Privatisation is no way to sustain Britain’s runaway spending
First there was “borrowing our way out of debt” which raised the eyebrows of sober-minded accountants. Then there was “printing our way out of debt,” as quantitative easing magically created money out of nowhere. Now the latest round is “selling our way out of debt,” as the Prime Minister announces the sale of £16bn worth of state-owned assets.
First will come the Tote, the Thames Dartford Crossing, the Channel Tunnel rail link, and student loans. The sale of the state’s 33 percent stake in Urenco, the uranium enrichment company, will follow. There are good and bad features of the sale. The good point is that most, if not all, of these will sit happily in private ownership. It has never been clear why the state should be involved in race-course gambling, while transport crossings and loan agencies are often handled elsewhere by private firms.
The disappointing feature is that these are all to be done by private sales. The sale to a single private buyer is the easiest and quickest to implement, but does least to secure public support or to secure improvements to the industry or service.
Many of the 1980s privatisations (now called by the mellower name of “asset sales”) featured public offerings with discounted shares available to workers so they could become part-owners of the new enterprise. Significantly, the Government has already tried a private sale of the Tote, but was rebuffed by the European Court as representing poor value for the public. It would have been bolder (and better) to involve employees and the public in the new round of sales.
Secondly, it is by no means clear that the proposed sales will actually be used to reduce the Britain’s huge debt burden. It is quite legitimate to use capital sales to reduce capital debt, and the sales would deserve support if that were the case. But this looks like the Government’s way of postponing reality until after the election.
Britain has to cut its spending, and that will involve some hard and unpleasant decisions. Asset sales are a one-off. They might be used to fund spending programmes but only for one year. Crucially, that one year will see a general election, and the suspicion arises that the sales revenue will be used to continue with spending that really should be cut until after the election.
The Government has not come up with realistic proposals to cut spending to what can be afforded. Nor has anyone else, to be fair. The budget deficit (£220 billion this year) means that debt is increasing. Asset sales are not, and should not be, a way to sustain high spending; they should be a means of reducing debt.
Published on Telegraph.co.uk here.
How David Cameron can reverse Labour’s unjustified attacks on civil liberties
Over the last few years, many traditional liberties which protected our way of life have been removed or compromised by the Government’s initiatives. In the name of taking more effective action against terrorists, drug dealers or paedophiles, customs and practices that shielded the citizen from arbitrary abuse by authority have been over-ridden or subverted.
We used to enjoy the protection of habeas corpus, and no detention without trial. We used to have the right to remain silent without it counting against us, or be forced to testify against ourselves. We could demand trial by jury, and once acquitted, need not face the ordeal of a retrial. We enjoyed the presumption of innocence, and could not be punished or have our property seized without conviction in a fair trial.
All of those liberties and many more have been eroded or abolished in a flurry of government and official zeal to crack down on possible law-breakers. Almost every day we read of incidents in which people are bullied or harried by police, not for criminal activity, but basically for doing things the authorities dislike. It will be difficult to regain ground lost for liberty, given a now-entrenched official culture unsympathetic to it.
It is fanciful to suppose that a consolidated repeal bill could be passed to reverse at a stroke all of the illiberal measures of recent years. There is, however, an effective measure that an incoming government could take. David Cameron should announce his intention to establish a year-long judicial review into the state of British liberties. Presided over by a senior and respected judge, the review body would hear evidence in public concerning the degree to which traditional liberties have been eroded.
Crucially, the review body would be empowered to make recommendations at the end of its enquiry, recommendations of measures to restore and entrench the freedoms needed to protect citizens from abuse at the hands of an arbitrary and oppressive authority. While the Conservative Government would not be compelled to implement its findings, there would be a moral pressure on it to do so. Through its year-long inquiry, the review body would raise awareness of liberty issues, and publicize the degree to which it has been lost or threatened. A culture of liberty would gradually supplant the illiberal culture that currently prevails. It would be difficult for government to resist its recommendations.
The announcement now of such a review would enable Mr Cameron to establish the pro-liberty credentials of himself and his party. It would not impose any great costs, nor commit his government to any specific pledges. What it would do it establish a momentum of liberty, and secure carefully thought-out and well-drafted proposals to restore our freedoms to their respected place at the heart of British law and tradition.
Dr Madsen Pirie is President of the Adam Smith Institute and author of the newly-published ‘101 Great Philosophers’.
Published on Telegraph.co.uk here.
Yes, let’s tax home ownership
Vince Cable’s proposed ‘mansion tax’ on high-value homes has come in for a lot of flak. But is it justified?
Vince Cable’s proposed ‘mansion tax’ on high-value homes has come in for a lot of flak, including from the ASI blog. But is it justified? Despite all the debate, I have still not seen a good argument against it that does not apply equally to parts of our existing tax system.
I agree that’s probably a sign that our entire tax system is in dire need of fundamental reform – but that’s not likely to happen. The question is not whether a homeowner tax is a good thing in itself, but whether it could – with the money used to reduce income tax – be an improvement on the existing system.
Yes there are some problems with Cable’s proposal – by taxing only high-value homes and using the money to raise the personal allowance, it is a redistribution primarily from a minority living in the south east (mainly but not all wealthy) to workers on below-average incomes.
But let’s look at the general principle rather than this particular design. What are the main objections to this type of tax, and how valid are they?
- It’s a wealth tax, and wealth taxes are bad
Yes, it looks like a wealth tax. But economically it’s more like an approximate income tax on the annual benefit of living in the house – taxing the return on your investment. And Cable’s proposed 0.5% charge is effectively around 15% of the likely rental value – quite low by UK income tax standards.
- It will discourage purchasers and so reduce property prices
Yes, but that’s a general objection to income tax – taxing anything discourages that activity. We currently tax, and therefore discourage, employment, entrepreneurship and investment – surely that’s worse. The homeowner tax will equalise the treatment of different investments, and if the money is used to reduce the income tax rate it will reduce the disincentive to work and save.
