Big government reduces growth
This probably doesn't come as much of a surprise to readers here, but a raft of new papers add to the evidence that bigger government leads to lower growth. It comes by the way of a rejoinder to a comment on a paper by Andreas Bergh and Magnus Henrekson. The rejoinder, entitled "Government Size and Growth: A Rejoinder" finds:
In our 2011 survey of the literature in the Journal of Economic Surveys on the effect of government size on economic growth in wealthy countries we find a relatively consistent pattern: An increase in government size by 10 percentage points is associated with a 0.5 to 1 percentage point lower annual growth rate. This conclusion is questioned by Colombier (2014). In this rejoinder we present a rebuttal of Colombier’s argument based on a detailed scrutiny of his own statistical evidence and regression results. Furthermore, we note that several new papers that have appeared since our original article was published give support to our main conclusion.
They handily review the new papers that they believe support their conclusions:
Oto-Peralías and Romero-Ávila (2013) confirm a negative growth effect of government size and finds that the effect is stronger in countries with lower institutional quality.
Berggren et al. (2014) finds that government legitimacy exacerbates the negative growth effect of government size in the long run. Afonso and Jalles (2013) find that the adverse impact on growth from government size can be mitigated using fiscal rules such as the Stability and Growth Pact in the EU.
Afonso and Jalles (2014) confirm that government revenue has a negative impact on growth in the OECD, a result they find to be driven by taxes on income. On the expenditure side, they find adverse growth effects from public sector wages, interest payments, subsidies and government consumption, while spending on education and health boosts growth.
Notably, the survey by Gemmell and Au (2013) manages to miss our survey published two years before, as well as some of the key papers in the field, but still arrives at the consensus view, that there are negative output effects from higher tax rates (but positive growth effects from some categories of public expenditures).
More surprising than all of this is the fact that this debate is still raging so fiercely.
The death of the Marine and General Mutual
An interesting little story of the transience of corporate life here. The country's oldest company is about to disappear:
An insurance firm that can claim to be the oldest registered British company still in existence is about to disappear, following a takeover by Scottish Friendly.Marine & General Mutual was incorporated in 1852 as a life insurance provider for teetotallers – who were considered a bigger than average risk at the time, given the dangers of drinking Victorian tap water.
M&GM, whose early customers include several passengers on the Titanic, has the company registration number 00000006. The five firms that were registered with lower numbers than M&GM no longer exist.
It's not entirely what it seems, in that there are businesses still extant that are older than this. It's partly a function of how late it was that it was possible to incorporate without a specific Act of Parliament to allow you to do so.
But even so it's a nice example of the transience of corporate life. Paul Ormerod has done interesting work on this (as have others in the US) pointing out that the giants of one generation tend not to be the corporate giants of the next. Companies fail, are eclipsed, merged, bought and generally just disappear over time. The image that some to our left have of corporate power being unbreakable simply isn't true in any manner.
Entrepreneurs' Relief is worth defending
Defenders of Entrepreneurs’ Relief are on the back foot. In the corridors of power, rumblings have been heard that this tax relief is under threat. As entrepreneur Guy Mucklow writes in City A.M.:
Originally introduced by Labour seven years ago, the Entrepreneurs’ relief lifetime allowance was doubled by the coalition government to £10m in March 2011. However, according to a report by the National Audit Office in November 2014, the cost of the relief has increased to almost £3bn. Subsequent political scrutiny could put its future in jeopardy.
Entrepreneurs’ Relief offers business owners a lifetime allowance of £10m of gain taxed at the reduced rate of 10% for individual shareholdings of over 5%. Since its introduction in 2008 – when it replaced Taper Relief – the allowance has been raised to £2m, 5m, and finally its current level of £10m.
Its success may well contribute to its downfall. The £3bn has been "lost" because entrepreneurship is flourishing in the UK – partly because successive government have realised how vital entrepreneurs are and therefore offered people tax incentives to take the leap. If the idea is to encourage entrepreneurs, it is short-sighted to bemoan the loss of tax revenue (an inevitable by-product of the policy's success).
In our Manifesto, Tim Hames of the BVCA argued forcefully that we should be extending Entrepreneurs' Relief:
If the Government were to discard the 5% requirement, lure business angels yet further into the start-up scene and eliminate the current cap altogether, it would revolutionise the tax treatment of entrepreneurs in Britain. The howls of anguish from the likes of Berlin, Dublin and Luxembourg would be audible in the Treasury.
