tag:blogger.com,1999:blog-84167088433867847122024-03-13T01:43:06.328+00:00Cantab83All economics is either physics or stamp collectingCantab83http://www.blogger.com/profile/12485401571391377815noreply@blogger.comBlogger34125tag:blogger.com,1999:blog-8416708843386784712.post-69914848402462790712017-01-18T00:33:00.000+00:002017-01-22T16:04:00.195+00:00The case for hard Brexit<div class="MsoNormal">
For all the talk of
Brexit meaning Brexit what has become abundantly clear over the past few months
is that most politicians and political commentators haven't got a clue what
Brexit means or should mean, and nowhere is this confusion more apparent than
in the Labour Party. At the heart of this confusion is the single market. Time
and again we hear politicians from both the Leave and Remain camps declaring
that while we might leave the EU, we will still need to be part of some aspects
of the single market. On this they are all completely wrong to the point of
delusion.</div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span style="mso-ansi-language: EN-GB;">The problem is not
that they want to cherry-pick which parts of the single market they want to
keep, and thereby appear to trying to have their cake and eat it. The problem
is that (a) they clearly do not fully understand what "access to the
single market" (as they term it) means or entails, and (b) they have still
failed to realise that all aspects of the single market, not just the freedom
of movement of people, represent an existential threat to the very concepts of
nationhood, sovereignty and democracy in the UK and in the rest of Europe. As a
result it is not just small parts of the single market architecture that we
need to reject, like the free movement of people, it is ALL of it.<o:p></o:p></span></div>
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<br /></div>
<div class="MsoNormal">
<span style="mso-ansi-language: EN-GB;">Today Theresa May
finally seemed to get some of this. Speaking from the same venue, Lancaster
House, <span style="mso-spacerun: yes;"> </span>where Margaret Thatcher once
extolled the virtues of the single market, the current prime minister finally admitted
that Brexit is incompatible with single market membership. Of course the big irony
in this whole debate is that the single market in its current incarnation is
<a href="https://mainlymacro.blogspot.co.uk/2017/01/the-single-market-was-mrs-thatchers.html" target="_blank">primarily a child of unbridled Thatcherism</a>. It is economic neo-liberalism in
its purest form. In which case one would think that the Labour Party should be
the party above all others that opposites it tooth and claw while the Tories
should be the most vociferous advocates. It's a strange old world. No wonder
the public are confused.<o:p></o:p></span></div>
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<br /></div>
<div class="MsoNormal">
<span style="mso-ansi-language: EN-GB;">As we are forever
being told, the single market is constructed around four fundamental freedoms:
the freedom of movement of goods, the freedom of movement of labour, the
freedom of movement of capital, and the freedom of movement of services. This
is my reasoning on why we need to reject all four of them.<o:p></o:p></span></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span style="mso-ansi-language: EN-GB;"><u><b>The freedom of
movement of goods</b></u><o:p></o:p></span></div>
<div class="MsoNormal">
<span style="mso-ansi-language: EN-GB;">On the face of it this
is the one aspect that everyone agrees that we should keep. After all we are
all in favour of free trade aren't we? Well yes, maybe, up to a point (although
in a future post I may proffer a more contentious view). But we can protect
most free trade using World Trade Organisation (WTO) agreements, and as most
global tariff barriers now average less than 2%, any further reductions will
have diminishingly small economic gains. Unfortunately this aspect of the
single market goes much further than just free trade. It also seeks to create a
"level playing field" within the EU by prohibiting any form of state
aid and outlawing any government action or policy that could be construed as
having distorted the market. Now while this may appeal to the neoliberal free
marketeers, it should fill anyone with a social conscience with profound
horror. <o:p></o:p></span></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span style="mso-ansi-language: EN-GB;">This freedom, in
concert with EU competition law, effective curtails many socially progressive
state interventions, ranging from taxation policy (such as minimum pricing of
alcohol) to industrial strategy such as support for key industries like steel
or nuclear power. If we accept the freedom of movement of goods, then we will
be compelled to accept the rest of EU competition law and thereby be prevented
from running our own economy in a way that allows us to protect it against
external shocks and predatory pricing from outside the EU. If we can't set
minimum prices for socially damaging substances like alcohol, then we can't set
minimum prices for anything else such as labour. So you can kiss goodbye to the
national minimum wage. If we can't support key industries in a recession then
you can kiss goodbye to Keynesian economics. In short you can kiss goodbye to any
form of economic choice at the ballot box. That is one reason why support for
social democratic parties has fallen across Europe. It has fallen because those
parties can no longer offer the policies that they once could. Instead they are
forced to offer a sanitised version of centre-left neo-liberal economic
orthodoxy and so democracy effectively dies.<o:p></o:p></span></div>
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<br /></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span style="mso-ansi-language: EN-GB;"><u><b>The freedom of
movement of labour</b></u><o:p></o:p></span></div>
<div class="MsoNormal">
<span style="mso-ansi-language: EN-GB;">The negative effects
of this part of the single market have become obvious. More than any other it
has led to mass migration across the continent and widening inequality in all
member states. The result has been catastrophic depopulation in the east and
high structural unemployment in the west. Yet it didn't need to be this way. <o:p></o:p></span></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span style="mso-ansi-language: EN-GB;">Before most of the
eastern former communist states joined the EU they were granted interim status
where they were able to trade freely with the EU but had no freedom of movement
of people, much as many Brexiteers want for the UK now. The result was that
firms inside the EU, including a number of major German car manufacturers, moved
some of their production out of the EU and into these states attracted by the
lower wages and supply of labour. The jobs moved to where the labour was. Then,
when these states gained full membership of the EU it all changed. The jobs
stopped moving east and the people were forced to move west instead. Why?
Because it was cheaper and more profitable for the corporate sector for people
to move to where the jobs were rather than the opposite happening. The result
has been one of the greatest economic migrations Europe has seen since the
Irish potato famine of the 1840s, and both have been driven by the same laissez-faire
liberal economic free-trade ideology.<o:p></o:p></span></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span style="mso-ansi-language: EN-GB;">This highlights one of
the key objections to the freedom of movement of labour: it transfers the
economic cost of matching jobs to people from the firm to the worker. In effect
the costs are socialised and the gains are privatised. There is nothing
remotely socially progressive about that. In fact it smacks of moral hazard as
was illustrated in extremis by the financial sector pre and post 2007 where the
benefits of an unequal system are privatised and the costs socialised. The
result for member governments is also potentially calamitous. Their potential
liabilities in terms of future welfare and education payments will become unlimited
due to immigration while their income could become squeezed by tax avoidance
from an increasingly mobile upper-middle class. The result would be either economic
insolvency at a national level or a collapse in public services, and before
either of these happens we would see a rise in income inequality and
unemployment as migrant workers drive down wage rates ever further.<o:p></o:p></span><br />
<span style="mso-ansi-language: EN-GB;"><br /></span>
<span style="mso-ansi-language: EN-GB;">Then there is the effect on tax revenues. Those that support freedom of movement claim it benefits the UK economy, that it leads to increased taxes and that immigrants make fewer demands on public services than the average UK citizen. What they fail to note is that many migrants are temporary and so are exempt from UK tax, and those that stay often send money back to their country of origin. According to the <a href="http://siteresources.worldbank.org/INTPROSPECTS/Resources/334934-1199807908806/4549025-1450455807487/Factbookpart1.pdf" target="_blank">World Bank (pdf)</a> this could be over $11.5bn. This has the double whammy effect of both reducing jobs and GDP per capita in the UK and worsening our current account deficit.</span></div>
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<br /></div>
<div class="MsoNormal">
So freedom of movement of labour represents a complete volte-face in terms of economic rationale. It treats
workers as little more than a commodity that exists to serve the economic
machine rather than treating the economy as a system designed to optimise the
happiness of the individual. When coupled with other measures that effectively remove any form of democratic choice for the individual, then it really is the stuff of a some nightmare
dystopian future that has so far only really existed in the pages of a few
sci-fi novels.<br />
<br />
Even more worryingly given that most in the Labour Party appear to support it, it is not even remotely socialist. For a start you cannot have full employment if you have open borders because the faster you create jobs the more migrants will flood in. It is like trying to bail out a rowing boat with a hole in the bottom. And if social democracy is about anything it is about aiming for full employment. On top of that freedom of movement of labour increases inequality. It allows rich countries to strip poor countries of their best talent to the disadvantage of the least well of in both countries. So much for international solidarity.</div>
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<br /></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span style="mso-ansi-language: EN-GB;"><u><b>The freedom of
movement of capital</b></u><o:p></o:p></span></div>
<div class="MsoNormal">
<span style="mso-ansi-language: EN-GB;">The ability to move
capital freely between member states may at first glance seem relatively
harmless, but actually it has had a major detrimental impact on the ability of
states to balance their budgets. The recent controversy over Apple's tax
dealings with Ireland illustrate how multinationals can exploit the freedom of
movement of capital to avoid tax. And it is not just Apple. <a href="http://www.nytimes.com/interactive/2012/04/28/business/Double-Irish-With-A-Dutch-Sandwich.html?" target="_blank">Google's Dutch double-Irish sandwich tax avoidance scheme</a> also plays heavily on this freedom,
not to mention that of <a href="http://cantab83.blogspot.co.uk/2013/05/tax-avoidance-2-gsk-loan-trick.html">GSK</a> and many others. <o:p></o:p></span></div>
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<br /></div>
<div class="MsoNormal">
<span style="mso-ansi-language: EN-GB;">It is of course not
just corporate tax avoidance that benefits from the freedom of movement of
capital. Tax avoidance by individuals does as well. In my last post I argued
for the taxation of UK ex-pats, partly as a way of tackling tax avoidance by
the rich. Yet as long as we are in the EU, and more importantly, obliged to
respect the freedom of movement of capital such measures will be impossible. In
short freedom of movement of capital is at the heart of most tax avoidance, and
so as long as we cling to it we will be unable to tackle the scourge of tax avoidance
and governments will find it ever harder to raise the taxes they need to fund
the services we all want.<o:p></o:p></span></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span style="mso-ansi-language: EN-GB;">And then there is the
issue of financial speculation. For years there have been calls for something
akin to a Tobin tax to be levied on financial transactions in order to suppress
both the size and the volatility of the financial markets in order to improve
market stability. Yet such a tax, particularly if imposed on currency trades,
would again violate the principle of the freedom of movement of capital. <o:p></o:p></span></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span style="mso-ansi-language: EN-GB;"><u><b>The freedom of
movement of services</b></u><o:p></o:p></span></div>
<div class="MsoNormal">
<span style="mso-ansi-language: EN-GB;">Of all the four
freedoms this is perhaps the most rarely used, overvalued and misunderstood.
The principal argument in favour of it is that because the UK has a large
service sector that accounts for up to 80% of its economy, and also because a
large part of that is the financial sector that accounts for a large part of
our invisible exports, then we desperately need to retain access to the single
market in order to protect jobs in London and to generate wealth and taxes. At
the heart of this freedom is the concept of the financial passport. This allows
any financial institution to operate in any other EU member state once it has
been given regulatory approval in another EU state. The problem is that this
just doesn't work.<o:p></o:p></span></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span style="mso-ansi-language: EN-GB;">This financial
passporting is the system that allowed unregulated Icelandic and Irish banks (among
others) to operate within the UK before 2007 and then collapse. It also allowed UK banks to import much of the financial crisis in 2007 from the US and the Eurozone. Do we really
want a repeat of that? <o:p></o:p></span></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span style="mso-ansi-language: EN-GB;">The fact is the
freedom of movement of financial services is a red herring. After 2007 the City
was complaining about excessive future EU regulation. Now it says it needs to
be part of the EU. These two positions are contradictory. The reality is it is
easy for a UK financial company to open an office inside to EU for regulatory
reasons and the cost is negligible. Moreover the financial benefits of exported financial services are puny.
Financial services may account for about 13% of the economy, but exported
financial services are a mere fraction of that. It really isn't worth the hassle.
<o:p></o:p></span></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span style="mso-ansi-language: EN-GB;"><u><b>Summary</b></u><o:p></o:p></span></div>
<div class="MsoNormal">
<span style="mso-ansi-language: EN-GB;">What I have shown is
that none of the four freedoms of the single market brings any real benefit. The
freedom of movement of services exposes our economy to high risk lending and
other dubious financial practices. The freedom of movement of capital prevents
governments taxing the rich and large corporations, and will ultimately lead to a collapse in national tax receipts. The freedom of movement of
people leads to social disintegration and alienation, inequality and unemployment,</span> and will ultimately lead to a collapse of national finances. The freedom of movement
of goods leads to a loss of democratic choice and sovereignty.</div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span style="mso-ansi-language: EN-GB;">What I think all this
illustrates is how the EU has lost its direction and its soul. The EU could
have been a force for social good. It could have protected workers rights while
promoting equality across the continent through the redistribution of income
and resources such as through a common industrial policy. Instead of exporting jobs to China and importing labour from Poland we should have been exporting jobs to Eastern Europe thereby re-industrialising the continent and not de-industrialising it. The result would have been an EU that was richer and more equal. Instead it has become
consumed by a neoliberal monster that ultimately has had the opposite effect.