- It’s my property – why should I have to pay tax on it?
Yes, but again that’s a general objection to income tax. Your investments, your work, your business ideas are being taxed now.
- I worked hard to buy it – I shouldn’t be taxed now
Yes, but again that applies to all income tax. Is it any more unfair than taxing the salary you worked hard for in order to pay the mortgage?
- The house was paid for out of taxed income – this is double taxation
Yes, it is economic double taxation. But we already do the same thing to investment income. If double-taxing home ownership is bad, surely it’s even worse to do it to investment in productive businesses.
- It’s unfair on the ‘asset rich, cash poor’ elderly
Yes, it will disadvantage them compared to the current system. But the current system disadvantages the ‘asset poor’, primarily young families who are trying to buy a house. Getting a mortgage to buy an average house needs a salary of around £50,000 – which means you’ll be paying higher rate tax. Is one really more unfair than the other?
- It can’t be an income tax – there’s no income
Yes, you don’t get any cash from your home. But by living rent-free there is an advantage equivalent to an income. And there’s nothing new about taxing non-cash benefits – we’ve done it to employees for decades (company cars, health insurance and many other ‘benefits in kind’); this just extends the same practise to property.
- It’s difficult to collect
Yes, but that’s a tax collectors’ objection, not a principle. The Treasury loves taxing salaries because it hopes that we won’t notice how much they are grabbing through PAYE, but supporters of low taxes should be encouraging tax visibility. The few really problematic cases, such as the elderly widow with no income living in the ancestral manor, can be dealt with through a postponement system with the Treasury taking a charge on the property to be redeemed on her death.
- It’s based on an estimate
Yes, and so there will be inaccuracies, costs and disputes. This is probably the strongest argument against the property tax, but taxing estimated property values is nothing new. Houses are already valued into fairly narrow bands for council tax, and expensive homes frequently have to be valued for inheritance tax.
So I can’t see any objection that wouldn’t also mean abolishing income tax (which might not be a bad thing, but isn’t going to happen any time soon). Indeed we could go further than Dr Cable, and integrate the homeowner tax into the income tax system. Instead of a half percent tax on values over half a million, we could estimate a notional rent for all owner-occupied housing and add it to the occupiers’ taxable income. But only, repeat only, if the money raised is all used to reduce income tax.
How much money are we talking about? The LibDems expect their proposal to raise £1 billion, but a fully integrated homeowner tax, at full income tax rates and with no threshold, should bring in about £25 billion. That’s enough to reduce income tax by 5p, cutting tax rates from 20% and 40% to 15% and 35%.
Effectively it’s the same approach that Lawson applied to business tax – broaden the tax base in order to cut the tax rate. Yes, overall we’d be paying the same amount of tax, so there would be winners and losers. But crucially the marginal rates – the tax paid on extra effort, each additional pound earned or saved – would be significantly reduced, which should boost the economy. And our competitive position within Europe, weakened by a decade of Brown stagnation, would be restored.
I know; I hate recommending new taxes. But this one could actually work.
An information revolution
In hankering for wide and sweeping reforms of our public services, the smaller steps that can be taken towards meaningful change are often overlooked, dismissed as vote-catching fads or shunted off to the sidelines. A particular proposal taking form from the utterances of David Cameron’s Shadow Cabinet is one such specimen, and in forgetting about it, we risk jeopardising any further significant attempts at bringing greater choice and public decision-making into our public services.
In June, Cameron spoke of using information to enhance accountability, proposing that every item of government spending over £25,000 be published online, in full and for all to see. Although the reason for setting such a high figure seems odd and arbitrary, the potential for such a move is monumental. Far from simply encouraging and utilising “an army of armchair auditors” to hold government waste at bay, the information available could be used to agitate widespread public and political backing for very specific reductions in government expenditure. The largely ignorant outrage over increases or cuts in expenditure for specific departments by commentators outside government would be almost immediately replaced by calculated, precise and unequivocal suggestions from countless sources.
However, there is another aspect to reforming government transparency: as well as making spending restraint easier, there is the potential to transform the way public services are run. Governments are currently able to manipulate the choices of the public on a vast scale, often with unpredictable consequences: school league tables and hospital rankings can be manipulated to suit the political pressures of the day simply by including a new criteria, or restricting another.
The release of all government-collected data other than that pertinent to privacy or defence would do away with a system so open to abuse, as well as making it easier for the public to make fully informed choices about the services that they want. Cameron has so far cited a few possible examples, such as local crime maps emerging from the full release of crime data, allowing communities to hold the police and local council to account – to see whether politicians have really fulfilled a promise to cut crime, or where they would like to see more done.
In some ways, the prospects for accountability and the functioning of democracy are also revolutionary. Voters would be able to see exactly how much a particular administration has done for them, and hold politicians to account not only for their individual expenditure decisions in central and local government, but for changes in countless variables in their local area. Voters would be able to make more informed choices, seeing through the obfuscations and misrepresentations.
If Cameron’s vision of a “Post-Bureaucratic State” is to be fully appreciated, the potential of this reform should be looked at in far more detail – other than headline a Conservative party commitment to the NHS, the same speech in late August proposed the far more significant proposal to allow patients to control personal budgets and see their full “health records online in the same way they would their bank accounts”, allowing them to make decisions about the GP they want or the hospital they would like to use.
Some of the Shadow Cabinet have started to have ideas of what they may have the chance to do in this context: Michael Gove announced in August that a Conservative government would establish a free online library of past exam papers to allow parents to track possible grade inflation. Nevertheless, Gove simultaneously fails to appreciate the larger possibilities of transparency: just a few weeks later, he proposed a reform of school league tables, arguing for a change in the way certain subjects are weighted – such a proposal is really no better than Ed Balls’ “school report cards” in that it is yet another adjustment at the edges.
