar: the new monster under the bed
In their ongoing campaign for plain packaging of cigarettes, Action on Smoking and Health have dismissed fears of a slippery slope, saying:
Tobacco is not like any other product, it is the only legal product on the market which is lethal when used as intended... Plain packs for tobacco would not set a precedent for other products.
This is the same mantra we hear from self-described health campaigners every time the Trojan horse of tobacco is to used to expand state interference in lifestyle choices. Meanwhile, back in the real world, the latest issue of Nature provides the most shameless indication yet that policies once seen as unique to cigarettes will be applied to food and drink. In an article entitled 'The Toxic Truth about Sugar', three San Francisco-based public health advocates argue that sugar is a poisonous substance of abuse which is too readily cheap and too available. 75 per cent of all US healthcare expenditure is, they claim, spent on treating sugar-related diseases.
The seriousness of the journal precludes the possibility that it is a spoof, but one can still enjoy the moments of unintentional hilarity, as when the authors make this appeal to nature:
Evolutionarily, sugar was available to our ancestors as fruit for only a few months a year (at harvest time), or as honey, which was guarded by bees.
"Nature," they add, "made sugar hard to get; man made it easy." The millions of people who live in sugarcane-growing regions—for whom nature made wurzels hard to get—may raise a quizzical eyebrow at this, but even if it were true, anyone who understands medicine, as opposed to the nebulous and debased concept of 'public health', knows that nature is to be feared and defeated. Mother Nature brings us disease, malnutrition and infant mortality; mankind bring us vaccines, cures and plenty. Few doctors would recommend abstaining from fruit for months on end because Gaia has willed it, and even the most primitive religions do not regard bees as gatekeepers of unhealthy vices.
The authors note that infectious diseases now kill fewer people than "non-communicable diseases" and that more people are obese than are undernourished. Man's triumph over starvation and parasitic killers is a jolly good thing, but in the glass-half-empty world of public health, it only serves to show that government action is more urgent than ever. "Non-communicable disease"—what we die of if malaria and tuberculosis don't get us first—is set to be the medical establishment's buzzword of the 2010s. It covers all the ailments that have traditionally been beyond the remit of public health and it is so broadly defined as to allow almost any intrusion into our private lives.
Denmark already has a fat tax and many US states have some form of soda tax, but these are usually set so low as to be stealth taxes by any other name. Public health crusaders would like to go much further. The authors of the Nature article suggest banning the sale of sugary drinks to the under-17s, banning the advertising of sugary products on television, banning vending machines, removing sugar from the Food and Drug Administration's list of products which are Generally Regarded as Safe (GRAS), doubling the price of soda drinks, reducing opening times of shops that sell sugar-containing products and limiting the number of fast-food restaurants and confectioners that can operate in a district. "We’re not talking about prohibition," says Dr Laura Schmidt, one of the authors, "We're not advocating a major imposition of the government into people’s lives." One wonders how heavy the government's hand would have to be for Dr Schmidt to recognise a major imposition.
Libertarian objections to one side, fat taxes and soda taxes are phenomenally ineffective. A recent study found that a penny-per-ounce soda tax, as proposed in the Nature article, would reduce consumption by just nine calories a day. A 10% fat tax on milk and fizzy drinks, as proposed in the British Journal of Nutrition recently, would have even less effect.
Sin taxes of whatever variety are useless when set at low levels and spawn a host of unpleasant, unintended consequences when set at high levels. The repeated failure of such neo-prohibitionist policies will not be enough to deter the rampaging public health industry from taking an ever more draconian line on what we eat and drink. Governments, meanwhile, are so desperate for cash that the unholy alliance between taxman and puritan is only likely to get stronger.
Patterns of sustainable specialization and trade
We've just released a new paper by Arnold Kling, "Patterns of Sustainable Specialization and Trade: A Smith-Ricardo Theory of Macroeconomics". Kling has been writing about patterns of sustainable specialization and trade (PSST) for some time now at EconLog, and I was delighted when he agreed to lay out his case in an ASI monograph. His argument is simple, but devastating to the current consensus view of macroeconomics: that unemployment (and recessions) are consequences not of insufficient aggregate demand, but of system-wide changes in the patterns of trade and specialization that people engage in. Some have termed this the "recalculation" view of recessions, but Kling gives the perspective a deep rooting in classical economic theory — hence the subtitle, "A Smith-Ricardo Theory of Macroeconomics".