That monster is the single market.<o:p></o:p></span></div>
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<br /></div>
<div class="MsoNormal">
<span style="mso-ansi-language: EN-GB;">The EU, and
particularly the single market, has become little more than a protection
racket. As we are now seeing as we try to leave, the EU not only bullies those
countries that have chosen to join, like Greece, it also bullies those outside.
The message it is sending out, even to non-members, is play by our rules or we
will trash your economy. This is another reason why it must be stopped. <o:p></o:p></span></div>
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<br /></div>
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Cantab83http://www.blogger.com/profile/12485401571391377815noreply@blogger.com0tag:blogger.com,1999:blog-8416708843386784712.post-21475831695188497622016-08-29T17:15:00.000+01:002016-08-29T18:17:08.413+01:00Time to tax ex-pats<div class="MsoNormal">
<span lang="EN-US">Apparently, John McDonnell, the shadow chancellor, wants Sir Richard Branson to be <a href="http://www.bbc.co.uk/news/uk-37208527" target="_blank">stripped of his knighthood</a>. Why? Because, he claims, Branson is a tax exile living (for most of the time) on his private island in the Caribbean (well the British Virgin Islands to be exact).</span></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span lang="EN-US">According to McDonnell:</span></div>
<div class="MsoNormal">
<span lang="EN-US"><b><i>"The whole purpose of the honours system is undermined when the rich and the powerful can collect their gongs without giving anything back. It's even worse when tax exiles are given honours."</i></b></span></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span lang="EN-US">Now John McDonnell may have a point, but is his solution the right one? Is the right solution to strip Branson of his "gong"? Or is the better solution to make him pay more tax in the UK?</span></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span lang="EN-US">According to McDonnell the problem is the honours system but I would argue that the real culprit is the tax system. What we are dealing with here is tax avoidance, even if Sir Richard Branson <a href="http://www.bbc.co.uk/news/uk-24513875" target="_blank">claims</a> his choice of residence is driven by the scenic location and not the potential tax advantage.</span></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span lang="EN-US">Sir Richard Branson is, however, not the <a href="http://expatandoffshore.com/blog/top-ten-tax-exiles" target="_blank">only alleged tax-avoiding knight</a> to be domiciled outside the UK. <a href="http://www.bbc.co.uk/news/business-36879241" target="_blank">Sir Philip Green has attracted controversy</a> recently, and it is probably only a matter of time before a neighbour of his in Monaco, <a href="http://www.independent.co.uk/news/people/sports-personality-of-the-year-contender-lewis-hamilton-i-pay-a-lot-of-tax-in-the-uk-9923752.html" target="_blank">Lewis Hamilton</a>, receives his own gong as well. So why does this matter? Well, because this issue highlights one of the key issues in tackling tax avoidance: residence.</span></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span lang="EN-US">In previous posts I have discussed how different types of corporate tax avoidance schemes work such as <a href="http://cantab83.blogspot.co.uk/2013/06/tax-avoidance-3-transfer-pricing.html">transfer pricing</a> and the abuse of <a href="http://cantab83.blogspot.co.uk/2013/05/tax-avoidance-2-gsk-loan-trick.html">debt interest relief</a>. Other possible techniques involve the abuse of royalty payments, but more on that some other time. Unfortunately it is not just corporations that are guilty. The super-rich, celebrities, sports stars and entertainers are all complicit. And so too are millions of middle income professionals living and working in places like Dubai, or retiring to sunnier climes with lower tax rates. In 2010 <a href="http://www.independent.co.uk/voices/so-many-brits-now-live-abroad-that-theyre-causing-immigration-debates-oh-the-irony-a6723006.html" target="_blank">it was estimated that 3.97 million Brits were living abroad</a>. Today the figure is probably even higher. Most are earning much more than the average wage in this country and many are earning that money virtually tax free. As I pointed out when discussing Brexit, <a href="http://cantab83.blogspot.co.uk/2016/06/the-labour-case-for-brexit.html">tax avoidance within the EU</a> is a major factor in undermining the finances of sovereign member states, but so too in tax avoidance from outside the EU.</span></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span lang="EN-US">At the heart of the problem is the tax system itself and its rules. Most countries only tax people who are resident in that country. Additionally they may tax their citizens living abroad, but only on income earned in their native country. <a href="http://hodgen.com/does-the-united-states-stand-alone/" target="_blank">The exception is the USA</a>. Only it of all the industrialised countries taxes its citizens wherever they live.</span></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span lang="EN-US">What is now becoming abundantly clear is that taxing individuals on the basis of either their country of residence or the place/location/country of their income does not work. In a globalised world with freedom of movement of labour and capital it is impossible to definitively allocate a person's earnings to a single territory. The result is that it is relatively easy for the rich (and not so rich) to avoid tax to the detriment of their fellow citizens whose employment is less mobile. The only way to solve this problem is to tax people based on the thing that they cannot change or disguise easily: their nationality. So why don't we?</span></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span lang="EN-US">Well part of the reason is historical, but another reason is the EU, and in particular the single market. Single market rules currently prevent us from taxing our citizens living in the rest of the EU, but as we are about to leave the EU there is now no legal reason why we couldn't follow the example of the USA. If we did we could also apply the same rule to UK citizens living in overseas crown dependencies like the British Virgin Islands, the Isle of Man and the Channel Islands. </span></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span lang="EN-US">So how would this work? Well tax should be payable in two stages. The first obligation should be based on residence (as now) with all individuals being obliged to pay tax first on income derived in their country of residence to the government of their country of residence. However, the second stage would be based on nationality with the payee paying additional tax to their country of origin (i.e. the UK) equal to the difference between what they would be expected to pay if they resided in the UK and all their income was generated in the UK, and the tax on their total global income that they do pay. </span></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span lang="EN-US">So, for those who are already living in countries that do tax their income on the basis of residence, standard double taxation rules should apply with the UK citizen paying the difference to the UK Treasury between what they pay abroad and what they would pay on their entire global income if they had remained in the UK and all their earning had been generated in the UK. For completeness we should of course continue to tax overseas nationals on their earnings in the UK based on residence. </span></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span lang="EN-US">In short, the only changes would be that British citizens living abroad would be obliged to pay tax as if they lived in the UK while British citizens living in the UK would be taxed in the UK on their worldwide earnings. </span></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span lang="EN-US">Taxing UK citizens in this way would have a number of positive advantages. Firstly, it would be easier to enforce. Secondly, there would be no tax advantage for UK nationals to move their country of residence away from the UK. That would make it easier for governments to adjust the tax rates without losing tax through avoidance schemes. Thirdly, it would reduce emigration of highly skilled professionals such as doctors. Fourthly, it would reduce demand for tax havens, and finally it would increase tax revenues. In fact it could raise over £100bn in extra revenues; enough to fund the entire NHS. And then if UK citizens did still decide to go and live on their own private Caribbean island, we could at least be more certain that the decision was more likely to be motivated by a love of the scenery and not by a love of their bank balance.</span></div>
Cantab83http://www.blogger.com/profile/12485401571391377815noreply@blogger.com0tag:blogger.com,1999:blog-8416708843386784712.post-22529453826770198882016-08-15T23:53:00.000+01:002016-08-15T23:54:31.342+01:00MMT vs the bond marketWhy do governments borrow from the bond
market? Is there a better way for governments to finance their deficits than
this? If so, what economic factors should determine where governments need to
look for finance? These are questions that I have been asking myself over the
past few months and years, but I seem to be in a minority. Certainly most
mainstream economists don't seem to be that bothered, but I think they should
be because it is becoming pretty obvious that the old ways don't work any more.<br />
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span lang="EN-US">This week the <a href="http://www.bbc.co.uk/news/business-36976528" target="_blank">Bank of England cut interestrates to 0.25%</a> and embarked on a new wad of quantitative easing (QE) in a bid
to head off recession. Now <a href="http://cantab83.blogspot.co.uk/2012/02/why-zero-interest-rate-equals-zero.html" target="">I pointed out a few years ago</a> that lowering interest
rates to near zero will have practically no effect on stimulating extra demand
for credit and so will not create new demand via increased consumer spending in
the real economy either. Only a fiscal stimulus will do that but this
government has set itself against doing anything that remotely resembles
Keynesian interventionism. But as <a href="http://cantab83.blogspot.co.uk/2016/08/who-is-afraid-of-bond-market-paradox-of.html" target="">I pointed out last time</a>, even governments
that are supposed to believe in Keynesian economics have consistently failed to
apply sufficiently large fiscal stimuli during major recessions. </span></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span lang="EN-US">Yes they increase welfare spending, but
only because unemployment has increased and that has forced their hand. Meanwhile,
they compensate by cutting spending in other areas to try and minimise total borrowing.
These cuts often further increase unemployment and lower GDP. This leads to the
austerity that we have been familiar with over the last eight years, and while welfare
spending has still increased, it has often been undertaken grudgingly and
parsimoniously. Consequently, while government spending increases, it does not
increase fast enough to reverse the effects of the recession. The result is the
recession is longer and deeper than it needed to be and chancellors like George
Osborne continuously miss their deficit targets. </span></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span lang="EN-US">So while the government may claim that
their actions are Keynesian because they are increasing spending and borrowing
in the recession, their actions cannot in any way be considered to be within
the spirit of Keynesianism because they make no attempt to restore the economy
to full employment or maximum output. But this failure to adhere to Keynesian
orthodoxy is not totally ideological. As I pointed out previously, the last
Labour government was almost as obsessed with deficit reduction post-2008 as
the Tories have been. What drives this fiscal trepidation is fear and loathing
about debt. In the aftermath of the 2007 crash the worry was all about debt to
GDP ratios and sovereign default. We were bombarded with threats to our credit
rating from the very credit agencies that partially created the financial
crisis in the first place. We were told that if we borrowed too much we would
end up like Greece. But all this was bogus economic scaremongering for two
reasons.</span></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span lang="EN-US">Firstly, unlike Greece we had control of
our own currency, and secondly all our debt was denominated in our own
currency. No developed country has ever defaulted on its sovereign debt when
that debt has been denominated in its own currency. But there is another more
important point that needs to be appreciated when it comes to sovereign debt.
Who you borrow from matters just as much as, if not more than, how much you
borrow.</span></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span lang="EN-US">To see this consider these two examples.
Greece currently has a debt to gdp ratio of 180%. As a result most economists
consider Greece to be essentially bankrupt and incapable of paying back what it
owns. Most expect it to default sooner or later. Japan on the other hand has an
even higher debt to gdp ratio of 230% but no-one expects Japan to go bust. Why?
</span></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span lang="EN-US">The answer is because Greece owes virtually
all its debt to foreign creditors (ECB, IMF, German and French banks) in a
currency that it cannot print, cannot control, and cannot devalue. Even if
Greece left the euro its new currency would devalue and its economy shrink
relative to its economic competitors, but its debt would not. So its debt to
gdp ratio would skyrocket even further. </span></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span lang="EN-US">Japan's debt on the other hand is owned
mainly by its own citizens and domestic banks and corporations and is also
denominated in its own currency. The Japanese government can never fail to
repay its debts because it can always raise taxes on the people it owes money
to in order to pay them the money it owes them. As a result it can never run
out of money and the money it pays out in interest and maturity repayments
never leaves the Japanese economy. The only risk to the Japanese government is
loss of confidence by the public in the government and a rush to liquidate the
bonds they hold, but this can be avoided in two ways. Either the government can
impose fixed maturity dates on the bonds or savings, or it can borrow from
itself in the form of its central bank (like QE). This latter mechanism is the
essence of what is known as modern monetary theory or MMT, which I will discuss
further in a future post, and what this and previous posts are intended to
provide the justification for.</span></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span lang="EN-US">What this shows is that when it comes to
national debt, borrowing from within your own currency area is more sustainable
than borrowing from outside it. In short, countries that borrow internally
instead of externally from the bond market can never go bust. This is one major
reason why countries should shun the bond market, but there are other good
reasons as well.</span></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span lang="EN-US">Every time a government borrows from
overseas it is adding to the current account deficit. The UK gilts created are in
effect exchanged for foreign currency which can then be used to purchase
additional goods from overseas. This happens without an equal amount of
production having taken place inside the UK and then exported. Alternatively,
the foreign currency is first converted to sterling in order to buy the gilts,
thereby leading to a strengthening of sterling on the currency markets. Neither
of these effects is desirable. </span></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span lang="EN-US">So what is clear is that conventional methods
of government borrowing come with a significant sting in the tail, and yet as
QE has shown, these stings are often unnecessary and could be avoided. So why
does most of the mainstream economic community not appear to get this? Why
don't they recognise that there might be better ways for governments to finance
their deficits and to run the economy?</span></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span lang="EN-US">Well one reason that they continue to use
the bond market is perhaps because that is what they have always done. In the
times before fiat currency and free flows of capital governments needed to
physically borrow other people's money in order to spend it. Money creation was
not possible. But I think there is a deeper problem. Economists don't think
like physicists. A physicist will always tackle a problem by simplifying it to
its core. This means first considering a closed system problem and then looking
at system leakage as a perturbation to that initial system. Economics on the
other hand seems obsessed with open systems, globalisation and free trade. </span></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span lang="EN-US">What I think MMT could do is allow a
government to more effectively internalise its economy and protect its currency.