In the touted dream of a “post-bureaucratic state”, all data on schools would be freely available, and independent rankings would be able to emerge in the same way as a car price comparison website, or in the way universities are already compared by various newspapers. The public would then be able to choose from those lists based on the criteria they use and on their own individual merits, free from the chance that governments may use data to skew choices or steer us towards what they think is “best for us”.
Rather than simply creating choice, transparency in government data allows existing choices to be informed, increasing the quality of public choice. It paves the way for further choice creation, for example breaking up the postcode lotteries associated with schools and hospitals, part of which could be remedied by current Sweden-inspired reforms. But these Scandinavian or other imported reforms can only be effective if the choices between schools and hospitals are properly informed.
A recent Google-sponsored competition on the “Young Rewired State” in late August explored the possibilities of websites based on government information, that don’t, but probably should exist. Among them was a web-based tool to show the safest school routes based on crime statistics; a phone application to show when public transport will arrive, based not on timetables but on live data London buses already send back to their controllers; or even something as mundane as collating council tax bands for every single postcode in the country, or finding your nearest NHS dentist.
If there is anything to be positively excited about from a potential Conservative government, it is this move towards transparency. Cameron has already shown a willingness to display information instantly online in the form of MPs’ expenses, but if and when they do gain control of Whitehall, it is crucial that everything is done to make them see these commitments through.
In pursuit of the greatest happiness
GDP is not the be-all and end-all of our existence; it talks of value added to economies but has little to say about anything else.
Richard Layard and Joseph Stiglitz (one a Nobel Laureate, the other one of those who tried to jam some economic understanding into my brain) rightly tell us that gross domestic product isn’t in fact the be-all and end-all of how we should be measuring life, the economy and everything. They also, again correctly, point to various alternative ways in which we might measure, thus set as our target, things which are more important than merely the value added in an economy.
What is always interesting is to take such suggestions and follow them to see where they lead: so let’s do exactly that with the proposal from the professor at the old alma mater, my Lord Layard.
So I propose a campaign for the Principle of the Greatest Happiness. This says I should aim to produce the most happiness I can in the world and, above all, the least misery. And my rulers should do the same.
Sounds like a plan, so, using only the professor’s own work, where will this lead? Specifically, where will this lead us if we try to design a tax system which accords with this principle (that’s the “rulers should do the same” bit)?
Vital clues can be found in his book Happiness, something which if you haven’t read you probably ought to. There are two major points made about the taxation of incomes in it and we’ll add just one commonplace observation from the world around us to reach what we must assume will be the taxation system that will produce the maximal amount of happiness: the top fluffy kitten count, if you will.
The first point is that happiness does indeed rise with income – but only to a certain point. That point varies a little, dependent on where you are and with exchange rates and so on, but a reasonable estimate is about £15,000 a year. Less than that and earning more money makes you happier simply because you’re earning more money. More than that and you might be happier or not, but it’s not the extra money that’s making you so.
Excellent. So the first and most obvious principle of our high kitten-cuteness tax system is going to be that we’re not going to tax incomes below £15,000. This would clearly make people less happy, as it would take them below that number where higher incomes make them happier.
The second point is a little more complex. The contention is that when we earn more than £15,000 we create a kind of pollution. It’s never quite really nailed down: one way of describing it would be jealousy, the green-eyed god, over the fact that others have more than we do. Layard’s description is more gentle, in that others having more impels us to emulate them; we try to keep up with the Joneses. In doing so we strive for higher incomes, despite the way that these will make us no happier, at the expense of the many other things that will make us happier – time with family, with friends and so on.
Thus those earning more than £15,000 are imposing an externality of unhappiness on those around them: and we all know what happens to such negative externalities in welfare economics. We tax them! This is exactly the same economic argument behind carbon taxes, the congestion charge and air passenger duty. The polluter must pay the social cost of their pollution. Turning the argument around the other way, that positive externalities should be subsidised is exactly the economic argument used for tax contributions to basic science and such things as universal primary schooling. There’s nothing odd or strange about the economics here, only the aspect of life to which it is being applied.
Layard’s estimate is that the unhappiness caused by those on higher than £15,000 incomes is some 30% of the amount of those higher incomes. Someone on £1,015,000 a year is causing £300,000 of unhappiness elsewhere while someone on £45,000 is causing £10,000s’ worth (umm, OK, I’m using one third not 30%, but you get the picture). We should thus tax the two, respectively, £300,000 and £10,000 for the externality of the non-fluffy kitten time they are imposing on those around them.
Our third point is simply the commonplace that people do not like to pay taxes. Yes, yes, I know, there are endless screeds here at Comment is free insisting that no, really, offering up the sweat of our brow to the state is such a pleasurable experience that we’d all do it willingly, without the compulsion of law. Actually, this seems not to be the case. Last time I got the figures from the Treasury (for the tax year 2005), it turned out that only five people across the entire nation had voluntarily paid more than was their legally demanded due – and four of those were dead. So if we adopt the entirely uncontroversial economic idea of revealed preferences (don’t look at what people say but what they do) we can be sure that for the vast majority of the population taxes are not something paid for the joy of them. They are, in fact, something which make us unhappy.
This now gives us the details which we need to build our tax structure for optimal happiness. We can and should tax those who cause unhappiness in others by the value of the unhappiness they create through their higher incomes. We should not tax more than this for we will be creating unhappiness by doing so. Finally, we should not be taxing incomes below £15,000 a year because taking money below that sum will again increase unhappiness.
So our tax system with the highest fluffy-kitten count, the one that will “produce the most happiness” as our rulers should strive to do, just as we ourselves should, is a flat-tax system of 30% with a high personal allowance of £15,000 a year.
While this is, of course, very different from our current tax system, it is still progressive (yes, it is: work out the maths for yourselves – as incomes rise so do the portions of those incomes paid in tax) and it ticks all the boxes that will lead to maximal happiness.