If Kling is correct, the world's governments have been doing precisely the opposite of what they should be in order to curb unemployment. Economic stimulus and government job creation distort the signals that unemployed workers use to figure out what pattern of trade they should be engaging in now. As Kling says in his Wall Street Journal article on his monograph today, the government cannot create sustainable jobs.
This paper is the second (following Scott Sumner's last year) in a new series of irregular papers we are releasing at the Adam Smith Institute in which we try to present some of the most interesting and important new ideas in economics for the intelligent layperson. It's more important than ever that ideas like Klings are understood by people both inside and outside the world of academia. As Keynes said, "Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist." With papers like this, we hope to change that.
Download: Patterns of Sustainable Specialization and Trade (PDF)
There, that's better!
Well, we’ve stripped those Royal Bank of Scotland rascals of their titles and bonuses and the surge of optimism pulsing through the economy is palpable. The stock market is soaring, businesses have launched ambitious investment schemes and dole queues are disappearing.
If only.
We’re somewhat ambivalent about this whole executive bashing brouhaha that is substituting for serious thought on stimulating economic growth. Before moving on, though, here’s one small point. Britain is a big player in the premier league of top executive talent. Earlier this week, the world’s most successful company Apple appointed Dixons CEO John Browett as head of Apple’s retail store operation. Born in Rutland and a graduate of Cambridge University and Wharton Business School, Mr Browett worked at Boston Consulting and Tesco before moving to Dixons. In short, he’s a serious player on the global stage.
Let’s remember that before we penalise top talent for the sins of RBS. The UK’s biggest industry by far consists of professional services like lawyers, accounts and architects and business services like IT, security, training and catering. Together, they’re 17% of the economy compared with 11% for manufacturing and 10% for financial services. We need a cultural climate that allows the likes of Mr Browett to come and to go, to teach and to learn.
Then there’s the collective waste of energy and hot air expended on the matter of executive compensation – the dispiriting politics of envy that won’t launch a single new business or entice existing ones to expand. How much better to spend that scarce time and political capital on liberating the economy.
For example, Europe continues embroiled in its financial crisis – floundering with grand plans for debt relief and squeezing taxpayers for every last penny. The surest way forward is to complete the Single Market project, especially since that which remains to be done applies to those very professional and business services that the UK is so good at. Now that we’ve got our RBS scalps, let’s put the same effort into finishing the Single Market.
Here’s one quickie – a single pan-European patent regime has been stalled by a squabble over where to locate the main patent court: London, Paris or Munich. For goodness sake, just give it to Germany, the biggest issuer of patents, and let’s get on with it. European patent protection and any consequent litigation now costs five times as much as in the US because of the filings required for each country.
This is a costless measure that will spur far more growth than any hocked knighthood or confiscated bonus. We need growth more than we need spiteful envy.
The future of European Monetary Union
Until a couple of years ago, any suggestion that the great experiment of European Monetary Union was in trouble met with a hostile response, but since then the problem has become more obvious and much has been written on it in the daily and weekly press. The 10th anniversary of the introduction of the currency and an apparent period of relative calm seems an excellent opportunity to stand back and look at the broader context. Where are we now, how did we get there and where do we go from here?
European Monetary Union (not an obvious "optimum currency area") was launched with fatal design faults: the long awaited, but disappointing, 1995 Green Paper [2] completely failed to address the real economic problems which those of us looking sympathetically but critically at the project had identified. The rules adopted made the change "irreversible" with no provision for countries to leave, or be expelled from, the union and no mechanism for dealing with asymmetric shocks. Creating the euro in such an inflexible form was a disaster waiting to happen, but had believed and hoped that, given the political will behind the project, the need for changes would be recognised and acted on before it was too late. This has not happened and the taxpayer’s money has been thrown at a futile attempt to “save the euro”, when the real problem is to prevent a financial catastrophe. Whether this was deliberate is a matter for future political historians but Peter Oborne and Frances Weaver (CPS September 2011) think they were `Guilty Men’. See also Irene Kyriakopoulos, World Economics, October-December 2011.
This paper gives only a summary of recent events and a critical analysis of the measures. None of them is likely to prove a pain-free solution particularly if introduced at this late stage. (Theory would predict, history confirms, and George Soros knows to his profit, that early and properly considered action to deal with a financial imbalance, though expensive, is cheaper in the long run than delaying with fudges.) There are no simple solutions (this is not a submission for the Wolfson prize!) but I discuss the problems of the ones proposed (including fiscal union) and very tentatively examine possible alternatives.