It could enable it to borrow unlimited funds (from its own central bank) in a
recession in order to enact a proper Keynesian response to a financial crisis.
This in turn could be used to fund investment, job creation or helicopter money
which would be far more effective than cutting interest rates to zero or
providing QE for banks. The result could be much greater macroeconomic control
and shorter and shallower recessions. </span></div>
<div class="MsoNormal">
<br /></div>
<!--EndFragment-->Cantab83http://www.blogger.com/profile/12485401571391377815noreply@blogger.com0tag:blogger.com,1999:blog-8416708843386784712.post-66463756374476559412016-08-11T21:48:00.000+01:002016-08-11T21:48:28.575+01:00Who is afraid of the bond market? The paradox of KeynesianismOne of the added benefits of Brexit is that it has finally forced the government to kill off George Osborne's tenure at No. 11 Downing Street and thus abandon his insane attempts to balance the country's finances through austerity. But it would nevertheless be unfair to blame George Osborne entirely for the austerity of the last six years. Why? Because he was only doing what most mainstream economists and the opposition Labour Party were telling him to do, only doing it better.<br />
<br />
The problem is this. Cast your mind back to the 2010 general election and remind yourself of the options that were available to the electorate. In essence there were only two: Osborne with his austerity-max, and the Labour Party with its austerity-lite. Neither were very appealing, but more pertinently, neither had any basis in macroeconomic theory, or more specifically in that part we consider as pure Keynesianism.<br />
<br />
According to Keynes, the appropriate fiscal response of a government in a recession is to cut taxes and increase spending. The aim is to increase aggregate demand in the economy to compensate for the fall that has induced the recession thereby helping to rebuild confidence and restore output to pre-recession levels. Unfortunately there is a problem with this plan: nobody seems to have the necessary bottle to carry it out. This is because the plan as it is conventionally implemented contains a fundamental flaw. That flaw is debt.<br />
<br />
In a recession incomes and employment levels fall and hence so too do tax revenues. In contrast unemployment levels rise and so consequently does social security spending. As a result the government budget deficit grows more negative and the national debt increases. And the bigger the recession, the bigger the deficit and so the bigger the borrowing requirement will be. Now in theory this shouldn't matter because a government that prints its own currency can never run out of money, but in practice it does matter because economists and the financial markets obsess about debt to GDP ratios and sovereign default, and driving this fear are the IMF, the bond market and the credit agencies.<br />
<br />
The consequence of this is that in a recession when Keynesian theory demands that governments borrow whatever is necessary to get the economy moving again and operating back near full capacity, the bond market is urging caution and threatening to restrict credit. So in 2010 even though UK gilt yields were at historic lows and government borrowing was dirt cheap, all the talk was about reducing borrowing as quickly as possible to prevent market bond rates rising and our credit rating falling. Yet paradoxically, before the crash when the economy was booming and the government should have been discouraged from borrowing, there was no such alarm in the markets about UK debt and borrowing was positively encouraged.<br />
<br />
This is the paradox of current Keynesian economics. When your economy is in a deep recession and Keynes says "borrow borrow borrow", the bond market wants to do the opposite. Yet when the economy is booming and Keynes says governments need to operate a surplus, the bond market is quite happy to lend you anything you want. Just ask Gordon Brown.<br />
<br />
So in 2010 instead of both main political parties promising to cut taxes, raise welfare payments and increase investment as Keynesian theory demands, both political parties promised to do the opposite, but by slightly different amounts (obviously) in order to at least maintain a pretence of economic and political pluralism. All of this should therefore make economists think seriously and critically about what they really understand by Keynesian policies and how they can implement them because what this clearly demonstrates is that the current paradigm that they adhere to just isn't working. Not only that, it can NEVER work.<br />
<br />
Fortunately there is a solution. That solution is Modern Monetary Theory or MMT. (To be continued...)<br />
<div>
<br /></div>
Cantab83http://www.blogger.com/profile/12485401571391377815noreply@blogger.com0tag:blogger.com,1999:blog-8416708843386784712.post-56562829571442956382016-06-29T17:50:00.000+01:002016-08-12T01:44:53.721+01:00Does migration reduce inequality?<div class="MsoNormal">
In his defence of the
EU the Oxford economist Simon Wren-Lewis <a href="https://mainlymacro.blogspot.co.uk/2016/06/brexit-and-left.html" target="_blank">recently made a number of interesting claims</a> that directly relate to the general debate on the benefits, or
otherwise, of immigration, globalisation and free trade. One that stands out is
this in response to Kate Hoey's claim that migration has been used to suppress
the wages of the low paid:<o:p></o:p></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<b><i><span style="mso-ansi-language: EN-GB;">"</span><span lang="EN-US">She seems to be arguing that free movement in the EU is a means of
keeping down the wages of the low paid. The first point to make is if labour
mobility keeps wages down in the destination country, it should increase wages
and/or reduce unemployment in the country the migrant came from. As migrants
move from lower to higher wage countries, then migration tends to equalise
incomes. This should normally count as a plus from a left wing perspective."</span></i></b></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span style="mso-ansi-language: EN-GB;">Well it is certainly
true that migration reduces unemployment in the country of origin. It is also
true that migrants tend to repatriate a portion of their earnings to their
country of origin and so help to <span style="mso-spacerun: yes;"> </span>increase
its GDP per capita and thus increase its overall prosperity. In theory this
should help to close the gap in inequality between rich countries and poor ones,
and thereby <i>"</i></span><span lang="EN-US">equalise incomes".</span></div>
<span style="mso-ansi-language: EN-GB;"> One could also then argue that once the
poorer countries have attained a sufficient level of income, they will also be
able to trade with richer countries as equals, in effect increasing the size of
the market accessible to firms in both countries. This is the essence of current
globalisation policy and is one reason for the EU's policy of continued expansion.
It is therefore certainly true that it could be claimed to be <i>"a
plus from a left wing perspective"</i> in that it raises living
standards and reduces inequality in the poorer country. As such it probably
does the same globally as well. The problem is that it doesn't do so in the
richer country.<o:p></o:p></span><br />
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span style="mso-ansi-language: EN-GB;">In the richer country most
of the immigration will be into low paid jobs, and much of the earned income that
results will leave the country. This will have two negative effects on
aggregate demand in the rich country. Firstly, it will force down wages of the
low paid through increased competition; secondly, the additional economic
activity that results from the immigrant workers will be exported and so will
not be used to stimulate extra demand (a multiplier effect) to replace that
lost through job losses and earnings reductions of the existing low paid
workers. On top of that the population will have increased so GDP per capita
will be reduced.<o:p></o:p></span></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span style="mso-ansi-language: EN-GB;">Now it is probably
true that once the economies of the two countries have equalised both countries
will benefit fully and equally from the larger market available to them. <span style="mso-spacerun: yes;"> </span>The question, though, is how long will this
take? As Keynes famously put it, "In the long run we are all dead."
The point he was making when he said it was that time is not infinite and
people are not immortal. After a recession or depression the economy will
inevitably recover eventually. The argument of classical economists is that, if
the economy is going to recover anyway, then it doesn't need any government
intervention to help it along. The argument Keynes was making was that ordinary
people can't wait that long and therefore the recovery needs to be brought
about as soon as possible through active interventionism, rather than arriving
at some unspecified later date because of passive liberalism. That same statement
can also be applied to the effect of immigration on the poor in developed
countries. How long must they wait for the benefits of migration to bear fruit?
Until after they are all dead?<o:p></o:p></span></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span style="mso-ansi-language: EN-GB;">The reality is migration
is just another manifestation of globalisation policy and both have been
exploited and abused to suppress wages in developed countries because that is
how western governments have managed to deliver economies that simultaneously
have low inflation and low interest rates. That is why living standards in most
developed countries have stagnated for the bottom 50% over the last 30 years. In
which case I would argue that Kate Hoey is correct in her viewpoint and
Professor Wren-Lewis is wrong. Moreover, I would argue that an economic policy
is only beneficial and equitable if those that sacrifice the most in the short
term also benefit the most in the long term. That after all is one reason why
most on the left reject austerity. But if migration hurts the poor in the UK
and benefits the rich, how is this <i>"a plus from a left wing
perspective"</i>? And of course the adverse side effect of all this
of course is massive wage inequality in the rich countries, excess savings by
the rich, low investment and asset price booms. Ultimately that is why we are
in the mess we are in now.<o:p></o:p></span></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
But the above is not
the only point of contention I find with the views of Professor Wren-Lewis. <a href="https://mainlymacro.blogspot.co.uk/2016/06/brexit-and-left.html" target="_blank">In the same blog post he then went on to say:</a><o:p></o:p></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<b><i><span style="mso-ansi-language: EN-GB;">"</span><span lang="EN-US">Migrants tend to be young, healthy and working. They provide more in
terms of resources than they take out by using public services. I remember
having a conversation about this with someone who lived in Spain. He said if
anyone should be angry about free movement it is Spain, in having to take lots
[of] non-productive British pensioners who will be a burden on Spain’s health
service.</span><span style="mso-ansi-language: EN-GB;">"</span></i></b></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span style="mso-ansi-language: EN-GB;">This argument also
contains a number of major flaws in its reasoning. Firstly, it neglects to take
into account the fact that most of the UK pensioners that have moved to Spain
have done so on large pensions. These pensions are paid out in the UK by
insurance companies and the government but spent in Spain. Therefore not only
does this constitute a massive export of capital from this country, it also
leads to an equally massive loss of both consumption and taxation in the UK.