In the UK, the US and Germany, happiness has been stagnating for decades. A civilisation based on the Greatest Happiness Principle would be a great improvement. Yes, indeed it will, as long as we actually accept the implications of that Great Happiness Principle as laid out for us by one of the great researchers into that principle, Richard Layard himself.
The only conundrum left is that there are only two organisations that I know of (that I am a member of both of them is entirely coincidence) which actually have as suggested policy anything close to this top cute-kitten system: Ukip and the Adam Smith Institute. But then the reason that I am a member of both is because they are both well ahead of the progressive crowd, in so many important ways.
Published on guardian.co.uk here.
The BBC has never hesitated to use its tax-funded clout to take on private ventures
Ben Bradshaw, the Culture Secretary, has stepped into a simmering row about the BBC’s expansion policy. He says it is “at the limits of reasonable expansion.” Set up originally by six private companies to broadcast radio programmes, and nationalised in 1927, the BBC has been a public body ever since. Although it attracted praise for the quality of its commercial-free broadcasting, the BBC has tried throughout its history to monopolise broadcasting by squeezing out competition.
It opposed the introduction of ITV in 1955 and of commercial radio subsequently, following the success of the offshore pirate stations. The BBC has never hesitated to use its publicly-funded clout to compete with private ventures dependent on commercial finance. Local radio stations, set up to fill a gap in the market, soon found themselves in competition with BBC versions, financed out of the licence fee, which cut into their audience and the commercial finance it brought.
The BBC looks at what others are doing commercially, and copies them, trying to maintain its dominant position by undercutting commercial operations with its “free” licence-payer-funded alternatives. The BBC has no need to finance such operations by market share because it has the compulsory licence fee behind it. Everyone who uses a television has to pay it, and bullying big brother tactics and intimidating commercials ensure that most of them do.
Part of the problem is that with media diversification in the internet age, the BBC still wants to do everything. It fears its dominance will be undermined by new technology unless it keeps a finger in every pie. This is very evident in its news services. Seeing the news audience move from broadcast news to internet coverage, the BBC has responded with “free” internet news to compete with and undercut those who need a market share and commercial backing to sustain their own news output.
In response to a proposal to award a small part of the licence fee to local news alternatives, Sir Michael Lyons, Chairman of the BBC Trust, has urged a cut in the licence fee rather than see any of it go to help competitors. Mr Bradshaw’s intervention is timely. Just occasionally, in the way the BBC treats its prima donna celebrities, do people glimpse how their licence fees are splashed around. Less visible is the ruthless way they are used to squeeze out commercial media competitors.
The BBC is rightly praised for some of its output, but it has traded on that goodwill to distort the media market to maintain its own dominance. It is time that its use of licence fees was subjected to close and independent scrutiny, and that alternative funding models were explored.
Published on Telegraph.co.uk here.
Archbishop of Canterbury’s views on the City capitalism veer close to populist sloganeering
I respectfully disagree with Dr Rowan Williams, the Archbishop of Canterbury, over his views on the City and its finance industry. He regrets there has been “no repentance for the excesses which led to the economic collapse,” and describes a feeling of “diffused resentment” that bankers have failed to accept their responsibility for the crisis.
While the archbishop is entitled to express his views, I am sure he will not mind me pointing out that these are somewhat uninformed views. He admits to not being an economist, saying the crisis has taught us that “economics is too important to be left to the economists.” I am sure he will not mind me pointing out, either, that financial services are not founded on greed. For the most part they represent honest trading by well-intentioned people whose skill lies in the efficient allocation of resources. This skill, internationally, has lifted more people from the blight of poverty and hunger than any other force in history, including religion.
Few economists think that the crisis was caused by greedy bankers. In increasing numbers they are coming to the view that recklessly loose credit created by politicians and central bankers sent false signals to the financial industry, causing them to act inappropriately and take on undue risks. Dr Williams describes a sense of “muted anger” at the bonus culture, pointing to a gap between what people are paid, and the worth of what they do. He might just as well criticise the huge rewards gained by footballers and pop stars, but the fact is that their pay reflects what people are prepared to pay for their services. The “bonus culture” is no different; it reflects the economic worth of people whose financial skills can add value to transactions.
Of course we can learn something from the crisis. Perhaps that banks should be encouraged to align bonuses with long-term returns rather than with short-term turnover. We can also learn that when governments try to “smooth” downturns for political advantage, it simply stokes up future calamity.
Everyone admits that there have been bad eggs in the City, as there have been in the Church, and perhaps in every walk of life. That is why we need institutions and practices to restrain them, and to improve these when they fall short. But to taint the financial industry with “idolatry” is to veer dangerously close to populist sloganeering.
Published on Telegraph.co.uk here.
It’s time for a U-turn on drugs
UK drug policy is a spectacular failure. Decriminalisation is the only way forward
The Adam Smith Institute today urges the next government to rethink policy from first principles. Its book, Zero Base Policy, will nowhere be more controversial than on narcotics. It suggests that Britain’s drug policy is “one of the most spectacular failures in history. Dozens of initiatives spread over many decades have left Britain with more addiction, more drug use, more drug-related crime, and more drug-induced health problems.”
Dealing with drugs costs money. The Department of Health and the Strategy Unit put the costs of drug use at £15bn-£20bn per year. Although ministers and police officers have uttered tough phrases such as “zero tolerance”, drug crime has steadily increased, not diminished. When a policy achieves the opposite of what was intended, rarely is more of it needed.
The ASI urges a different approach, recognising that addicts need medical help, not punishment. Many who could be helped medically avoid seeking it because drug-taking is illegal. When drugs were decriminalised in Portugal, drug addicts chose to undertake treatment.
Drug addiction should be viewed as a medical problem. Doctors and nurses, rather than police, should handle it. There should be high-street clinics, staffed by medical personnel, where addicts can receive supplies to be consumed on the premises. Subject to medical examination and counselling, they should receive a free supply to use within the building. The medical examination required as a condition of supply would enable monitoring of their health, and counselling could help dependent users to better control the adverse physical effects of drug use.