Getting rid of the 5% equity requirement should be prioritised in any move pushing for its extension. It may be pushing entrepreneurs to exit their companies or not take on extra funding in case they get diluted below the 5% threshold. Labour may be amenable. Its March 2013 Small Business Taskforce report stated:
Extend entrepreneurs’ relief beyond capital gains to dividends, in order to remove the incentive for entrepreneurs to dispose of their businesses rather than grow them. Reduce the 5% threshold for entrepreneurs’ relief to 1% or below to allow more employees to benefit from investing in the high growth companies they work for.
In contrast, the Liberal Democrats’ 2013 autumn conference, a policy paper entitled Fairer Taxes, Policies for the Reform of Taxation was endorsed by the party. It included the following statement:
We wish to focus Entrepreneurs' Relief to better serve the purpose for which it is intended; incentivising entrepreneurs and start-up business owners, and prevent it from simply being used as a way for wealthy investors to reduce their tax bills. We would therefore increase the shareholding requirement to 25%.
Extending it to 25% would definitely incentivise entrepreneurs to exit their companies early. There is no earthly reason why it should be raised from 5% and every reason why is should be cut. Britain is backing entrepreneurs – now isn't the time to take the foot off the pedal.
So who did cook Adam Smith's dinner then?
The portrait of Adam Smith’s mother above has been published here with the kind permission of her owner Rory Cunningham
Much excitement over in Grauniadland as a new book comes out talking about why that economically rational man so beloved of us neoliberals could not ever be the economically rational woman. Because, you know, women do all that caring and cleaning and stuff for love, not for reasons of calculated rational self-interest:
But a polemical and entertaining new book by journalist Katrine Marçal suggests that Economic Man has another major shortcoming: he’s not, and never could be, a woman.
Hmm. The book's blurb says:
It is not from the benevolence of the butcher, the brewer, or the baker, that we can expect our dinner, but from their regard to their own interest When Adam Smith wrote that all our actions stem from self-interest and the world turns because of financial gain he brought to life 'economic man'. Selfish and cynical, economic man has dominated our thinking ever since and his influence has spread from the market to how we shop, work and date. But every night Adam Smith's mother served him his dinner, not out of self-interest but out of love. Today, our economics focuses on self-interest and excludes all other motivations. It disregards the unpaid work of mothering, caring, cleaning and cooking. It insists that if women are paid less, then that's because their labour is worth less - how could it be otherwise? Economics has told us a story about how the world works and we have swallowed it, hook, line and sinker. Now it's time to change the story. In this courageous look at the mess we're in, Katrine Marcal tackles the biggest myth of our time and invites us to kick out economic man once and for all.
The contention is entirely poppycock of course. For we can only make sense of gender roles and how they have changed within that very concept of economic rationality. The work of Gary Becker explores this world, where the decision to form a family for example, is explained in those rational economic terms. In a world reliant upon human muscle power to feed itself (ie, all of history until the tractor) there was obviously going to be a gender divide in who did what. And as the biologists tell us it really does take two to raise a family (historically one agricultural labourer could produce enough in a year to feed 1.7 to 2.3 people in total). So many other things about men and women only make sense if there is a division of labour (as Smith repeatedly pointed out, this is the basis of wealth creation) and trade in the subsequent produce. "Hunter Gatherer" as a decription of pre-agriculture societies is in itself a gender distinction of roles on the grounds of comparative advantage (which is all about David Ricardo).
We might also look at the work of Amartya Sen and Joe Stiglitz on the Sarkozy Commission. One of the questions they considered is what is the economic value of that unpaid household production that women tend to do? Given that it is undifferentiated labour (while there is that gender divide the specialisation and division rarely extends beyond two people) then it should be valued at the undifferentiated labour rate: minimum wage.
So two of the founding figures of economics address exactly this point, Smith and Ricardo, three Nobel Laureates point out the implications and then some journalist comes along to shout that of course economic rationality doesn't apply to women?
Yes, we'll probably file that under poppycock.
Quite apart from anything else it's impossible to explain the changes in society in the past century without using that structure of economic rationality. Why have fertility levels fallen so much? Because children now generally survive into adulthood, the name of the game is to have grandchildren, thus one needs fewer children to have them. Why have male happiness rates stayed largely static while female ones have fallen as they gain ever more choice over their lives? Because having more choices means that the opportunity cost of making any single one of them rises. Why have female paid working hours risen? Because automation has meant that the gender division of labour based upon muscle power is no longer useful.
You simply cannot explain this modern world without that assumption that we're all, men and women together, acting as economically rational beings to at least some extent. For, as Marx pointed out, the level of technology determines social relations: the inventions of the reasonable cooker, the microwave, the vacuum cleaner, the washing machine, the steam iron and so on quite killed off the servant class just as one example.