Whatever else happens, Greece will surely have to default and leave the Eurozone. This would have been expensive and messy even if it had been done at the first sign of trouble. It will now be far more of a problem, cost more and be very difficult to deal with contagion. Most of the relevant recent talk has been on Spain and Italy - we have heard little about Portugal.
Early history and the pensions time-bomb
Geoffrey Wood and I had worked and written on the general concept of monetary union from the early days when it was being discussed. My book "A History of Monetary Unions" (Routledge 2004) summarises the issues. Our joint 1989 pamphlet "The Right Road to Monetary Union" [3] had earlier suggested the immediate use of the `basket ecu’ as a secondary currency. This, a road obviously not followed, would have immediately achieved most of the promised "transaction costs" which we still do not enjoy, (Graham Bishop still claims this as an achievement of the EMU.) and later progress would have been driven by market choices rather than politics. Later, I worked with Christopher Johnson's “Sherpa” group looking at the prospects for the introduction of the euro from the point of view of the UK. My accepted role in the group was to draw attention to problems in the hope, dashed by the Green Paper, that they could be solved.
When the final details emerged, it was obvious to us that there was a disaster waiting to happen but we did not know when and how. One long-term shock which seemed inevitable unless there were urgent policy changes, involved pensions. My 2001 paper for a Chatham House economics meeting under the title "Will the Pensions Time Bomb blow apart EMU?" analysed the figures produced by Eurostat that year [4] showing a huge difference in the effect of the pensions time bomb on different member states. This continues to be a key problem and will certainly have to be taken into account when we come to reorganise the structure of the Eurozone. These figures showed that the UK should certainly not join, given that UK pension liabilities were largely backed by independent pension funds (some €1 trillion) while very similar expectations while the equivalent in France and elsewhere were an off balance sheet liability of the State. Very oddly, the Commission very recently claimed that the UK pension funds needed “topping up”. This may be correct but what about the others? The problem persists on `unchanged policies’. The French made a very modest change in increasing the retirement age from 60 to 62, but one of the Presidential candidates now `promises’ to reverse even this!
This problem has been recognised for a decade but it would have taken at least another before it was obvious in actual budgetary outflows. We knew that another shock might hit earlier - and one now has. There have been rifts in the Eurozone for some time, partly because of the convergence of interest rates to a level which was not right for everyone (the “Impossible Trinity”). The apparent benefit to the weaker countries proved to be a dangerous trap, leading to an over-borrowing (e.g. Greece), or an unsustainable asset price bubble in Ireland. The more general financial crisis did not cause, but simply precipitated, the crisis.
The rake's progress — Greece
The current phase of the crisis began with Greece. Why does it cost so much to bail out such a small country and why was it delayed so long? It was obvious that Greece is insolvent and could never meet its obligations. It had a continuing primary deficit and the attempt to solve this by deflation is making the long term problem even worse. Early action to deal with Greece and to take convincing steps to prevent contagion would have cost less than what is happening now and would have given time to find a long-term solution.
In October, we all thought it was decided to allow Greece to impose an alleged 50% "haircut". Because of the `banking’ problem, the relevant authorities seemed desperate to avoid having this treated as a technical default precipitating credit default swaps. Soros pointed out that this would only effectively be 20% on the original proposals (still not agreed) while even a 50% effective rate would still leave Greece with unsustainable level of debt. Since then, both Greece and Italy have acquired "technocrat" governments but thanks to earlier inaction more countries are now involved. Far from converging, the spread on different sovereign bonds has widened enormously, and several countries including France have now had their ratings down-graded.
Greece should never have joined the Eurozone which only tempted the country into an unsustainable economic policy, and however it got there, it was an obvious case for the classic solution of devaluation and default. There are excellent examples of such a policy succeeding. In Russia, it took only eight months for a substantial recovery to begin. There was a similar experience in Argentina, [5] and from the UK’s exit from the ERM and more recent events in Iceland. (In all these cases, though, postponing necessary action added substantially to the transitional costs.) What would have happened if there had been a well-planned debt restructuring on Brady bonds lines? Either way, instead of throwing money at Greece, Germany, the IMF, the ECB, and others could have incorporated an element of subsidy into the deal and where necessary recapitalised banks – or at least the banking system. Was it wise really to bail out failed banks while leaving the regulatory delays restricted new entrants into the market?