Such a policy would eliminate the crime associated with hard drugs such as heroin. Users who currently fund their habit by criminal behaviour would not need to, since the supply would be free, costing the state very little.
This would work for some narcotics, but not recreational drugs. Addicts might take their fix of heroin in a clinic, but not social users of recreational drugs. Few people would want to enter a high-street clinic to take an ecstasy tablet – this is something used in clubs. Similarly, few people would want to snort a line of cocaine in clinical and antiseptic conditions. Neither would people want to smoke cannabis in a clinic. They would shun the medical conditions envisaged for supervised use. The cafes in the Netherlands in which cannabis use is tolerated are rather more social and relaxed than medical clinics.
The policy that could succeed would be to medicalise hard drugs, and to legalise the production and sale of recreational drugs such as ecstasy, cocaine and cannabis. They would no more be without controls than alcohol and tobacco are without controls, but no longer criminal.
The street price would collapse without the need for illegal supply. Quality could be controlled and subject to regulation and labelling. Advice could be given on packages warning of associated dangers, and alerting users to the early signs of adverse health effects.
Would their use increase? Many people choose not to smoke, even though they could. They rate the costs and health hazards of smoking higher than any pleasure it brings, and most people are moderate drinkers, even though binge drinking is legal. The same could be true of drugs.
Drugs are currently out of control and widely available. Without illegality, the criminal culture they sustain would disappear, creating a far preferable situation.
Published on guardian.co.uk here.
It is no time for Westminster to be squeamish over spending cuts
The C-word is out in the open. The Prime Minister previously insisted the debate was between indiscriminate and savage Tory cuts, versus Labour’s investment in public services. The Prime Minister uses the term “investment” as we might talk about “investing” in a Mars Bar, which most people would call spending. Now Lord Mandelson has described Labour policy not as big spending, but as wise spending, to be contrasted with Tory “savage cuts”.
The Government is trying to pitch the debate as one between cuddly and sensible economies from Labour, versus Tories “salivating about wielding the axe”. The debate has changed, however, in that the public now expects cuts and even supports them. Moreover, they trust the Tories to better implement them.
They are correct. Several studies have identified savings to be made without cutting essential services. The James report identified £35bn, the Taxpayers’ Alliance and Institute of Directors report pointed to £50bn, and the European Central Bank has said that Britain could save £96bn if its public services could operate with the efficiency achieved in the US, Australia and Japan – and without reducing actual services.
The notion that the public services were simply under-resourced has been tested to destruction by Gordon Brown. The torrent of public money poured their way has not brought commensurate improvements. What it has done is to leave Britain poorly placed (not “best placed”) to deal with the global financial crisis, and with an overhang of debt that will stifle future development and growth.
National Debt is over £800bn and heading for £1tn, and far more than that if the cost of baling out the banks is factored in. A Britain saddled with the costs of paying the interest on that, never mind repaying the debt itself, would see its business and industry intolerably burdened, with its ability to generate the jobs and wealth of the future severely handicapped. It is like a ball and chain tied to the economy.
That debt burden can be diminished in two ways. One is to let the economy grow by tax incentives and deregulation. The other is to cut public spending. The first targets must be waste, profligacy and inefficiency. But after that we must ask which services currently provided by government could be better done outside it, and which should not be done at all.
The enemy of our future prosperity is not the savagery of any spending cuts, but the hesitancy of those not prepared to do what is necessary. It is no time to be squeamish.
Published on Telegraph.co.uk here.
The Great Crash of 2008: Are governments or markets to blame?
In the early 1980’s I was working as the Research Administrator at the World Bank, whilst the Third World was engulfed by a debt crisis. The current global financial crisis has eerie similarities, but different outcomes. Why?
First, both the crises arose because there was a surplus of savings in a number of countries- the oil producers in the 1970s, the Asian economies and commodity exporters today-which was recycled through the international banking system. Second, highly liquid banks imprudently funneled cheap credit to un- creditworthy borrowers: the fiscally challenged and inflation prone countries of Latin America and Africa in the 1970s, the ninja (those with no income, no jobs, no assets) sub prime mortgagees of the current crisis. Third, there was a rise in commodity prices and a worsening of the terms of trade of the OECD, posing the stagflation dilemma for their central banks, having aided and abetted the earlier asset boom. Fourth, the imprudent banks sought bailouts from taxpayers, claiming their demise would fatally damage the world’s financial system.
But, the outcomes have been different. The 1980’s crisis was finally solved after a prolonged cat and mouse game when the banks accepted substantial write downs of their Third World debt, sacked their imprudent mangers and shareholders suffered large losses. But no systemic threat to the world’s financial system (or the global economy) emerged. By contrast, today the Western financial system seems to be dissolving before our eyes, and with the US Fed’s ever expanding balance sheet, bailouts are no longer the exception but the norm. Many now foretell a deep and perhaps prolonged recession, with deflation, rising unemployment, and Keynes’ famed liquidity trap about to engulf the world’s major economies.
I
Changing Financial Structures
What explains this difference in outcomes? It cannot be purported ‘global imbalances’, which were the origins of both crises. It is the differences in financial structures within which these temporally separated but largely similar crises occurred. In the 1970’s the recycling of the global surpluses was undertaken by the offshore branches of Western money centre banks, which were neither supervised nor had access to the lender of last resort facilities of their parent country’s central bank. Hence, when their Third World Euro dollar loans went into ‘default’, there was no direct threat to the Western banking system.
The present crisis emerged in a radically different financial structure: the rise of universal banks from the UK’s Big Bang financial liberalization in the 1980s, and the Clinton era abolition of the Glass-Steagall Act, which had kept a firewall between the commercial and investment banking parts of the financial system since the 1930s. The former had implicit deposit insurance and access to the central banks’ lender of last resort facilities. The latter did not. It is worth explaining why this matters.