Sorry, but the concept that there's a male world which is economically rational and a female one that isn't is simply poppycock. Otherwise we wouldn't be in a world where one female journalist writes about a book by another one instead of them both being tied to the domestic treadmill in that game of producing grandchildren.
Uncertain IP leads to less innovation
We've been debating patents on the blog recently. Charlotte wrote about a really cool experiment that appeared to show that IP limits follow-on innovation.
I previously wrote that the follow-on benefits of innovation were on net positive, because the effect of bringing what would otherwise be business secrets into the open outweighs the cost of firms not being able to build on other firms innovations for free.
A newly published paper takes on another angle: collaboration. Entitled "R&D Collaboration with Uncertain Intellectual Property Rights" (full pdf of 2011 version) and by authors Dirk Czarnitzki, Katrin Hussinger, and Cédric Schneider it argues that firms shy away from working with other businesses when their intellectual property rights are less clear.
Patent pendencies create uncertainty in research and development (R&D) collaboration, which can result in a threat of expropriation of unprotected knowledge, reduced bargaining power and enhanced search costs. We show that—depending of the type of collaboration partner and the size of the company—uncertain intellectual property rights (IPRs) lead to reduced collaboration between firms and can, hence, hinder knowledge production.
Among firms with patent applications the average probability to collaborate with a competitor amounts to 13%. The probability of collaborating with a competitor decreases by 3% points for these firms if the share of pending patents in the patent application stock increases by one standard deviation at the mean. Thus, the average probability of collaborating with firms in the same industry is reduced by about 23% (=3/13), which is a sizeable impact.
Take that, Charlotte!
'Munibonds' and the national debt
Local authorities are on the verge of issuing bonds in order to raise revenues and make up for further cuts to their government grant.... The "munibonds" will be issued by a new municipal debt agency, and are backed by 48 local councils and the LGA. Scotland will also acquired the powers to issue its own debt in what have been dubbed "kilt-edged bonds".
Why is it such bad news? Shouldn't government be allowed to borrow, for investment, like the rest of us? Few of us could buy a house from our savings: instead we take out a loan. So why should a local authority – or even a country – not borrow to fund its schools, roads and care homes?
I used to read eighteenth-century authors and economists like William Cobbett (of Rural Rides) and Adam Smith (of The Wealth of Nations) and chuckle to myself as they went on and on against the idea of the national debt. Much of the huge rise in prosperity of our times, I supposed, had been built on debt, much of it government debt taken out to fund market-enhancing improvements in roads, bridges, airports, schools, hospitals and housing.
Now I think the Cobbetts and Smiths were right and I was wrong. If we could rely on governments to make rational, objective decisions about the overall benefits and costs of infrastructure finance, then there might be a case for allowing them to borrow for public investment. But we cannot rely on governments to be so dispassionate and high-minded. The very power to borrow is itself too much of a temptation pulling them in the opposite direction. Consider, for example:
(1) It is impossible enough to measure the 'public' benefit of government spending, when there is no such thing as the 'public interest' – only a clash of opposing interests. (Think airports, and the convenience for travellers of extra flights and the distress of local residents over traffic and noise.)
(2) The problem is compounded when it is confused by electoral interests. (As Khruschev noted, "politicians will build a bridge, even where there is no river." All the more so, if there is an election coming up.)
(3) With electoral advantage in mind, it is too easy for those who control the public finances to segue from investment to spending. As Chancellor, Gordon Brown, to his credit, said he would confine borrowing to investment projects. But by his reckoning, anything spent on schools or hospitals was 'investment' for the future – even though much of it was patently simply consumption for today.
Such factors help explain why governments have growth so much, and spend money on so many marginal activities. It is too inviting to spend now, earn the applause of the public, and let the next generation, who do not yet have a vote, foot the bill for it all. Public Choice economists call it 'time shifting'. And in that, of course, the public themselves are complicit. With interest groups, from pensioners to patients, demanding more spending on themselves, and politicians happy to borrow, at little cost to themselves, to provide it, how can we ever expect prudence in the public finances.
It is a draconian answer to say that we should stop government borrowing at all. But actually, the eighteenth century thinkers were right.