This loss of government revenue far exceeds any burden those pensioners would
place on the NHS if they were to return to the UK. The UK therefore loses from
this arrangement and Spain gains.<o:p></o:p></span></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span style="mso-ansi-language: EN-GB;">Secondly, the argument
fails to take account of my previous point, that migrants tend to repatriate a large
portion of their earnings to their country of origin. As a result any increase
in economic activity that results from the immigrant workers will be exported
and so will not be used to generate extra demand in the UK. In short there will
be no multiplier effect that would create additional jobs to compensate for the
immediate effects of immigration.<o:p></o:p></span></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span style="mso-ansi-language: EN-GB;">What this shows is
that it is not just inward migration that can hurt the UK economy, but also
outward migration. Both have negative effects on our budget deficit and our
trade deficit. And as I have argued previously, both therefore represent an
existential threat to the solvency of the national government and therefore
ultimately to the democracy of the UK, because if a Labour government cannot
fund its programmes, then there can be no Labour government. In short we end up
like Greece.<o:p></o:p></span><br />
<span style="mso-ansi-language: EN-GB;"><br /></span>
<span style="mso-ansi-language: EN-GB;">But if you still think unlimited immigration is a good thing then consider <a href="http://socialdemocracy21stcentury.blogspot.co.uk/2016/06/jeremy-corbyns-fantasy-world.html" target="_blank">this from Social Democracy for the 21st Century</a>:</span><br />
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span lang="EN-US"><b><i>"Corbyn is also delusional if he
thinks effective Keynesian fiscal policy will be possible in Britain with an
open border policy, for the more prosperous a country becomes, the more it will
simply become a magnet for mass immigration from Europe, which in the process
will defeat the whole purpose of fiscal policies to create full employment."</i></b></span><br />
<br />
In other words full employment is impossible if you have an open borders policy. And what is the point of a Labour Party that doesn't believe in full employment?</div>
</div>
<div class="MsoNormal">
<br /></div>Cantab83http://www.blogger.com/profile/12485401571391377815noreply@blogger.com0tag:blogger.com,1999:blog-8416708843386784712.post-7076430713366858392016-06-23T00:00:00.000+01:002016-08-11T01:23:19.842+01:00Lies, damned lies, and EU statistics<div class="MsoNormal">
<div class="MsoNormal">
<span lang="EN-US"><span style="font-family: "times" , "times new roman" , serif;">According to virtually every major
economics organisation (IMF, OECD, IFS, BoE, The Treasury) the EU is such an
enormous benefit to the UK economy that leaving would amount to economic
suicide. Yet despite 95% of mainstream economists supporting the Remain
campaign the public is unimpressed. Why? Well perhaps the reason is this: there
is no definitive data to support their claim.</span></span></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span style="font-family: "times" , "times new roman" , serif;"><span lang="EN-US">One of the arguments against Brexit </span>from economists such as Simon Wren-Lewis is that it would make it more difficult for us to trade with
countries next to us and that would hurt our economy. It is the classic neoliberal
free-trade argument even though Wren-Lewis <a href="https://mainlymacro.blogspot.co.uk/2014/02/speaking-as-old-new-keynesian.html">claims to be a New Keynesian</a>. But
no-one who supports Brexit is arguing that leaving the EU is for the purpose of
reducing trade with Europe. Nor can any rational and informed thinker possibly believe that a reduction trade with the EU would be the end result. The lobbying power of the multinationals would ensure that. This then is a spurious argument. The fact that it relies on a contentious, unproven and ideological belief in the universal benefit of free trade makes it even worse.</span></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span lang="EN-US"><span style="font-family: "times" , "times new roman" , serif;">Another argument put forward is that
because 40% of our overseas trade is with the EU then our future economic growth
will be greater inside the EU than outside. This is the argument put forward by
George Osborne. In addition he and David Cameron have claimed that leaving the
EU would result in a massive recession and a third world war (or both), while our membership of the EU has
delivered greater economic growth than would otherwise have happened. The problem is that claim is untestable because the alternative scenario is counterfactual. That said, we can attempt to test it simply by going back in time.</span></span></div>
<div class="MsoNormal">
<span lang="EN-US"><span style="font-family: "times" , "times new roman" , serif;"><br /></span></span></div>
<div class="MsoNormal">
<span style="font-family: "times" , "times new roman" , serif;"><span lang="EN-US">If we assume that leaving the EU represents the converse process
to joining, then leaving should deliver the converse results of joining. So the question then becomes: what was the
economic consequence of joining the EU? Well t</span>he graph below shows the growth rate in
real GDP in the UK over the last sixty years.</span></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span lang="EN-US"><span style="font-family: "times" , "times new roman" , serif;"><iframe height="300" span="" src="http://cdn.tradingeconomics.com/embed/?s=ukgrybzy&v=201606141716n&d1=19160101&d2=20161231&h=300&w=600" style="mso-spacerun: yes;" width="600">
</span>frameborder='0' scrolling='no'></iframe><br />source:
<a href="http://www.tradingeconomics.com/united-kingdom/gdp-growth-annual">tradingeconomics.com</a></span></span></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span lang="EN-US"><span style="font-family: "times" , "times new roman" , serif;">If joining the EEC was the economic boon
that the Pro-Europeans claim then there should have been a significant increase in the
growth rate after 1973, yet according to the graph above there was none. Moreover, after the signing of the
Maastricht Treaty in 1992 there should have been a second boost. Again none is detectable. What there is instead is a clear decrease in the amplitude of the fluctuations in growth rate, possibly
in part due to a decrease in the inflation rate over the period in question. To analyse the above data more
clearly it is perhaps better to present it as a plot of real GDP per capita
versus time (rather than growth rate versus time) and calculate the compound
growth rate. This is shown below for the period 1960-1973 covering the period
immediately prior to the UK joining the EEC.</span></span></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span lang="EN-US"><span style="font-family: "times" , "times new roman" , serif;"><iframe height="300" span="" src="http://cdn.tradingeconomics.com/embed/?s=gbrnygdppcapkd&v=201606141716n&d1=19600622&d2=19740622&h=300&w=600" style="mso-spacerun: yes;" width="600">
</span>frameborder='0' scrolling='no'></iframe><br />source:
<a href="http://www.tradingeconomics.com/united-kingdom/gdp-per-capita">tradingeconomics.com</a></span></span></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span lang="EN-US"><span style="font-family: "times" , "times new roman" , serif;">The above data shows that real GDP per
capita rose by a factor of 53% over this period. This equates to an average
growth rate of 3.3% per annum. Now if we look at the period immediately after
joining the EEC we see a different behaviour.</span></span></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span lang="EN-US"><span style="font-family: "times" , "times new roman" , serif;"><iframe height="300" span="" src="http://cdn.tradingeconomics.com/embed/?s=gbrnygdppcapkd&v=201606141716n&d1=19730622&d2=19920622&h=300&w=600" style="mso-spacerun: yes;" width="600">
</span>frameborder='0' scrolling='no'></iframe><br />source:
<a href="http://www.tradingeconomics.com/united-kingdom/gdp-per-capita">tradingeconomics.com</a></span></span></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span lang="EN-US"><span style="font-family: "times" , "times new roman" , serif;">Over the period 1973 to 1992 real GDP per
capita rose by 38%. This equates to only 1.7% per annum.</span></span></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span lang="EN-US"><span style="font-family: "times" , "times new roman" , serif;"><iframe height="300" span="" src="http://cdn.tradingeconomics.com/embed/?s=gbrnygdppcapkd&v=201606141716n&d1=19920622&d2=20140622&h=300&w=600" style="mso-spacerun: yes;" width="600">
</span>frameborder='0' scrolling='no'></iframe><br />source:
<a href="http://www.tradingeconomics.com/united-kingdom/gdp-per-capita">tradingeconomics.com</a></span></span></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span lang="EN-US"><span style="font-family: "times" , "times new roman" , serif;">Finally, if we look at the period after the
Maastricht Treaty was signed real GDP per capita grew by 42% equating to an
annual growth rate of only 1.6% per annum.</span></span></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span lang="EN-US"><span style="font-family: "times" , "times new roman" , serif;">What all this clearly demonstrates is that
there was no spurt in economic growth after joining the EEC, or after signing
the Maastricht Treaty. In fact in both cases the growth rate went down. So this appears to torpedo the principal claim of the Remain camp that EU membership boosts growth. The reasons of course are easy to understand.</span></span></div>
<div class="MsoNormal">
<span lang="EN-US"><span style="font-family: "times" , "times new roman" , serif;"><br /></span></span></div>
<div class="MsoNormal">
<span style="font-family: "times" , "times new roman" , serif;"><span lang="EN-US"><span style="font-family: "times" , "times new roman" , serif;">Firstly, over much of the last thirty years the EU has been obsessed with enlargement, and most of the new member states have been economically underdeveloped. It therefore follows that any process of economic convergence must have involved a transfer of economic growth from the old member states to the new ones. This will inevitably have had a negative impact on growth rates in the developed countries. In effect at each level of increasing EU integration the developed countries have effectively exported an increased amount of their economic growth to other countries in the EU.</span></span></div>
<div class="MsoNormal">
<span lang="EN-US"><span style="font-family: "times" , "times new roman" , serif;"><br /></span></span></div>
<div class="MsoNormal">
<span lang="EN-US"><span style="font-family: "times" , "times new roman" , serif;">Secondly, migration has had negative impacts on wages, tax receipts and investment. <a href="https://mainlymacro.blogspot.co.uk/2016/06/brexit-and-left.html">According to Simon Wren-Lewis</a>:</span></span></div>
<div class="MsoNormal">
<span style="font-family: "times" , "times new roman" , serif;"><br /></span></div>
<div class="MsoNormal">
<span lang="EN-US"><span style="font-family: "times" , "times new roman" , serif;"><i><b>"Migrants
tend to be young, healthy and working. They provide more in terms of resources
than they take out by using public services."</b></i></span></span></div>
</div>
<o:p></o:p><br />
<div class="MsoNormal">
<br /></div>
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<span style="font-family: inherit;"><span style="font-family: "times" , "times new roman" , serif;">Well the first part of this
may be true but the second is most definitely not. What Professor Wren-Lewis has conveniently
omitted from his thesis is that most migrants pay little or no tax because most of them are
seasonal workers, and under EU rules, if you work in a country for less than 6 months
you are exempt from income taxes. In addition, most migrants are net savers and
they spend those savings in their country of origin, not here, so there is no
multiplier effect. The result is that they do not create as many new jobs as they take away. The best migration is permanent migration because it is more
likely to involve people with tradable skills, in high income professions who
invest all their earnings in this country thereby creating as many, if not
more, jobs than they take away. On top of this, migration also has a negative impact on investment because employers don't need to train or retrain their existing workers if they can source the necessary skills from elsewhere at zero cost.</span> </span></div>
<div class="MsoNormal">
<span lang="EN-US"><span style="font-family: "times" , "times new roman" , serif;"><br /></span></span></div>
<div class="MsoNormal">
<span lang="EN-US"><span style="font-family: "times" , "times new roman" , serif;">The analysis above all seems to have passed by the economics establishment. The big question is why?</span></span></div>
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</div>Cantab83http://www.blogger.com/profile/12485401571391377815noreply@blogger.com0tag:blogger.com,1999:blog-8416708843386784712.post-2872023002377538192016-06-04T17:15:00.000+01:002016-08-29T18:18:13.086+01:00The Labour case for Brexit<div class="MsoNormal">
<div class="MsoNormal">
<span style="mso-ansi-language: EN-GB;">You would be hard pressed to deduce this from the current political mood music but, like the
Conservatives, the Labour Party has always had a pretty ambivalent attitude to
the EU. That much is at least self evident if one looks back at the history of
the party and how it split over the 1975 EEC referendum. The main difference though between the two parties is that the things Labour likes about the EU (the Social Chapter, protection of human rights etc.) tend to be the things the Tories hate, and vice versa. What is therefore surprising is
that there is<span style="mso-spacerun: yes;"> </span>not the same debate about the EU in the Labour Party this time around as there was in 1975. My view is that
there should be because the potential threats posed to our democracy and to the
viability and effectiveness of any future Labour government by the EU (at least
in its current form and with its current direction of travel) are now much
greater than they have ever been.<o:p></o:p></span></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span style="mso-ansi-language: EN-GB;">These threats I
believe are two-fold. The first is economic, the second democratic. The
economic threat comes from the increasingly unviable state of national finances
and taxation frameworks and the negative impact on both of these posed by the
single market. For a government to function effectively it needs to be able to borrow what
it needs when it needs, and it needs to be able to tax who and what it needs in
a similar vein. This is because taxation is not just a means of raising revenue to fund services: it is also a macroeconomic tool that should be used in conjunction with borrowing to correct imbalances within the economy and thereby promote economic stability. Yet even outside the euro this will become increasingly hard as the
EU becomes more integrated and the single market becomes all-powerful and all-consuming.<o:p></o:p></span></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
This is because at the
heart of the new EU is the single market. The single market is everything. The
single market is sacrosanct. Nothing will be allowed to interfere with the
single market. That means all government policies will be tested against this
question: do they distort the single market? If so then they will be deemed to
be illegal. We have already seen the start of this trend with the decision of
the European Court of Justice (ECJ) to <a href="http://www.bbc.co.uk/news/uk-scotland-35160396" target="_blank">vote against minimum pricing of alcohol in Scotland</a>. Next it will be differences in excise duty that come under the
spotlight, then VAT. After that it will be corporation tax on companies, and
possibly even income tax. But you don't need the single market or the ECJ to
bring about harmonisation of tax rates: that will happen automatically if we
continue to allow the freedom of movement of people.<o:p></o:p></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span style="mso-ansi-language: EN-GB;">The freedom of
movement of people or workers is one of the four pillars of the single market,
the other three being the freedom of movement of capital, goods and services. Implicit
in these is a fifth freedom, the freedom of movement of jobs. Most criticism of
the first of these, the freedom of movement of people, has concentrated on its
effect of immigration. However, there is a secondary impact. If you allow
people to move country then you effectively allow them to choose which taxation
regime they wish to work under. In other words they are able to exercise
consumer choice to choose their tax rate by selecting a country of residence
with as low a tax rate as possible. <o:p></o:p></span></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span style="mso-ansi-language: EN-GB;">We have already seen
the effect of this when President Hollande raised the top rate of income tax in
France to 75%. Many of the wealthy moved to London or across the border into
Belgium, Luxembourg, Germany or Switzerland, and then commuted back to France
for their work if they needed to. Of course if your income tax was dictated by
your nationality and not your country of residence (as is the case for US
citizens) such movements would not be financially beneficial, but of course EU
rules and the single market prevent this.<o:p></o:p></span></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span style="mso-ansi-language: EN-GB;">The impact of all this
will be two-fold. Firstly it will undermine democracy because it will
effectively allow some voters to circumvent the democratic outcome of national
elections. If you don't like the result then you can just move somewhere else. If
your fellow countrymen vote for a socialist government with better public
services and higher taxes on the wealthy, then the wealthy can just move to a
country with lower taxes. The rich get to have their cake and eat it. <o:p></o:p></span></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span style="mso-ansi-language: EN-GB;">The second impact is a
direct consequence of the first. If the voters can move from country to country
in search of the best tax deal, then countries will be forced to compete for
income. This competition will force them to outbid each other in terms of tax
cuts. The net result will be an inevitable race to the bottom in terms of tax
rates. As a consequence the tax gap that governments currently suffer from will
widen, revenues will fall, spending will decline, and services will worsen,
whether these are in social security, healthcare or education.<o:p></o:p></span></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span style="mso-ansi-language: EN-GB;">The one great virtue
of the EU in the eyes of Labour voters and trades unionists has always been the
Social Chapter of the Maastricht Treaty. This encapsulated the core ideal that
the EU should be for the benefit of workers, and not the owners of capital, by
setting common standards for working rights and conditions that multinational
corporations in particular operating in the EU would have to abide by. The rationale
was that individual member states were too small and powerless to implement
these standards unilaterally because multinationals could effectively force
nations to compete against each other for the jobs those multinationals could
provide. The irony now is that it is competition within the single market that
is the great threat, not to wages but to government finances. Once you allow
freedom of movement of labour then you undermine the fiscal sovereignty of
individual states. Eventually they become financially non-viable with only the
EU itself being able to levy income tax across the EU and across national
borders. The result will be a push towards introducing a federal income tax and
a federal budget with more loss of sovereignty and democracy at national level.<o:p></o:p></span></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span style="mso-ansi-language: EN-GB;">The result of all this
is that it will become virtually impossible to elect a left wing government
because a left wing government by definition is one that will always want to
intervene in the market, either to prevent economic crisis or to stabilise an
economy that is already in crisis, or to reduce the impact of inequality. All
these interventions will necessarily result in a distortion of the market, and
even though the market is imperfect and may be in crisis, this will be deemed
to be against the rules of the single market. So while you may still be able to
vote for a left wing government, that government will not be allowed to
implement anything that resembles a socialist platform. It will be like voting
for a Labour local council but finding that they still have to implement the
same austerity-driven cuts as would have happened under a Tory administration.