This distinction between what were previously non-bank financial intermediaries and banks is important because it is only clearing banks which can add to (or reduce) the stock of money. A clearing bank holds deposits in cash (legal tender base money) from non-banks, repaying deposits in notes, and making payments for depositors by settlements in cash through an account in the central bank. When a clearing bank extends a loan it adds to its assets and simultaneously creates deposit liabilities against itself, increasing the broad money supply at ‘the stroke of a pen’. This ability to create money ‘out of thin air’ is limited by the bank’s capital and cash. As cash can be borrowed from the central bank, the ultimate constraint on its ability to create money is its capital. But it is only because banks take in cash deposits – Keynes’ ‘widow’s cruse’ – that they can create money.
By contrast, a non-bank financial intermediary, say a mortgage lender, when it takes deposits or makes a mortgage loan has to ‘clear’ these through deposits held at the clearing banks. Thus when someone deposits ‘cash’ at an S&L this comes out of the depositor’s bank account with a clearing bank. Similarly when the S&L makes a loan to a mortgagee this comes from the S&L’s bank account with a clearing bank.
Thus the essential difference between non bank financial institutions and clearing banks is that they cannot create the bank deposit component of broad money (M2 or M4).
When the FDIC was created as part of Roosevelt’s New Deal, to prevent the bank runs which the earlier universal banks gambling had engendered, Marriner Eccles who redesigned the Federal Reserve system for FDR in the Great Depression, insisted that with deposit insurance the banking industry must be split in half: the public utility part of the financial system which constitutes the payments system must be kept separate from the gambling investment banking part, which is an essential part of a dynamic economy. For these gambles impart the dynamic efficiency through the cleansing processes of creative destruction. But if these gambles are protected against losses by taxpayers, as the payment system activities have to be because of deposit insurance, the gamblers will always win: keeping their gains when their gambles are correct and passing their losses onto taxpayers when their gambles turn sour. Hence the Glass-Steagall Act.
Given this ‘moral hazard’, many classical liberals have favored free banking. Banks combining the payment and investment functions and issuing their own notes, should be monitored by their depositors, who would stand to lose if their banks undertook imprudent lending. But with the near universality of deposits as a means of payment, there is little likelihood of this monitoring function being effectively exercised. Whilst the rise of Demos precludes any government being able to resist pressures to bail out imprudent banks to protect their depositors. This makes deposit insurance inevitable, and to prevent investment banks from gambling with the tax payer insured deposit base, something akin to Glass-Steagall remains essential.
II
Policy Errors
The recent emergence of universal banking was followed by a number of public policy mistakes on the path to the current crisis. The first was the bail out of LTCM in 1998. Its failure posed no obvious systemic threat. Its public salvation changed expectations of market participants that non bank financial institutions could also hope for bailouts. Next the infamous Greenspan ‘put’ which put a floor to the unwinding of the dotcom stock market bubble, promoted excessive risk taking. Third, the promotion of ‘affordable’ housing for the poor by the Clinton administration through the unreformed and failed Freddie mortgage twins, led to the development of subprime mortgages. Fourth, the Basle II capital adequacy requirements led banks to put their risky assets into off- balance sheet vehicles- the SIVs- leading to the opacity currently being bemoaned. Fifth, when the housing bubble burst, and the credit crunch began with the gambles taken during it turning sour, the Fed chose to bail out Bear Sterns, sending the signal that the Fed’s balance sheet was open to non-deposit taking ‘banks’ as signaled by the earlier LTCM bailout. Sixth, and most heinously given all that had gone before, the US authorities then chose not to bail out Lehman’s- like a fallen woman suddenly finding virtue. This dashing of the bailout expectations that the authorities had endorsed only in the spring, led to the intensification of the credit crunch. Seventh, as the authorities finally seemed to tackle the toxic subprime infected financial assets which caused the crisis through TARP, it calmed the markets. When TARP was changed to be used only to recapitalize banks, markets went into free fall. The essential step, of forcing banks to come clean on their balance sheets, and then removing the toxic assets they reveal into a newly created institutional ‘cordon sanitaire’, has still not been taken. Worse, instead of recreating a firewall between the payment part and the gambling part of the banking system, even the pure investment banks, like Goldman Sachs, were pushed into becoming universal banks with access to the Fed’s balance sheet and thence taxpayer’s money.
Given these public shortcomings the near universal calls for greater regulation and state intervention is astounding. Public agents, not private ones- who reacted rationally to the implicit or explicit ‘rules of the game’ promoted- are to blame for the crisis. It would be foolish to blame the puppets for the failings of the puppeteer.
III
Remedies
What of the remedies? In answering this it is essential to be clear of the nature of the crisis, and to view it from the correct theoretical perspective. Because of the association of Keynes’ name with the Great Depression, the crisis and its cures are being seen through ‘crass Keynesian’ lenses. Is this appropriate? To answer this question I briefly outline the alternative theoretical perspectives which seek to explain the current crisis as well as the remedies.
Here a personal note is in order. When I got my first academic job as a lecturer at Christ Church, Oxford, my senior colleague was Sir Roy Harrod- Keynes’ first biographer and keeper of his flame. On having to provide a reading list for my tutorials on “economic fluctuations and growth” I asked him what I should ask my pupils to read. I expected him to say Keynes, and his own work on trade cycles and growth. But after some reflection he said: Wicksell. So before I prescribed this to my pupils I immersed myself in Interest and Prices and Lectures on Political Economy. Since then I have been pleasantly surprised that most of the macro economic perspectives on offer really hark back to Wicksell.
Wicksell asked: how could the price level be anchored in a pure credit economy? Bagehot had observed in Lombard Street that the whole of the Bank of England’s note issue depended on a slender and declining gold ratio. What if this ratio went to zero, asked Wicksell? His answer was that, if the Bank rate were set at the natural rate of interest, which balances productivity with thrift, the price level could be kept constant. This is, of course, the theory underlying inflation targeting, as embodied in the Taylor rule. As John Taylor has noted, it was the failure of the Greenspan Fed to follow this rule which led to the credit bubble after the dotcom bust.