How they are trying to solve it
Most of the solutions have involved throwing money at the problem sometimes indirectly by borrowing from third parties, but more usually by “quantitative easing" ("printing money" in my schooldays), but this will only buy time, a commodity which, when bought at taxpayers’ expense, politicians do not, typically, use wisely. The main concern has been with the banking system which was inadequately reformed after the 2008 crash and many banks continue to hold the debt of the less stable countries although the figures have now been reduced. In spite of Germany’s objections to a `fiscal union’ and a `no bail out clause’, the support fund now looks like needing at least €1 trillion. The European Financial Stability Fund was based on packaging high risk debt into tranches which they hoped would achieve AAA status. Financial markets have short memories, but surely not this short.
“Eurobonds” guaranteed collectively by the Eurozone Member States would achieve little. If these are the pro rata liabilities of each State, they certainly would not have the AAA rating (which several of them have actually now lost) assumed. Bonds of even the Netherlands, Austria and Finland, surely core countries, have at times traded at around 100 basis points above Germany, and as for the others …! If they are jointly and severally liable, this would in the last resort fall on the Germans, which they certainly won't accept and if they do, it would even threaten their own rating.
The current proposal, if the agreement between twenty five countries survives a discussion of the small print, would enforce fiscal discipline on German lines on weaker Members. This will inevitably mean tax rises and expenditure cuts and a sharp contraction in the economies which will adversely affect all of us. Given that the exchange rates of these countries are uncompetitive, the only alternative to devaluation (the classic remedy) is deflation. As often noted, "if the Greeks started behaving like Germans they wouldn't be able to buy German cars."
Internal devaluation by deflation is actually working quite well in Ireland where the problem was an unsustainable property bubble which could not be checked by interest rate policy. The country’s finances were sound enough but they then made the big mistake of guaranteeing the banks.
One rather mischievous thought: if "quantitative easing" effectively increases the money supply proportionately across the Eurozone, it could generate inflation in all relevant countries. If this caused prices in Germany to rise (unthinkable?) and (possible but not inevitable) the weaker countries took the opportunity to create an internal devaluation by holding down nominal prices, this would offer some of the benefits of devaluation and also reduce the real cost of Euro debt. To be effective without damage, it would have to be unanticipated inflation and the ECB would then need to convince markets that this had created a one-off adjustment rather than a continuing propensity to inflate.
A fiscal union?
It is in theory possible, but difficult, to create a monetary union without a fiscal union. The essential conditions are balanced budgets and great labour market flexibility, including wage flexibility. And even unions which had those, such as the Latin Monetary Union, could not survive all the strains that hit them. In fact, all such unions (unless they preceded political union) eventually came to an end.
The latest proposal would involve a botched fiscal union. It is hard to know what this means. Politically, it would fall far short of a federal union (which would require a very different constitution) but economically may go even further as even these typically give more freedom, on tax and expenditure to States, Provinces and Cantons.
There seem to be two main issues, greater transfer of funds from the stronger to the weaker Members (will the Germans accept that?) and a far more central control of broad economic policy in Member States. (Who would take the decisions?)
Over the years, there have been many proposals for "tax harmonisation" and although these have got nowhere, it has been argued that one cannot have monetary union without something approaching a common tax system. This is the reverse of the truth: the only economic weapon left to Member States for dealing with asymmetric shocks would then be on the "expenditure" side! What is now being proposed is actually more central control of expenditure.
Some members of the EU political class keep persisting in trying to find some way of creating a "tax collectors’ cartel" forgetting that this would weaken the competitive position of the EU with the outside world notably, for different reasons, North America and Asia. Fortunately, tax is one of the issues which requires unanimous agreement, although attempts keep being made to bypass that, including the recent pressure on Ireland and the suggestion of introducing a Financial Transactions Tax (by finding a loophole in the “unanimity” provisions of Article 113). [6] This issue, like so many in the EU, raises the question of whether the State exists to serve the citizens, or the citizens to serve the State. Can tax competition be reconciled with the free movement of capital within the EU? I have written on this over the years, see (e.g.) the 2007 paper I gave at a conference in Trier, "Eliminating Tax Obstacles for Cross-Border Operations.
A full fiscal union would have to include only those who had signed up for it. Any country considering signing up for such a union would be well advised to compare their properly calculated Balance Sheet as a nation with those of the intended partners. This would obviously mean looking at the present level of formal debts, projected budgetary cash flows and other figures which are at least in theory readily available to the enquirer but they would need to look much deeper. There are several other ways in which the nation's solvency (and therefore whether it will contribute to, or make claims upon, the group as a whole) can be seriously affected.