It usually begins with Ayn Rand
Ayn Rand was born on this day in 1905. “It usually begins with Ayn Rand,” said author Jerome Tuccille of this Russian-American thinker, novelist and screenwriter. An amazing number of people have come to support a free society and a free-market economy through reading her novels, especially The Fountainhead (1935) and Atlas Shrugged (1957), in their student years. Those novels may not be works of great literature. The characters are little nuanced, more mouthpieces for Rand’s political and philosophical views. But decades on, they remain hugely influential, because they have what young people – and others looking for some purpose in life – actually want. Their weaknesses are the obverse of their strengths. Her heroes are role models: ambitious, purposive, independent and strong; ruthlessly self-interested and yet deeply moral. These are stories with a message, a coherent worldview that conquers all: the morality of rational self-interest. Atlas Shrugged, for instance, describes a world in which industry leaders overcome the stifling controls of over-mighty governments by closing down production and creating an alternate order based on freedom and strict respect for personal property. Unlikely, for sure: but it makes you think.
No surprise, then, that many of the world’s leading businesspeople have been influenced by this twentieth-century Russian émigré to America, whose fiction and philosophy has sold 25 million copies. One, Lars Seier Christensen, founder and CEO of the hugely successful online investment broker Saxo Bank, gave the Adam Smith Institute’s annual Ayn Rand Lecture in London last year. Even though Rand died in 1982, he observed, her robust individualist approach to economic and social life is needed more now than ever.
Rand held that the key thing that makes human beings unique is their reason. We betray our species and our selves if we do not use it. But to act rationally, we need a long-term view of the world. It might sound good to tax the wealthy and spend the money on education, welfare and much else. But there is no free lunch. Those short-term benefits come at a long-term cost, because taxation depresses risk-taking and enterprise. As in Atlas Shrugged, the majority cannot exploit the minority and expect them to put up with it forever.
The long-term view reveals that most regulation is irrational. Minimum wage laws, for example, might boost the wages of poorer workers; but by making it too costly for employers to hire unskilled or untested applicants, they deny hundreds of thousands of young people jobs and consign them to the welfare rolls. American regulations that forced banks to lend to poorer people gave families ‘affordable housing’ but created the sub-prime crisis and the crash.
It is the same in business. Rational self-interest means long-term self-interest, not short-term greed. Greed comes back to haunt you, as certain bankers will testify. It is interesting that about the only American bank to come out of the financial crash unscathed was BB&T, run by John Allison – an adherent of Ayn Rand’s principles and another past Ayn Rand Lecturer. There are only two stable relationships, he insists: win-win or lose-lose. You don’t need self-sacrifice or even altruism. You benefit yourself by benefiting others.
Money is not the end. Happiness is. If people in a business – from the CEO to the cleaners in the works canteen – know that they are part of an enterprise that makes a positive difference to others, they will have purpose and self-esteem. That will make it a better business – and will make them happier, more complete human beings.
The inheritance of wealth and social mobility
Many of the papers are covering the new Greg Clark paper showing that social mobility isn't quite as fast as some think. But it has to be said that the paper isn't quite showing what people think it does. It is true that the intergenerational elasticity of wealth inheritance is 0.7-0.75 as the paper defines it. But this isn't quite the same as saying that that wealth is inherited. To understand the point imagine that it is purely wealth itself that is inherited. People now are rich because their forefathers were rich and that's the only reason. OK. But that's not what this paper has proven in the slightest.
What this paper has shown is that the children (and male children only, as they're tracking surnames) of people who die rich are highly likely to die rich. That means that there is a correlation between being the child of a rich man and being a rich man. It does not show that that richness comes from having inherited the wealth.
Consider this example that is used:
Joseph Bazalgette was responsible for building the world's first sewer system in London in the 19th century, the Pepys family tree contains noted diarist Samuel Pepys, and John Bigge was a judge and royal commissioner.
They found that, compared to their relatives in 1850, those living with that surname today are almost certain to have amassed fortunes well beyond the reach of the average Briton.
For example Sir Peter Bazalgette, the great-great-grandson of Sir Joseph, is the founder of Endemol television production company which created Big Brother and Deal or No Deal.
The company was floated on the Dutch stock exchange in 2005. It trebled in value and was sold for £2.5billion in 2007.
There's a number of different options available to us to explain this. That Sir Peter inherited wealth and was thus able to invest in something that was a further success. Someone who had not inherited could not have done this perhaps. Sir Peter inherited a social position that meant he was able to have such an entrepreneurial success. Or Sir Peter had a privileged education that enabled him to do so and so on. But it's also possible that there's an entirely different explanation, that Sir Peter inherited something else that enabled his success.
It is, after all, indubitably true that intelligence is inheritable. The very concept wouldn't have arisen through evolution if that were not true.