The reasons for this failure are provided by Hayek’s refurbished Austrian theory of the trade cycle. Hayek saw divergences between the Wicksellian natural and market rates of interest as causing booms and slumps. If increased bank credit led to market interest rates below the natural rate, businesses will undertake relatively more capital intensive projects with relatively low rates of return. There will also be an unsustainable boom, with more projects undertaken than can be completed, leading to resource scarcities which end the boom. The financial crash which follows will lead to the liquidation of these ‘maladjustments’, followed by an economic recovery with resources being reallocated in line with inter-temporal consumer preferences and resource availabilities. Whilst broadly accepting the quantity theory of money, Hayek argues that it assumed the absence of ‘injection’ effects, which even with prices stable could lead to false signals in the pattern of inter-temporal prices, and thence to maladjusted investments. The recent US housing boom, with a stable general price level, provides an example of these ‘maladjustments’.
But Hayek’s prescription that the slump should be allowed to run its course, came to be disowned even by his LSE circle led by Robbins in the 1930’s. As Gottfried Haberler (a close friend and member of Hayek’s Austrian circle) noted in his astute appraisal of Hayek’s business cycle theory: “Keynes, Robbins, and many others were correct: if a cyclical decline has been allowed to degenerate into a severe slump with mass unemployment, falling prices, and deflationary expectations, government deficit spending to inject money directly into the income stream is necessary. Moreover, Hayek himself has changed his mind on this point”. (The Cato Journal, Fall 1986, p. 422).
Though Keynes’ General Theory, unlike Hayek’s, provides no explanation for the boom preceding the slump, he was right in emphasizing “effective demand” failures in the face of a financial crash, and the need for deficit spending. Though not, as advocated by many current Keynesians, through counter cyclical public works. Thus Keynes wrote in 1942: “Organized public works at home and abroad, maybe the right cure for a chronic tendency to a deficiency of effective demand. But they are not capable of sufficiently rapid organization (and above all cannot be reversed or undone at a later date), to be the most serviceable instrument for the prevention of the trade cycle” (Collected Works, vol. XXVII, p.122). A point reinforced by the Congressional Budget Offices’ assessment of the planned Obama infra-structure spending.
Friedman, unlike Hayek, was closer to Wicksell in concentrating on the effects of divergences between the natural and market rate of interest on the general price level and not as Hayek’s theory presupposes on relative prices. With the real (natural) rate being determined by productivity and thrift, monetary expansion will only raise nominal interest rates through inflationary expectations. Given the natural rate of interest there will also be a corresponding natural rate of unemployment. Monetary policy can only lead to transitory deviations from these natural rates, if capital and labour markets are efficient. There is little about credit markets in Friedman, or in his successors of the New Classical and Real Business cycle schools. As the current New Neoclassical synthesis is based on these models (with some twists of Keynesian ‘imperfections’), but contains neither money nor finance, it is useless in explaining or providing cures for the current crisis.
Thus, though Hayek provides the best diagnosis of the cause of the current crisis, neither he nor Keynes provide an adequate explanation of the financial aspects of business cycles, assuming these are endogenous to the fluctuations in the real economy. It is Irving Fisher (“The Debt-Deflation Theory of Great Depressions”, Econometrica, 1933) who provides the correct diagnosis of the nature and cures for the current crisis. Fisher saw a ‘balance sheet recession’ as an essential element in the Great Depression. He argued that, whilst there were many cyclical factors behind trade cycles, for Great Depressions the two dominant factors are “over-indebtedness to start with and deflation following soon after (p.341). Like the Austrians he saw over indebtedness as caused by “easy money” (p.348). This provides a succinct explanation of the current crisis and pointers to its cure. We have a Hayekian recession with Fisherian consequences. Having learnt the lessons of Friedman and Schwartz’ work on the Great Depression, Ben Bernanke has made sure that the second leg of a Fisherian debt deflation will not occur. But, past and present US authorities have failed to adequately restore the balance sheets of over leveraged banks, firms and households. US banks urgently need to be restored to health, perhaps through temporary nationalization as in Sweden in 1992. Whilst, stimulus packages have failed to adopt the obvious means to restore household and firm balance sheets, by a massive across the board tax cut accompanied by an equivalent fiscal deficit. It is argued that most of this extra income will be saved not spent. But this is to be bewitched by the wholly inappropriate Keynesian income-expenditure analysis, which fails to deal with balance sheets. If this Fisherian aftermath of a Hayekian recession is caused by attempts to reduce unsustainable debt, the ‘savings’ generated by the tax cut (i.e. reducing liabilities to the government) will allow the necessary deleveraging, without a downward spiral in income and increased bankruptcies. By facilitating households to pay off their mortgage and credit card debts, it will prevent further impairment of bank assets. Instead, we have the dog’s breakfast of the Obama stimulus package and a dubious Geithner ‘plan’ to clean up the banking sector. This, like Nero, is to fiddle while Rome burns.
IV
A New Financial Oligarchy?
Finally, I want to consider who are the winners from this on- going global financial crisis? The answer is: China, India and Goldman Sachs!
Let us consider the latter. This also provides a clue to the political economy behind the current crisis in its epicenter the US. As in the numerous Third World financial crises the question to be asked is who are the ‘rent-seekers’ who created the crisis and whose reluctance to take a ‘hair cut’ prevents the domestic polity from accepting the obvious cures. So that ultimately the intervention of an external agency like the IMF is need to administer the necessary cures. The crisis was caused by financiers taking ever risky gambles with the complicity of the government. This is reflected in the changing share of US domestic corporate profits that have gone to the financial sector. From 1973 to 1985 it was 16%. In the 1990s it oscillated between 21-30%. In the last decade it reached 41%. This was accompanied by a dramatic increase in pay: which rose from 1999=108% of the average for all domestic private industries to 181% in 2007. This great increase and concentration of wealth has created a new financial oligarchy similar to the one in the early years of the last century, which has great political weight in the US. At its head is Goldman Sachs. It has provided the Treasury secretaries under the last 2 US presidents and numerous alumni have held and continue to hold influential posts in devising and implementing US economic policy. (see Simon Johnson: “The Quiet Coup”, The Atlantic Online, May 2009).