Part of the deal will and indeed already does involve substantial fiscal transfers which probably fall outside the scope of the intended eurozone rules. This will be viewed differently by different countries. Voters in the paying countries will not like this while the beneficiaries will take a different view. They may, but should not be, encouraged to delay taking internal remedial action. Help should be carefully designed to ease the transition rather than to postpone action.
In the United States, the individual States have their own credit ratings even though the country is far better placed to act as a union having a much higher degree of labour mobility then multilingual Europe. Switzerland is a rare example of a multilingual federation - but we do not think the type of people who are pressing for a closer union of Europe would welcome the degree of taxing rights enjoyed by Swiss Cantons and Communes. Instead of political parties competing to bribe voters for their money, Cantons compete to attract people and business, keeping tax rates sensible. Some forms of social payments are handled at the level of the Communes which it is said ensures efficient monitoring - people realise that neighbours who are cheating the system are cheating them. The Australians have complex arrangements for leaving their States with a degree of control over some taxes and expenditure, calculating the Federal contribution on perceived standard needs rather than on actual expenditure.
A two-speed Europe?
If some Members under the leadership of German formed a smaller eurozone with transfer capabilities, proper central sanctions on government expenditure and a Central Bank capable of being a lender of last resort. Those staying outside would divide into three categories: the “opt out” countries, notably ourselves, Denmark and Sweden, who would clearly not join; Those like Greece and maybe others which would leave the eurozone, devalue and default and an intermediate group including those mostly in the CEE who are committed to membership and will have to choose one side or the other.
A multi-speed Europe would raise several major problems, most obviously about which assets and liabilities could be converted into a new currency, the impact on the banking system and the inequitable way in which the inevitable loss of capital assets would be distributed partly to the benefit of the well advised who will have already moved their money. This will keep the lawyers in business for many years.
This raises a very delicate diplomatic problem. The inner group wouldn't want outsiders having an equal say in their relevant discussions and for them the unanimity rule on tax policy would not work. The non-members, including the UK, would need to negotiate considerably less interference, particularly in financial regulation and employment policy in case these could be abused by the fiscal union group to force us to share their uncompetitive practices. We economists need to ensure that those negotiating really understand what is at stake. It would be politically unwise to see this as an opportunity to “bring back powers from Brussels” but we must take great care to ensure that our own markets are protected.
The weaker countries would have to be given the right to opt out of the eurozone, raising very difficult questions which may, or may not, involve default. It must be made absolutely clear that their debts, both internal and external, were entirely their own responsibility - an aim intended (unsuccessfully) to be achieved by the Stability and Growth Pact.
What could have been done — plans for the future?
My "History of Monetary Unions" inevitably covered "dis-unions" but most of the interesting unions based on non-metallic money (the Soviet Union, Austria-Hungary, former Yugoslavia etc.) collapsed at a time of hyper-inflation which solved that problem while creating others. There are more useful lessons from two "sort of" unions – Bretton Woods and the Sterling Area.
The Bretton Woods (40th anniversary in this case) approach involved initially fixed exchange rates bolstered by international transfers negotiated by the IMF but with the right, and indeed the obligation, to change the rate when there was a "fundamental disequilibrium". There were many examples often in Latin America. The original design of EMU should have included such a workable proposal for exit. This could well be on the lines of the “living wills” to deal with the problems of banks deemed too big to fail, making sure that both countries and banks could not be treated as too big to fail. Is it too late to achieve that?
The essential step is to make it absolutely clear that each Member State is responsible for its own debts. They could then make their own arrangements, on the classic gold standard procedures, for maintaining external balance: surely there should be a "living will" procedure as proposed for banks for dealing with the inevitable occasional default in a less damaging way. "Convergence" would cease to be an intelligent tactic for investors (if it ever was) and interest rates on each country's debt would reflect investor perception of its government actions and give early warning of possible troubles to come. There would remain the problem of how to adjust interest rates to deal with internal problems when the international balance was perceived to be satisfactory.