And of course the Greeks have already discovered this. They elected Syriza (twice)
and still ended up with their economy being run by <a href="https://en.wikipedia.org/wiki/Dr._Strangelove" target="_blank">Dr. Strangelove</a> in Berlin.<o:p></o:p></span></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span style="mso-ansi-language: EN-GB;">To put this into
perspective imagine some of the policies that a future Labour government might
wish to implement to raise extra taxes and tackle wealth inequality: the
mansion tax; a citizen's income, support of key industries (e.g. steel) in
times of external shocks; taxes and controls on intellectual property. All of
these could be at risk from EU rules and regulation. <a href="http://www.bbc.co.uk/news/business-35105778" target="_blank">The citizen's income (or basic universal income)</a> in
particular is one idea that is gaining support across the continent. <a href="http://www.bbc.co.uk/news/world-europe-36443512" target="_blank">The Swiss are currently voting in a referendum on this issue</a>, but one concern is that the
freedom of movement of people would make it unworkable whereas if eligibility were
based on nationality then immigration would have little or no negative impact.
But under EU rules countries are not allowed to "discriminate" on
grounds of nationality. <o:p></o:p></span></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
The worrying thing is
that the current Labour hierarchy seem oblivious to most of these potential
pitfalls of EU membership. Moreover, by hitching his wagon (and by association
most of the Labour Party) to the Remain campaign, Jeremy Corbyn has made a
massive tactical miscalculation. If the electorate votes to leave them he will
have made Labour unelectable for a generation as no-one will trust the party in
government to keep the UK out of the EU. After all who is going to vote for a
pro-EU party and prime minister if the country is negotiating to leave the EU? At
least if a significant number of senior Labour figures (other than the
commendable Frank Field and Gisela Stewart) had signed up to the Leave campaign
then there would be sufficient alternative leadership candidates, or cabinet
members who could be entrusted to lead future negotiations. And even if the
public votes to stay in the EU the Labour party will likely lose significant
votes to UKIP in future elections as a result. It is an outcome <a href="http://www.bbc.co.uk/news/uk-politics-eu-referendum-36135768" target="_blank">Frank Field has warned about</a> but no-one seems to be listening.<o:p></o:p></div>
<div class="MsoNormal">
<br /></div>
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Cantab83http://www.blogger.com/profile/12485401571391377815noreply@blogger.com3tag:blogger.com,1999:blog-8416708843386784712.post-38210688761882691512013-08-18T23:45:00.001+01:002013-08-18T23:45:10.608+01:00Football economics part 1: transfer fees<div style="text-align: justify;">
This weekend is the start of the Premier League football season. Hooray! Or maybe not? As a football fan even I am becoming disenchanted by the role money plays in the game today, the effect it has on motivating or de-motivating players, and the contribution it makes to the financial instability of clubs of all sizes. So perhaps it is time we started asking if the economics of football can be redesigned, and we could start with that most topical of issues: transfer fees. </div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
The last few weeks have seen the sports pages of our national newspapers monopolized by speculation over the future of players like <a href="http://www.bbc.co.uk/sport/0/football/23446686" target="_blank">Luis Suarez</a>, <a href="http://www.bbc.co.uk/sport/0/football/23316448" target="_blank">Cesc Fabregas</a>, <a href="http://www.bbc.co.uk/sport/0/football/23526530" target="_blank">Gareth Bale</a> and <a href="http://www.bbc.co.uk/sport/0/football/23596179" target="_blank">Wayne Rooney</a>. Of particular interest has been the £40m clause in the contract of Luis Suarez which bares a certain similarity to the buy-out clauses that often feature in the contracts of players at European clubs. These clauses are supposed to represent the amount any other club would need to pay to acquire that player, except that the buy-out clause is hardly ever enforced, and when the player does move clubs it is usually for a much smaller fee. </div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
Of course the Suarez clause isn't technically a buyout clause, so at the time of writing Suarez is still a Liverpool player, and in theory there is nothing that any bidding club or <a href="http://www.bbc.co.uk/sport/0/football/23592181" target="_blank">Luis Suarez can do</a> to change that situation. But as we have seen in the past, if the bid is large enough then the club will sell irrespective of the wishes of the player, and if the player demands a move strongly enough then he usually gets his wish irrespective of the wishes of his current club. The result is a system that suits no-one, that is opaque and arbitrary, and which appears vulnerable to external manipulation and corporate bullying. </div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
The current system is therefore clearly dis-functional. The contracts often appear to be meaningless, particularly to supporters who expect total loyalty of the player to the club and the contract. However those same supporters are less exercised when it comes to selling players that the club no longer wants. And when it comes to the players themselves there is an equal degree of hypocrisy. Players have temporary fixed-term employment contracts that they expect to be honoured in full if they suffer an injury, but which many try to break if they see a better opportunity elsewhere. </div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
So is there a better way for players to be exchanged between clubs? I think there is. As money is the facilitator of such actions then the answer must lie in the economics of the transfer process. At the centre of any transfer policy must be the market value of the player, or his marginal utility. It is fairly easy to calculate what this should be. It will be determined by the player's salary and his length of contract. At any given time an employee's wage is supposedly (in neoclassical theory) determined by the company's gain in net revenue that results from his employment. Therefore his annual value to the company is determined by his salary. His total value over time will be set by the expected duration of his working life at that club and his average annual salary over that time period. For a footballer his expected working life at his current salary is set by the length of his contract. Risk of injury, age and loss of form are all factored into the contract length. Therefore the total marginal utility of the player is set by his current salary multiplied by the time left on his contract. </div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
The advantage of this formula is that everyone would know where they stand. The player and his current club would know that if a rival club were to bid more than the product of the player's current salary and the remainder of his contract then the player can move. His current club would know that if they wish to ward off such rival bids then they must offer the player either a longer contract, or a higher salary. And everyone would know that the closer that a player gets to the end of his contract the less his transfer fee will be. In that sense this idea merely formalizes the situation that already operates in practice where players with only one or two years left on their contract start to see their transfer value decline. </div>
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The net result of such a change would be that transfer fees would probably fall and players' wages probably rise, with the wages of the very top players being most affected. Whether that is good or bad depends on your perspective (I will deal with the question of clubs' income and player salaries in another post), but it would mean that transfers of players would be smoother with the player's current club being unable to block such moves with outrageous demands over transfer fees. (Is Gareth Bale really worth £100m, or Suarez worth more than £40m?) In return though, the selling club would be guaranteed a fair fee. It would also mean that the most valuable players would move to the teams where they would have the greatest marginal utility. But more importantly it would rid football of the current tug-of-love fiascos that are played out in the media between players and competing clubs, as well as the tapping up of players, and all the other mechanisms by which clubs, journalists and agents seek to unsettle players in order to force a move, often at below the market rate.
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Cantab83http://www.blogger.com/profile/12485401571391377815noreply@blogger.com0tag:blogger.com,1999:blog-8416708843386784712.post-14733171708911262242013-07-05T22:54:00.001+01:002013-07-05T22:54:23.848+01:00Loony policy proposal No. 1 - 200 GBP visas to deter use of NHS<div style="text-align: justify;">
Have we reached the silly season already? It seems like it with <a href="http://www.bbc.co.uk/news/health-23156403" target="_blank">this</a> proposal. </div>
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Political parties are rarely any good at coming up with workable policies when they are in office, but then again they don't seem to be much better at it when they are out of office either. And when it comes to the design of inept policies they don't get much wackier than <a href="http://www.bbc.co.uk/news/health-23156403" target="_blank">this</a> one. It therefore seems entirely apposite to start a new series of articles highlighting such political ineptitude and fuzzy logic with this real corker of an idea. </div>
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The ConDem coalition's <a href="http://www.bbc.co.uk/news/health-23156403" target="_blank">latest big idea</a> is to charge all overseas non-EU visitors an extra £200 for their visas in exchange for the right to use the NHS when they are here in the UK. The alleged reason for <a href="http://www.bbc.co.uk/news/health-23156403" target="_blank">this</a> policy is to counter so-called health tourism where overseas migrants come to the UK to use our NHS but then avoid paying for the treatment they get. The first question, therefore, is will this policy work? Will it deter people from coming to the UK just to use our health service for free? </div>
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The answer to this is clearly no. Charging foreigners £200 pounds is going to be no deterrent when the potential benefits are health costs that could be a hundred or a thousand times greater. In fact £200 is even barely significant when compared to many international air fares. So where is the actual deterrent? In fact you could argue (and <a href="http://www.taxresearch.org.uk/Blog/2013/07/03/wont-the-new-nhs-visa-levy-on-immigrants-increase-health-tourism/" target="_blank">Richard Murphy does</a>) that the new policy could actually increase the scale of the problem by legitimizing it. That, however, is not the only massive flaw in this policy. </div>
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The second question is does it result in any adverse or negative consequences? The answer here is clearly yes. In effect the proposal is to levy a tariff on all foreign visitors in order to pay for a minority that might abuse the NHS system. But that means that the majority will be punished for the actions of a minority, and as the majority are free to avoid the tariff by simply travelling to another country, the result is likely to be a substantial fall in students and tourist numbers entering or visiting the UK. So not only does the policy not deter the people it is supposed to, it instead actively deters the people we want and need to come here to boost our economy. </div>
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The third test of any policy should be, do the benefits outweigh the costs? The answer here is also clearly negative, as the results of the first two tests do not even begin to compensate for each other. They are clearly both additive and negative. So the sum of the two effects in massively negative. </div>
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The fourth question any new policy needs to address is, do we need it? Well in the case of health tourism no-one really knows how big this problem is. It may cost the country £12m a year or it may be £200m, but either way it is still insignificant in comparison to the size of an NHS budget of £109bn. So this policy clearly fails the fourth test of any workable policy - necessity. </div>
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So what we have is a policy that we don't need (yet), that will fail to deter the people it is designed to deter, that will instead deter the overseas visitors we want and need, and may in fact even encourage the problem of health tourism to grow further by legitimizing it. It really does take a phenomenal degree of incompetence to invent a policy that is quite that useless and counterproductive. </div>
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Cantab83http://www.blogger.com/profile/12485401571391377815noreply@blogger.com0tag:blogger.com,1999:blog-8416708843386784712.post-83424832502047528252013-06-02T18:54:00.001+01:002013-07-05T22:56:44.904+01:00Tax avoidance #3: transfer pricing<div style="text-align: justify;">
When will they ever learn? Just when it looked like a politician had finally begun to get real over tax avoidance Ed Miliband goes and shoots himself in the foot again.<br />
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First he pledges that if elected PM <a href="http://www.bbc.co.uk/news/uk-22585407" target="_blank">he will tackle corporate tax avoidance without international agreement</a> if necessary. So far, so good. But then he falls for the same misguided arguments as the rest of the political class by <a href="http://www.bbc.co.uk/news/uk-politics-22613205" target="_blank">seeking to blame</a> the existence of avoidance techniques on the companies that use them. Principal amongst these is the technique known as transfer pricing.<br />