We can even tie this in with earlier work by the very same Greg Clark. In a Farewell to Alms he makes the point that what really enabled the Industrial Revolution etc was that those who were wealthier, had those bourgeois values that created higher incomes, had more surviving children than those that didn't. And thus over the centuries those values spread further down the income bands as the descendants overwhelmed (and there's an argument there about whether it was genes or cultural education) the genes of those who did not start out with these views. Essentially his eariler argument is that it was inheritance of being bourgeois that mattered.
We're going to have an awful lot of shouting in the next week or two about this new paper. And we're prefectly willing to agree with the concept (no, this does not mean we think it necessarily true, just that we're willing to take it as a working assumption and see where it goes) that something or other is being inherited leading to the same sorts of people getting to the top in each subsequent generation. But everyone's going to have to be extremely careful in trying to tease out exactly what it is that is being inherited.
From the information we've got here it's not immediately obvious that it is wealth itself that is being inherited. After all, as the paper itself notes, there's been many different taxation regimes upon both wealth and income over the hundreds of years they study. If it were purely cash that made the difference then the results would not be so consistent over this time. And if it's something else that is being inherited then even 100% death duties aren't going to make much, if any, difference.
Logical Fallacies: 6. Unaccepted enthymemes
https://www.youtube.com/watch?v=qKYsNzei0QA
Madsen Pirie's videos on logical fallacies continue. This time he looks at unaccepted enthymemes.
You can pre-order the new edition of Dr. Madsen Pirie's How to Win Every Argument here
In praise of Standard Chartered and their advice on African tax avoidance
The perenially enraged over at Action Aid are today enraged about the way in which Standard Chartered bank gave advice on how to avoid (legally, of course) certain corporate taxes upon investments in poorer African countries. We, in contrast, would like to congratulate Standard Chartered on their public spiritedness in advising people on how to avoid certain corporate taxes in poorer African countries. And we do so on the basis of a point made by Joe Stiglitz. The outrage is here:
One of Africa’s most high-profile banks – Standard Chartered – publicised the advice of a Mauritius-based financial company on how to avoid tax in some of the poorest countries in the world, a new ActionAid report states.
The FTSE-100 bank which operates in 15 African countries published the advice in its Standard Chartered Insights 2013/2014. The publication is aimed at company treasury departments.
The tax avoidance advice – which is entirely legal – can be used to avoid potentially hundreds of millions of dollars in tax in some of the poorest countries in Africa. It suggests structuring investments through Mauritius in order to avoid capital gains tax and withholding tax.
You can hear the frothing at the mouth as they shout in rage at this, can't you? However, this outrage is entirely misplaced, presumably as a result of their ignorance of how corporate taxation works.
The most essential thing to grasp about it is that the company itself is never bearing the economic burden of such a tax. It is always some combination of shareholders and workers. In an entirely autarkic economy it will be the shareholders, capital if you like, which will carry 100% of that burden. In a more open economy the workers pick up some of that burden. For taxing capital in an economy where capital can leave, capital decide not to enter, means that there will be less capital in that economy. Capital plus labour is what raises productivity and thus wages, meaning that less capital means lower wages. As the economy becomes ever more open, and smaller relative to the size of the global economy, then the burden on the workers increases.
It never quite reaches zero on capital as Adam Smith pointed out in his one Wealth of Nations use of "invisible hand". Even if people can invest abroad without penalty some will still prefer to invest at home and thus led, as if by that invisible hand, benefit their fellows. For us, here, this means that the impact of corporate taxation on capital will never be zero.
Which brings us to Joe Stiglitz's point. Which is that the burden of a tax can be over 100%. What people lose from the tax being levied can be greater than the amount raised from that tax. That's one of the failures of the Robin Hood Tax of course.
But now to the case at hand. As an economy becomes smaller relative to the global economy the workers carry more of the tax burden. Poor African countries have economies the size of a modest English town: they're small therefore. And given that we are talking about foreign investment here they are entirely open to the global economy. So, the burden of any capital taxation is largely going to fall upon the workers in those poor African economies. And that burden can be (and we would estimate will be) higher than the tax collected.
Meaning that, if you've advised people to dodge that corporate taxation and the investment thus goes ahead, that you've just raised the wages of some of the poorest people in the world. For note that the effect isn't upon just those workers in the investments made. It's upon all of the workers in the economy where the investment is made.
Advising people to invest in sub-Saharan Africa through Mauritius thus raises wages in sub-Saharan Africa by whatever effect on investment happens now it's free of those corporate taxes. All of which strikes us as a bloody good idea.
So why is Action Aid so spittle flecked at the very thought of it? We assume it's just because they're ignorant of how corporate taxation works. Which leaves us with only one last question. Why do they expend so much effort telling us how the tax system should work when they've no clue about how it does?