This explains some of the bailouts. Why for instance was Lehman allowed to go the wall but AIG was ‘saved’? Lehman had the misfortune of both being a major competitor to Goldman’s and being run and staffed by the ‘barrow boys’ from the Bronx rather than the Ivy League gentlemen manning its rival. AIG was saved I suspect because, as appeared when Congress forced AIG to disclose what it had done with its bail out money, it had to disclose that most if it was to pay off its counterparties, the major one being Goldman! It is ironic that just as the century old rise, decline and now fall of GM, which marked the era of American industrial ascendancy, with one of its chairman claiming that “what was good for GM was good for America”, should now be followed by an era in which seemingly “what is good for Goldman is good for America”, or more generally Wall Street.
V
Geopolitical Consequences
What of China and India? Though their growth rates have fallen with the backwash from the US crisis on global trade, they are still likely to grow robustly. This points to some important geo-political consequences of the current crisis.
The last two centuries have been dominated by two Anglo-Saxon empires (the British and the US) whose liberal international economic orders have allowed the wholly benign processes of globalization to bring untold global prosperity. The inter war imperial interregnum saw a period of grave disorder and the emergence of Fascism and Communism. Today, will the US be able and willing to maintain its hegemony, allowing globalization to continue?
On the 10 October 1916 in the middle of a British financial crisis, Keynes wrote a memorandum to the Treasury, noting that financial hegemony had passed across the Atlantic. (see R. Skidelsky: John Maynard Keynes, vol.1, p.335). Is the collapse of Lehman Brothers on 15 Sept. 2009 a similar turning point? For with the three high savings countries China, Japan and India as the major source of funding for the exploding US public debt, will the US have to adopt the policy Keynes recommended for Britain: ” not only to avoid any form of reprisal or even active irritation but also to conciliate and please”. ? And which of these countries is likely to replace or help US hegemony?
Japan because of its continuing reluctance to match its economic with military power and with its stagnant economy and demographics is an unlikely candidate. This leaves the two emerging Asian giants. George W. Bush’s most notable achievement was the strategic partnership he established with India, cemented by the Indo- US nuclear deal. But India’s economic and military power is at present dwarfed by China’s. As China has signaled that it is not planning to sell its holdings of US debt, it along with the Gulf State sovereign funds are the most likely source of finance for the exploding US budget deficit. So expect talk of Chinese ‘currency manipulation’ and lectures on human rights to diminish as the US faut mieux has to follow Keynes’ advice. Though, at present, it is impossible for China to take over the US’ hegemonic role, it will undoubtedly have increasing leverage over US foreign and domestic policy as the financier of the US.
This is likely to make the US’ war against the current totalitarian threat from militant Islam more difficult. For given China’s desire to assure supplies of primary products- particularly oil- for its rapid industrialization, China’s foreign policy is unlikely to antagonize many natural resource producing countries, like Iran and the Sudan, which continue to aid and abet international terrorism. Nor, given China’s historical support of the current crucible of jihadists, Pakistan, as a counter weight to its emerging Asian rival, India, can much help be expected in this quarter. This leaves India, which even more than the US (as the Mumbai attacks demonstrated), has to fear the rise of militant Islam and the impending implosion of the Pakistani state. In many ways it would be the natural partner of the US with its large army to accompany the technological wizardry of the US military. But is it able or willing to take on the role of a partner in the US Imperium?
Meanwhile, as the other potential partners of the US in sharing its imperial burden- the Europeans- have (apart form the British) clearly signaled, with their refusal to send more troops to Afghanistan that, they are going to continue to be free-riders, the US stands alone in maintaining global order. Will the aftermath of the current crisis leave it with the means and will to do so?
The parallel with Rome is instructive. The causes of Rome’s’ decline were ultimately economic. As the past rents acquired during the empires growth had been in part committed to a vast expansion of a welfare state without extending the domestic tax base, the empire faced an endemic fiscal crisis. It tried to close the deficit by levying the inflation tax by debasing the currency. Not being enough, taxes had to be raised, leading by the middle of the 4th century to tax evasion and avoidance by high officials and large landowners. The fiscal crisis also led to problems in maintaining the old military organization. Without the means to provide the Italici satisfactory treatment, recruitment was expanded to the provincials and in the late Empire to the barbarians. Having let them inside the gates the Empire sealed its doom.
That the US imperium is on a similar primrose path was pointed out in a dire warning by the former US Comptroller general David Walker in August 2007, when the US budget deficit was only projected to be under $500 billion. He explicitly drew parallels with Rome, including “declining moral values and political civility at home, an over confident and over extended military in foreign lands and fiscal irresponsibility by the central government” (Jeremy Grant: “Learn from the fall of Rome, US warned”, FT.com, 14 August 2007).
This irresponsibility has increased manifold with the current crisis. The 2007 report noted that, it was primarily the health entitlements which made the US budget unsustainable. This is the entitlement Obama is planning to enlarge. Walker also warned that, the crisis could not be solved by growing out of the problem, eliminating earmarks, wiping out fraud, ending the Iraq war or cutting defense expenditures, restraining discretionary spending or letting the Bush tax cuts expire (US, GAO-07-389T, p.18). These are the very policies that Obama is hoping will reverse exploding future deficits. With projected reductions in military spending, it seems likely that the US like its Roman predecessor will find it difficult to maintain the sinews of the forces which have maintained global order. With no obvious alternative to provide this global public good, I fear the ensuing erosion of global order, so essential for the processes of globalization to work, is likely to be the most serious long term consequence of the global financial crisis.