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This is a technique used by multinationals where the prices for goods or services traded internally within the company but across international frontiers are set either artificially high or artificially low in order to move profits from one (high tax) country to another (low tax) country. As a problem it is not new. Economics texts have been highlighting the issue for over forty years (for proof see Chapter 19 of <i>Economics of the Real World</i>, by Peter Donaldson, published in 1973). The received wisdom is that all that is needed in order to counter this activity is some form of international agreement, greater corporate transparency, more resources for HMRC staff and a modicum of moral pressure. Robert Philpot of Progress <a href="http://www.huffingtonpost.co.uk/robert-philpot/tax-avoidance-dont-wait-for-international-action_b_3365690.html" target="_blank">tried to make some of these arguments</a> again last week on the Huffington Post. Yet none of this is true.<br />
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As <a href="http://cantab83.blogspot.co.uk/2012/10/the-taxing-problem-of-tax-avoidance-1.html">I have pointed out before</a>, under capitalism companies are driven by the imperative to maximize profit, not some moral obligation to maximize government tax revenues. The moral choice is to do what is best for the shareholders, not what is best for the wider community. And anyway, why should Google or any other company be obliged to pay more than it needs to in tax when to do so could put it at a competitive disadvantage with respect to its rivals?<br />
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The arguments in favour of international agreements are equally flawed. Such agreements would require all countries to sign up to the same set of rules as those that didn't would gain a competitive advantage over those that did. Yet as long as countries compete against each other to attract multinational corporations to their territories, either in order to generate greater tax revenues at the expense of other nations, or to attract inward investment at the expense of other nations, then there will never be any hope of a binding international agreement. There will always be one country that refuses to be bound by the wishes of the majority in order to gain advantage. And given the size of multinational profits in comparison to national incomes, the power to undercut on tax will always favour the small nation (e.g. Luxembourg, Switzerland, Austria, Ireland) over the large nation. Countries like the USA and UK can therefore never hope to compete with these smaller countries by lowering their corporate tax rates. They need to look for a different approach. That means implementing tax laws that are not reliant on the actions or agreement of governments in competitor countries, but are instead based on objective measures of business activity within each country's own borders. One possible solution is the <a href="http://en.wikipedia.org/wiki/Common_Consolidated_Corporate_Tax_Base" target="_blank">Common Consolidated Corporate Tax Base (CCCTB)</a> proposed by the EU.<br />
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At the heart of the transfer pricing problem is the thorny issue of corporate profits and how they are calculated. Even at the best of times the quantification of a company's true annual profit is something of a black art, one that is complicated by one-off asset write-downs, debt interest, rolled over losses from previous financial years, and the deferral or front-loading of capital investment. Yet over time most of these factors cancel themselves out. However, on top of all that there is the problem of how those profits are spread across the different divisions of the company. Again, if all the divisions of the company are located within the same country it matters not a jot. The total profit of the company in that tax jurisdiction is the same however it is divided between subsidiaries, and so the tax paid is the same. Yet, as soon as the profit is spread across subsidiaries in different countries with different tax rates, problems abound.<br />
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This is where transfer pricing comes into its own. There are a number of variants of this type of scheme that essentially only differ in the form of the goods used as the vehicle for the price transfer mechanism. In its most classical manifestation the goods are typically manufactured components of a larger or more complex final product. However, increasingly transfer pricing schemes have begun using brand licences or other intellectual property as the good that is traded internally within the company (as used for example by Starbucks). As an illustration of how transfer pricing works it may help to consider the following hypothetical example.<br />
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Suppose a car maker has two production facilities. The main assembly plant is in the UK and is owned and run by subsidiary A. However, the engines are manufactured in country Z by the company's subsidiary B. Now suppose it costs £4000 to build the engine and another £4000 to construct the rest of the car, but the car sells for £10,000. The profit is therefore £2000 per car. If the car company builds 1,000,000 cars each year then its annual profit will be £2bn, but which in country should this profit be declared and taxed; the UK or country Z?<br />
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The answer is that it depends on the price that subsidiary B charges subsidiary A for its engines. For most goods bought by ordinary consumers or firms the price is set by the market and it is therefore beyond the capabilities of any single agent to dictate this price unilaterally. In transfer pricing schemes, however, the commodity or good at the centre of the scheme is only ever traded within the multinational company. There are no external customers and so there is no objective market price for the good. Whatever the multinational charges for the good it ends up paying to itself, so it can set its own price for its own reasons. That reason is usually tax.<br />
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In the above example the cost of producing the engine and the car body is the same (£4000 each), so one might naturally assume that the fair way for the profits to be divided between the two subsidiaries would be in the same 50:50 split. In which case subsidiary B would charge £5000 for each engine, thus allowing it to make a profit of £1000 per engine. Subsidiary A in the UK would then buy the engines for £5000 each, build the rest of the car at an additional cost of £4000, and then sell the cars to the public for £10,000 each. Thus the cost of manufacture for subsidiary A is £9000 per car and its profit is £1000 per car, the same as for subsidiary B. If the tax rates in the UK and country Z are the same, let's say 30%, then the multinational will pay £300m of tax in each country, or £600m in total.<br />
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But if the tax rate in country Z is lower than in the UK (say 25% instead of 30%), then the car maker will pay less tax in country Z (£250m) than the £300m it continues to pay in the UK. Its total tax bill at £550m is now less than the £600m it was originally. But it can reduce its tax bill even further by raising the price of its engines.<br />
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If subsidiary B charges £6000 for each engine, then subsidiary B will make £2000 profit per car. Yet the cost of production for subsidiary A then rises to £10,000 per car, £6000 for the engine and £4000 for the body, and so it makes zero profit. Now all the profits are taxed in country Z at 25%, and so the total tax bill falls to £500m.<br />
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Similarly, if the UK were to retaliate by lowering its tax rate to 20% (as advocated by Osborne and Cameron) then the car company would respond by changing the cost of its engines once more. Now subsidiary B might charge £4000 for each engine so that it makes no profit while subsidiary A earns £10000 for each car sold but now spends only £8000 on their manufacture (£4000 on assembly costs and another £4000 buying the engine from subsidiary B). As all the profits are now located in the UK they will be taxed at the UK rate and the total tax bill for the company is now £400m.<br />
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Thus by raising or lowering the cost of its engines (or any other internally manufactured component) the car maker can in effect choose which country it wishes to be taxed in. And in so doing it can also force countries to compete against each other by competitively reducing their tax rates in a self-defeating race to the bottom where the only winner is the multinational.<br />
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One reason why the scheme is so difficult for governments to challenge is that there is usually no other external customer for the good or service used in the transfer pricing, so the price is difficult for the tax authorities to challenge. In addition, multinationals can always find one country to base their headquarters in that will offer a lower tax rate than any other. Worse still, with complex lines of procurement it is doubtful whether even the company itself can accurately determine the true cost of many of its internally sourced components. Nevertheless, despite these difficulties it is clear that many multinationals actively operate aggressive policies of tax avoidance based on transfer pricing that are designed to minimize their corporate income tax bill. It is therefore time governments adopted an alternative approach to tackling the problem.<br />
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<b>The Solution:</b><br />
There is only one realistic solution to the problem of transfer pricing, and that is to tax companies on the basis of data that they cannot challenge or manipulate. As already noted, profits can have a distinctly ethereal quality at times, particularly when looked at on a country-by-country basis. However, a company's global profit (<i>P</i>) is much more tightly defined. So too for that matter are other global aggregate measures of a company's performance such as its global sales (<i>S</i>), its global wage bill (<i>W</i>), and the total value of its global capital assets (<i>K</i>).<br />
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It is also true that, while a multinational operating in the UK can disguise its UK profit via transfer pricing, it cannot disguise the level of its UK sales, wage bill or capital investment. Its UK sales are already recorded for VAT purposes, and its wage bill for calculating its national insurance liability. As for its UK capital, that is mainly in the form of property, which is also rather difficult to conceal.<br />
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It therefore follows that governments should take the initiative when it comes to determining the profit levels of subsidiaries operating in their territories. As neither the government nor the multinational really knows the true profit level of these subsidiaries, the government should in effect use the objective data outlined above to tell the multinational what its UK profits are, rather than relying on the multinational to tell the government what it thinks it is. And it turns out that a formula for just such a calculation already exists.<br />
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In an attempt to tackle the issue of transfer pricing the European Commission has proposed the <a href="http://en.wikipedia.org/wiki/Common_Consolidated_Corporate_Tax_Base" target="_blank">Common Consolidated Corporate Tax Base (CCCTB)</a>. This utilizes data for the company's global sales (<i>S</i>), wages (<i>W</i>), capital (<i>K</i>) and profits (<i>P</i>), together with the equivalent terms <i>S<sub>i</sub></i>, <i>W<sub>i</sub></i> and <i>K<sub>i</sub></i> pertaining to any individual country <i>i</i> only. This allows the company's profits in country <i>i</i> to be estimated by taking a weighted average of the fraction of its global capital, sales and wages that are deployed in that country, and using that average to set an estimate for its profits in country <i>i</i>. In the absence of any more authoritative data, this estimate will <i>de facto</i> be assumed to be the true profit level <i>P<sub>i</sub></i> for the subsidiary operating in that country.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiqXiF2-qBPKiPI77Dx6UuoQq4TP7CMach1mvDCMyomWLxMq_oyiS99vHSK0Cns1wyHnIl1tg-FEYzkUC2BN5JTIz8pOyBHwUZahBQoAN07jlKxVj_AEB9Ji56iCoXP7G2-8B-vNgJh-DM/s1600/tp1.gif" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiqXiF2-qBPKiPI77Dx6UuoQq4TP7CMach1mvDCMyomWLxMq_oyiS99vHSK0Cns1wyHnIl1tg-FEYzkUC2BN5JTIz8pOyBHwUZahBQoAN07jlKxVj_AEB9Ji56iCoXP7G2-8B-vNgJh-DM/s1600/tp1.gif" height="67" width="640" /></a></div>
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The coefficients are defined to be the same for all companies operating in country <i>i</i>, and are then set such that each is less than unity, and their sum is always equal to unity as follows.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj2VktN5bJU5zkytM04T2lDf-31e7v9GinQ-AVOamYgE0mce4E5B3MQYegJ5gY7x9f-Y0akM6EIaOUthJZbLXAaFMCxw55wnGB9Exc2wejlyNHXU-XZm0fUvOo8ifVbMl5s0zg4m6nNlqk/s1600/tp2.gif" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj2VktN5bJU5zkytM04T2lDf-31e7v9GinQ-AVOamYgE0mce4E5B3MQYegJ5gY7x9f-Y0akM6EIaOUthJZbLXAaFMCxw55wnGB9Exc2wejlyNHXU-XZm0fUvOo8ifVbMl5s0zg4m6nNlqk/s1600/tp2.gif" height="42" width="640" /></a></div>
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In practice these coefficients are all likely to be set to be equal to each other as there is unlikely to be much overall variation in the proportion of wages, sales and investment capital for all multinationals within a given country <i>i</i>. In which case the profit in country <i>i</i> becomes<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgRNu92ONf7S4L3KnsSinv6QRefiseUgyWIewl1kfIr5DTsAxXbZCl-WkVWVXanaij9IcRTzdNeCNf4_Ja0PALOfutSo0-tdDX3Y2CrGFgNbi_nwMTiN8kNyK0Ru3QR9RWnz9JfWii0nkU/s1600/tp3.gif" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgRNu92ONf7S4L3KnsSinv6QRefiseUgyWIewl1kfIr5DTsAxXbZCl-WkVWVXanaij9IcRTzdNeCNf4_Ja0PALOfutSo0-tdDX3Y2CrGFgNbi_nwMTiN8kNyK0Ru3QR9RWnz9JfWii0nkU/s1600/tp3.gif" height="76" width="640" /></a></div>
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We have then a profit calculating mechanism that is impervious to transfer pricing. Companies cannot manipulate their profit in country <i>i</i> because they cannot manipulate the quantities used in Eq. (3) to calculate that profit. It is this type of approach that politicians and government tax advisers should be adopting, not the empty rhetoric of cynical political posturing.