The Sterling Area, being informal, worked well for many years, but because of that, quietly fell apart when it became less relevant. The only Monetary Authority was the Bank of England, others had neither any say in UK monetary policy, nor (after they ceased to be colonies) any obligation to follow it but they had, in the Area’s heyday, strong incentives to remain in the club, which had substantial benefits for most of the time including freedom from exchange control. The "early leavers" such as New Zealand introduced their own currency without any immediate or expected change in parity. This arrangement had some similarities to, but was distinct from the Currency Boards used in the old colonies and which could be an alternative for smaller EU members.) [7]
The same result could have been achieved economically, but certainly not politically, by countries accepting Germany’s Bundesbank as the monetary authority and voluntarily adopting their currency. This could be achieved either by simply shadowing the currency, adopting it by “dollarization” like Panama, Montenegro and Zimbabwe, or by the more formal procedure of a Currency Board familiar in the old colonies and introduced in many countries as diverse as Estonia and Hong Kong. This could well be the right answer for smaller EU Members. Note issues and the monetary base would then be the responsibility of the Central Bank or Currency Board of the country concerned.
Countries which leave the Eurozone and others (even outside the EU) might well find that a “New Euro” becomes widely used as a secondary currency creating the partial advantages of our old 1989 proposal. It may even become the currency of choice for internal contracts, a role which the US dollar once had. This might reach the stage when they would accept "euroisation" and partly or wholly abandoned their own currencies. A currency board could be used which would have, these days, to involve any "lender of last resort" holding "euros" not only against banknotes but against the prudential reserves of banks.
There are broader issues of future world monetary arrangements. The November 2011 issue of "Central Banking" has several articles extolling the virtues of gold bonds and a "hard SDR", and discussing other approaches.
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[1] Chown Dewhurst LLP, 51 Lafone Street, London SE1 2lX. Tel: +44 (0) 20 7403 0787; Fax: +44 (0) 20 7403 6693; jchown@chowndewhurst.com; www.chowndewhurst.com.
[2] Green Paper on the Practical Arrangements for the introduction of a single currency. Commission of the European Union 31 May 1995.
[3] John Chown and Geoffrey Wood "The Right Road to Monetary Union", Institute of Economic Affairs, 1989
[4] Eurostat's “2009 Ageing Report” gives updated and very detailed figures covering all 27 members.
[5] John Chown, “Currency Crises Compared”, [Argentina, Turkey, Russia] Central Banking, Volume XIII, No. 2, November 2002, pp. 64-68.
[6] I have given oral evidence to the House of Lords Committee on this.
[7] My book discusses briefly how colonies created independent currencies and, at rather more length, the history of the Irish pound. Exchange controls ruling at the time means there are no real helpful messages from these.
Ayn Rand's birthday
Ayn Rand, author of the novels The Fountainhead, Atlas Shrugged and books on the philosophy of capitalism like The Virtue of Selfishness and Capitalism: The Unknown Ideal, was born in Russia 107 years ago today. Rand is a divisive figure, often misunderstood, but her writings have served as the "gateway drug" into libertarianism for many people. (There's even a book called It Usually Begins With Ayn Rand!) Most recently, her magnum opus Atlas Shrugged, which tells the story of a crumbling dystopian world in which creative people have gone on strike, has been enjoying a resurgence in popularity in these troubled times.
What's special about Ayn Rand is how, unlike economists like Mises, Hayek and Friedman, she gave a moral foundation to the capitalist system. Not only does a capitalist system enrich the lives of its inhabitants by making efficient use of resources, Rand said, it allows them to flourish by living productive, independent lives. There's something very appealing about that view of humanity — that, absent the slaver's whip and the taxman's calculator, men and women can better themselves by thinking, creating and producing new things, by remaking the world as they want to.
Many of Rand's critics focus on her personal failings, ignoring her deeply humanistic philosophy, which cherished ideas and creative people. On her birthday, it's worth reflecting on what makes Ayn Rand so important to so many people, and what her writings have to offer us at a time when bold creators and new ideas are sorely needed.
Economics Is Fun, Part 3: Specialization
Madsen's videos have proved to be a lot more popular than we expected, so we've decided to speed up their release to keep up the momentum. They're all based on his excellent new book, Economics Made Simple, which makes a terrific introduction to economics and markets, going from value and trade all the way up to banking and finance. We've mentioned the book on the blog before, but what I've only just noticed is how affordable the Kindle edition is — £2.40 for the full book! As a digital media enthusiast like me, that's exciting: as the overheads of book publishing fall, books like Madsen's will become even more available to everyone. Of course, the Youtube videos are free. Even if you don't buy the book, do share Madsen's videos far and wide.
Here's a playlist of the videos so far, and here's where you can subscribe to our YouTube channel so you don't miss any of our other great videos either.