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Cantab83http://www.blogger.com/profile/12485401571391377815noreply@blogger.com0tag:blogger.com,1999:blog-8416708843386784712.post-69085913886734227922013-05-27T21:17:00.000+01:002013-05-27T21:20:16.043+01:00The right way to regulate and rescue banks<div style="text-align: justify;">
When it comes to the question of how (or even if) we should rescue failing and insolvent banks, so far the choice on offer has been between two equally unpalatable brands of medicine. Either the State should do nothing (as the neo-liberal Right are forever demanding) and risk contagion spreading within the financial system as the collapse of one bank leads to the decreasing creditworthiness of others, or the State should act as ultimate guarantor for all deposits and thereby institutionalize moral hazard, effectively legitimizing every bad investment every bank or investor has ever made. As I pointed out in my <a href="http://cantab83.blogspot.co.uk/2013/05/banking-lessons-from-cyprus.html">last post</a>, the central problem is a triangular paradox at the heart of the current bailout provisions. For an orderly restructuring of a bank to be achieved while protecting the wider banking system, the economy and the taxpayer, three key objectives need to be met.<br />
(i) No taxpayer funds should be used in any bank rescue.<br />
(ii) The bank's customers must still be able to access some deposits.<br />
(iii) There must be no capital flight or run on the bank.<br />
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As I also pointed out <a href="http://cantab83.blogspot.co.uk/2013/05/banking-lessons-from-cyprus.html">previously</a>, these three conditions are fundamentally incompatible with each other. Only two of the three can be achieved at any one time. If the bank remains open for business in order to service the day-to-day needs of its customers, and at the same time the taxpayer is to be relieved of any compensation obligation, the depositor will be forced to bear the cost of bank restructuring. The inevitable result will be capital flight as the depositors seek to avoid the impending financial penalties, and so the taxpayer will be forced to step in. If, however, the bank is closed for business to protect against capital flight, then the taxpayer will be protected but the wider economy will suffer as businesses and their customers run out of cash, many firms will be forced to close down, and the economy will start to slump.<br />
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There is though a second iniquity with the current system as I again outlined <a href="http://cantab83.blogspot.co.uk/2013/05/banking-lessons-from-cyprus.html">previously</a>. This applies to customers who may have the misfortunate of receiving a once-in-a-lifetime large cash deposit (e.g. from a house sale or lottery win or business deal) that temporarily flows through their bank account at the very instant that the bank enters its state of crisis. So when the bank's restructuring or liquidation is complete these unfortunate souls will lose almost everything. Unlike conventional depositors, these customers have yet to make any investment decisions with regard to their new deposits. They are merely using their bank as a conduit through which to transfer the money to its final destination, a destination that may ultimately involve payment to a third party with no net gain for them (as for example during the process of moving house). So why should they be punished when they have not yet sought any high-risk reward? Clearly they should not. In which case, how can we then ensure that we protect these customers from suffering catastrophic and life-destroying financial penalties?<br />
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The answer to both this question and our initial capital flight problem is the same. Our initial paradox rests on the fact that we want bank accounts to operate in two distinctly different ways. On the one hand we want them to be fully accessible while at the same time we wish to prevent excessive withdrawals in a time of crisis. The solution, therefore, is to define two classes of account within each bank with each class having its own distinct rules with regard to its level of accessibility in return for differing levels of insurance protection. As a result one class will be applied to current accounts, with the other being for savings. This leads logically to the following 8-point plan, as this post will explain.<br />
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1) Set different compensation and access rules for current accounts and savings accounts. .<br />
2) Current accounts to remain instant access.<br />
3) Current account deposits to be fully insured by the Government.<br />
4) Current accounts to be restricted to low interest rates.<br />
5) The bank's own capital reserves (Tier 1 capital) to be set to cover at least 100% of all current account deposits.<br />
6) Savings deposits to be used to cover bank losses when Tier 2 capital is exhausted.<br />
7) Savings accounts to be time-locked in an emergency to prevent capital flight.<br />
8) Bank restructuring to be by debt-for-equity swaps.<br />
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The key to the bank insolvency problem ultimately lies in the accessibility of the bank's different customer accounts. One type of account needs to be "instant access" so that normal banking functions can continue for most customers. But if the deposits in such an account are to be freely accessible, then they must be fully guaranteed by the State in order to guard against capital flight. As the generosity of this protection necessarily brings with it the risk of creating moral hazard, the guarantee must therefore be limited to only the most conservative of all investments. That means those carrying the lowest financial reward or yield. So a state-backed 100% deposit guarantee can only be applied to accounts with the lowest of interest rates, with the additional <i>quid pro quo</i> for the customer being that the guaranteed deposits remain available for instant withdrawal at all times.<br />
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However, while the taxpayer may act as guarantor in the above scenario, he must also be protected from having to fund the bailout. He may provide liquidity during the bailout process, but he expects to get all his money back (with interest) when it is complete. This means that the bailout must be self-financing. For this to be the case, the bank's own reserves of capital - its equity - must be greater than the liabilities that these reserves are required to cover, namely the current account deposits. In addition, the reserves it maintains would need to be of the same class as the deposits that they are designed to protect. That means that they would have to be in the form of cash, or government bonds that are highly liquid, easily convertible to cash and of secure value.<br />
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The next and complementary step is obviously to equate accounts with higher financial rewards with having a higher level of risk and therefore reduced level of state-backed guarantee. With no 100% guarantee over the security of their deposits these accounts will inevitable experience severe capital flight if they too are granted instant access. Therefore some form of time-lock must be imposed on such accounts such that no money can leave these accounts until the restructuring process is complete.<br />
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In the event of a bank suffering such increasing levels of bad debt that it begins to affect the very creditworthiness of the entire institution, then the following event sequence would play out. First the bank would freeze all high interest accounts while restructuring took place. This is a similar move to <a href="http://www.guardian.co.uk/business/2013/mar/18/cyprus-closes-banks-bailout-package" target="_blank">that imposed on the main Cypriot banks in March</a> with the exception that in the Cypriot case the entire bank was closed for business, not just access to its savings accounts. The funding for any bailout would then come from deposits in these high interest accounts via a haircut. However, unlike the Cypriot case, the haircut would not be in the form of a simple forfeiture or confiscation, but should instead be a debt-for-equity exchange with depositors receiving new shares in the bank with the same market value as the total amount of funds that they stand to lose. The same deal should be granted to bondholders and the holders of any other form of the bank's debt. The only remaining question then concerns how the bank's new shares should be valued. Should it be determined by the price pertaining at the very instant that the bank's share were suspended prior to it ceasing to trade normally, or should it be set by the price pertaining at some earlier point in time when the bank's share price was still stable? Ultimately the answer will depend on a political decision as to which parties should be forced to forfeit the most: shareholders or creditors?<br />
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The advantages of this scheme are four-fold. Firstly it extends the haircut to other creditors of the bank like bondholders but on similar terms. Secondly, the large increase in shares results in a diluting of the share capital thereby extending the haircut to shareholders. As the value of deposits in the bank prior to its collapse will massively exceed its market capitalization, these measures will ensure that the shareholders suffer greater percentage losses than depositors as should be the case. The third advantage of this deal is that it ties in the depositors to the bank when the restructuring is complete. If depositors start a run on the bank once it reopens by removing their remaining savings, then they risk collapsing the bank and wiping out the value of the shares they received in lieu of their confiscated deposits. Finally, the new share issue ensures that once the bank reopens after its restructuring, not only will it be financially sound (as its liabilities will be much less than its assets), but it will be able to begin trading as normal immediately, as will trading in its shares.<br />
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With these measures in place the State would not in any likelihood actually have to bail out the bank. The State would merely stand as guarantor of last resort perhaps providing bridging loans or liquidity to enable the bank to smoothly implement the above process.<br />
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Finally, as the two types of account are clearly distinguished by their relative rewards (i.e. interest rates), with the risk associated with each account being dependent on that reward, it logically follows that the division line between the two account types should itself be set by the level of reward. As that reward is the interest rate in each case, so the division line must be based on an objective standard of this type, in other words a standard market interest rate (e.g. <a href="http://www.bankofengland.co.uk/Pages/home.aspx" target="_blank">BoE</a> base rate, or LIBOR, or base rate + <i>x</i>, etc.). Given the relative values of the <a href="http://www.bankofengland.co.uk/Pages/home.aspx" target="_blank">Bank of England (BoE)</a> base rate, current account interest rates and most savings rates at the current time, it is likely that under current market conditions the boundary line between our two classes of bank accounts would be set by the <a href="http://www.bankofengland.co.uk/Pages/home.aspx" target="_blank">BoE</a> base rate.<br />
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The mechanism outlined above therefore requires banks to hold two types or levels of capital. One must be highly liquid and sufficient to cover current account deposits. The second would be used to protect against bad loans. This is similar to the current system as introduced under the <a href="http://en.wikipedia.org/wiki/Basel_I" target="_blank">1988 Basel I accords</a> where <a href="http://en.wikipedia.org/wiki/Tier_2_capital" target="_blank">Tier 2 capital</a> was supposed to be used as a reserve of capital that banks could use to cover the cost of bad debts and defaults by customers, and <a href="http://en.wikipedia.org/wiki/Tier_1_capital" target="_blank">Tier 1 capital</a> was supposed to provide a capital reserve of last resort that would fund the winding up of any insolvent bank.<br />
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As we now know, Basel I rules were insufficient to prevent the collapse of banks and other financial institutions after 2007. The new <a href="http://en.wikipedia.org/wiki/Basel_III" target="_blank">Basel III rules</a> are designed to strengthen financial regulation by forcing banks to hold more capital. Yet these new rules are fundamentally flawed for two reasons. First, they take no account of asset price inflation and how that undermines the solvency of banks by allowing them to increasingly leverage their balance sheets to an extent that only becomes critical when there is a massive crash in asset values. But secondly, there is nothing in Basel III that provides for safe defaults of banks, or that will protect economies from the moral hazard that comes from cleaning up the mess arising from bad banks that are too big to fail.<br />
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The structure outlined here might just help do the latter, although other measures are needed as well. These would include provisions for other bank liabilities such as redundancy payments for staff as the bank downsized and rules for the protection and sustainability of pensions. There would also need to be a new set of rules concerning the level of deposit protection afforded to high-risk savings accounts and the necessary capital reserves needed to fund such protection. Imposing haircuts on small savers will never be politically acceptable, but the level of any deposit guarantee will have to be determined by issues of affordability and risk.<br />
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Equally important, though, is the need for better preventative measures. These should include new rules that actively discourage and de-incentivize acquisitions and mergers, as well as limiting the activities of overseas subsidiaries. Too many banking failures in the UK over recent decades have had their origins in policies of aggressive expansion. The remainder are generally due to sudden corrections in overheated markets in speculative assets, mainly in the property sector. In the case of asset price inflation, what is needed, therefore, is a new set of rules governing the risk-weighting of assets in measures of Tier 1 and Tier 2 capital ratios that are self-limiting as house prices or share prices increase more rapidly than the rest of the economy. Only then will our banks begin to exhibit the financial strength and resilience that we desire.
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Cantab83http://www.blogger.com/profile/12485401571391377815noreply@blogger.com2tag:blogger.com,1999:blog-8416708843386784712.post-83645774608897418862013-05-14T00:10:00.000+01:002013-05-27T21:03:20.793+01:00Banking lessons from Cyprus<div style="text-align: justify;">
Why is it that six years on from the collapse of Northern Rock there is still no semblance of any workable administration procedure having been put in place to deal with distressed or collapsing banks? With the recent banking crisis in Cyprus still fresh in the memory it is apparently <a href="http://www.3spoken.co.uk/2013/03/a-rational-solution-to-cyprus-issue.html" target="_blank">not only me who is asking this question</a>. Yet there is still no political or economic consensus regarding how governments should rescue banks. Perhaps the reason is because most people have failed to appreciate the paradoxes that the current system creates. The solution to this problem is, I believe, to fundamentally change the structure of bank deposits, as well to limit the way banks capital ratios are set and the way banks are allowed to operate over national borders. </div>
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After 2007 the two big issues were contagion and moral hazard. The Brown government acted swiftly to protect all bank deposits in first Northern Rock and then other UK banks and building societies such as HBOS and RBS because they were worried about contagion. They feared that the collapse of one big bank could bring down another, and then another, and ultimately the whole system. </div>
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The Bush administration in the USA on the other hand allowed both Lehman Brothers and AIG to collapse because they were more concerned about moral hazard. They were also politically antipathetic to any form of state subsidy or intervention. </div>
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Now we have the Cypriot banking crisis where depositors are facing a 'haircut' on deposits above the EU depositor protection limit of €100k. The problem that we are now seeing is that all three of these approaches have significant downsides. At the crux of the problem is a triangle of paradox and conflicting aims or interests that renders the conventional approach unworkable. </div>
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Ideally what most economists and policymakers want to see is an orderly restructuring of a bank in crisis. That means that three key objectives must be met. </div>
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(i) The losses of the bank should be met by the customers and owners of the bank, not the taxpayer. This is the necessary condition to eliminate moral hazard. </div>
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(ii) The bank must be able to continue operating normally throughout its restructuring without adversely affecting the wider economy. In other words, businesses that use that bank need to have their normal cash-flow operations protected so that they aren't destabilized. </div>
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(iii) The restructuring must be carried out in such a way that there is no capital flight or run on the bank. Otherwise the restructuring won't work. The money to pay for it will vanish. </div>
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The problem is that these three conditions are mutually incompatible. It is currently possible to satisfy at best only two of these conditions simultaneously, but not all three. </div>
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For example, it is currently the wish of the overwhelming majority of people and also of most politicians for the excessive risk-taking of the bankers to be borne by the bankers themselves and not by the taxpayer. If a bank fails it should be the shareholders and the senior management that should bear the cost. However the RBS and HBOS situations show that this will never be enough to cover the cost of most bank bailouts. Depositors will invariably have to take a haircut on some of their savings above the €100k limit. But the Cyprus situation shows how politically difficult this could be to enforce.
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Suppose though that the €100k deposit limit can be implemented so that the taxpayer is protected from the cost of the bailout. The depositors will then know that they are all expected to forfeit a fraction of their savings over €100k. Now suppose also that the banking authorities attempt to continue normal operations of the bank while it is being restructured. Such action is essential to ensure that the bank's business customers can pay their bills and thereby safeguard the normal operations of their own businesses. Without this provision businesses will fail due to cash-flow problems, and there will be a domino effect of redundancies and business bankruptcies that will ripple outwards from the stricken bank over time. </div>
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The problem is, if the bank is allowed to operate normally while it is being restructured, and the depositors are forewarned of impending deposit forfeitures, then capital flight is inevitable. No rational depositor is going to leave all their savings in a bank in the full knowledge that most could be confiscated. Thus if conditions (i) and (ii) above are implemented successfully, condition (iii) will clearly fail. </div>
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On the other hand, if capital flight is to be avoided so that condition (iii) is achieved, then only one of the other two possible actions can be implemented. Either the bank is closed for business while the restructuring takes place (as happened in Cyprus) and the deposit write-downs are performed, or the bank remains open but deposits and depositors are fully protected. The first of these options means that only conditions (ii) and (iii) are met, while the second means that only (i) and (iii) are, with the State inevitably having to pick up the final bill for the cost of the bailout instead of the depositors.
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Finally there is a fourth problem. In most discussions of depositor haircuts there is an implicit assumption amongst most neoclassical economists that all depositors are fully aware both of the risks inherent in their choice of bank, and of the limitations in extent of the deposit assurance scheme. While the latter is certainly true now, the former is not and will never be. The balance sheets of most banks are impenetrable to even the most expert of financial advisers. You only have to see how the credit crunch developed post-2007 to appreciate how the culture of rumour and counter-rumour within the financial markets highlighted the widespread ignorance that existed over the size and whereabouts of all the toxic debt. If the market players don't know where the problems are, how can the humble customer? </div>
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And then there is the question of fairness. Implicit in the €100k deposit protection limit is an assumption that those who fall foul of it are only those guilty of chasing excessive returns. Yet what about the homeowner who sold his home for more than €100k on the very day his bank collapsed. Or the business that received payment for a major order on that same day. They too will lose almost everything, not because they sought to overplay their hand, but simply because they happened to have accounts with the wrong bank at the wrong time. Such instances may be rare, but such instances of large payments happen every day in every bank. The probability that such misfortune happens to you may be small, but the probability that it happens at all will be close to unity. So you know it will happen to somebody. Should the financial system play Russian roulette with people's lives in this way? Isn't that what the insurance and regulatory systems are supposed to prevent? </div>
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These then are some of the problems, but there are others, not least in the disjointed and often illogical approach that the current system of regulation takes. These regulations are enshrined in the latest Basel accords, denoted as <a href="http://en.wikipedia.org/wiki/Basel_III" target="_blank">Basel III</a>. As I will argue in later posts, Basel III is unlikely to correct all the major problems within the banking system. It won't tackle the paradox inherent in the three conditions (i)-(iii) above. Nor will it address problems associated with <a href="http://en.wikipedia.org/wiki/Capital_adequacy_ratio" target="_blank">capital adequacy</a>, <a href="http://en.wikipedia.org/wiki/Reserve_requirement" target="_blank">reserves</a>, or banks being too big to fail. What are needed are new rules that are fit for purpose. These rules need to resolve the triangular paradox I have outlined here so that insolvent banks can restructure in an orderly and fair manner. But we also need rules that reduce the likelihood of bank failure occurring in the first place. That means introducing new rules on capital requirements that will actively compensate for asset price bubbles, thereby removing some of the main sources of risk in the banking system. It also means having reserve requirements that recognize the systemic risk of large banks and which therefore financially penalize excessive size.
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Cantab83http://www.blogger.com/profile/12485401571391377815noreply@blogger.com0tag:blogger.com,1999:blog-8416708843386784712.post-41610525551193175582013-05-04T20:48:00.000+01:002013-07-24T15:25:37.460+01:00Let's pay the people to vote<div style="text-align: justify;">
Another election; another poor turnout. </div>
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In this week's county council elections the turnout was barely above 30%, not that we should be surprised. Four years earlier when the same seats were contested the turnout was again only 39.2%. In the local elections of 2011 the turnout was 42.6%. In fact the only recent local election with a turnout of over 50% was in 2010 when it coincided with the general election, and yet even for that general election the turnout was a fairly pitiful 65.1%. While this was an improvement on the 59.4% in 2001 and the 61.4% in 2005, it is still a long way short of the 77.7% in 1992. </div>
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These figures should be worrying for Labour because it is the Labour Party that suffers disproportionately from differential turnout. At the last general election the average turnout in consistencies that returned Labour MPs was about 61%. For those electing Tories it was over 68%, and in one Conservative-held seat (Kenilworth and Southam) the turnout was a staggering 81%. Overall this means that approximately 10% more people vote in Tory-held seats than in Labour-held ones. This goes some way to explain why the Tories need a greater number of national votes to gain a parliamentary majority, and why with <a href="http://news.bbc.co.uk/1/shared/election2010/results/" target="_blank">24.6% more votes than Labour in 2010</a> they only won 19% more seats. </div>
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It is partly this issue of differential turnout that allows the Tories to (falsely) portray the electoral system as being biased in favour of Labour, and thus to provide cover for their attempts to gerrymander the electoral system with policies like the recent one to equalize constituency sizes in terms of voter numbers. Of course their approach conveniently overlooks the other issue that damages Labour: the problem of voter non-registration in many urban areas. As a result there could be as many as an extra 10% of potential voters missing from the electoral roll in these predominantly Labour constituencies.</div>
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Taken in combination with the differential turnout problem, these figures suggest that the Labour vote may be over 20% below what it should be, which means that even at the 2010 election Labour's total vote should have matched that of the Tories at around 10.5 million votes, ceteris paribus. The question is, how many extra seats would this have yielded for Labour? I suspect not many as most of these missing votes are in safe Labour seats. Of course that suggests that the 19% extra seats that the Tories won in 2010 is entirely down to an electoral system that actually favours them, not one that penalizes them. So the big question is: how can this problem be rectified? </div>
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So far most of the media analysis has concentrated on issues centred around political apathy. There are many causes for this malaise. The electoral system is clearly one. The combination of a first-past-the-post (FPTP) system and a large number of safe seats clearly makes many voters feel that their vote is worthless. </div>
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Another problem is of course the lack of voter/consumer choice. With elections dominated by swing voters in marginal seats there is a tendency for all three parties to converge on the "centre ground" and to steal each other's policies. As a result most of the potential remedies have focused on <a href="http://cantab83.blogspot.co.uk/2009/10/av-or-not-av-that-is-question-or-is-it.html">changes to the electoral system</a>, of which the <a href="http://www.bbc.co.uk/news/uk-politics-13297573" target="_blank">AV referendum</a> was a prime example. </div>
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Other solutions have focused on improving the ease of voting. Thus strategies for increasing the number of postal votes have been proposed, as well as making polling day a <a href="http://www.bbc.co.uk/news/uk-politics-22283124" target="_blank">bank holiday</a> or putting it on a <a href="http://news.bbc.co.uk/1/hi/uk_politics/7471052.stm" target="_blank">weekend</a>. So far, however, no-one really appears to have considered financial incentives, with the possible exception of <a href="http://www.bbc.co.uk/news/uk-politics-22283124" target="_blank">implementing some form of lottery</a>. Why? </div>
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Perhaps because it seems to resemble a form or bribery reminiscent of the <a href="http://en.wikipedia.org/wiki/Rotten_and_pocket_boroughs" target="_blank">rotten boroughs of the late 18th and early 19th centuries</a>. Yet politicians bribing the electorate is nothing new, old, or unusually. The tax cuts, privatizations and council house sell-offs under Thatcher in the 1980s were little more than bribes to a certain section of the electorate. In that sense they were truly insidious because they were selective and divisive rather than universal. They only benefited those with large incomes, spare cash or current tenure of council properties. Those who fell outside these groups were left out of the feeding frenzy. Doubtless some would argue that such a measure would run counter to the provisions of the <a href="http://en.wikipedia.org/wiki/Ballot_Act_1872" target="_blank">Ballot Act of 1872</a>, but if the "bribe" is merely conditional on voting and not on voting for a particular candidate or party, would that still be so? </div>
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Of course the principal reason why paying people to vote has probably not been considered is the cost. To make it attractive enough to the potential voter each would need to be offered over £100. Yet with around 45 million potential voters the total cost could then be over £4.5bn. If this was only applied to general elections, though, it would still only equate to £900m per annum. That is peanuts for the UK government. Yet there is another solution that would cost nothing in nominal term. Use the shares the government already owns in the privatized banks. The total government stake in RBS and Lloyds TSB is currently valued (according to their FTSE-listed share price) at over £30bn. That is enough to fund a voter giveaway at the next six general elections. </div>
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Earlier this year Lloyds TSB claimed it was close to being ready for privatization. Now <a href="http://www.bbc.co.uk/news/business-22394716" target="_blank">RBS is saying the same</a>. However it is highly likely that any share sale would need to be staggered over a number of years in order to get the best price. </div>
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Nor is the idea of giving these shares away a new idea. This is an idea that was <a href="http://www.bbc.co.uk/news/business-12661005" target="_blank">originally proposed by some LibDems</a> a couple of years ago. Then in February <a href="http://www.telegraph.co.uk/news/politics/9874496/George-Osborne-considering-RBS-shares-gift-for-every-taxpayer.html" target="_blank">there were reports</a> that George Osborne may consider giving bank shares away to all taxpayers (does that include poor pensioners and the unemployed?) It is therefore only an additional small step to suggest that such a gift should be conditional in some way. So why not make it conditional on a citizen exercising their democratic right, nay duty, at the ballot box? Let us call it the citizen's dividend. </div>
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It should be clear that while all may benefit from this idea, the Labour Party and Labour voters will benefit the most. A typical Labour voter is more likely to be incentivized to register on the electoral roll and to subsequently vote by a cash windfall of £100-£200 than is a merchant banker living in Surrey. And when they vote they are more likely to vote Labour in order to ensure that the policy would not be discontinued. If the Tories and LibDems copied Labour's policy then they would still lose out because of the greater benefit to Labour in terms of differential turnout. If they fail to support the idea then they risk the loss of even more votes to Labour. And then there are the economic benefits. Most of the shares will be sold on receipt, and the proceeds spend. The result will be an urgently needed fiscal stimulus for the economy, while the universality of the share allocation will help reduce inequality. So where is the political downside?
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Cantab83http://www.blogger.com/profile/12485401571391377815noreply@blogger.com0tag:blogger.com,1999:blog-8416708843386784712.post-6349674844748146022013-05-01T16:30:00.000+01:002013-05-05T01:03:37.852+01:00Tax avoidance #2: The GSK loan trick<div style="text-align: justify;">
In an <a href="http://cantab83.blogspot.co.uk/2012/10/the-taxing-problem-of-tax-avoidance-1.html">earlier post</a> I argued that tax avoidance is not as immoral as many politicians insist on claiming, but instead reflects the failure of those same politicians to enact laws that are designed to be consistent and foolproof. I also argued that, contrary to conventional wisdom, tax avoidance cannot and should not be tackled through the use of international treaties or agreements, but should instead be countered through the use of unilateral action. The growing use of <a href="http://www.reuters.com/article/2012/11/25/usa-tax-arbitration-idUSL1E8MGA6U20121125" target="_blank">"baseball arbitration"</a> by the USA and other countries is a salutary warning in this respect for it could in particular enable multinationals to reduce their tax bills by playing countries off against each other in an increasingly damaging game of winner-takes-all. </div>
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The solution therefore must be for countries to be self-reliant, rather than being reliant on others. To demonstrate the point I will outline some of the most common tax avoidance schemes currently in use by multinational companies and then demonstrate how I believe such schemes could be countered through simple changes to UK tax law. The first such example I have chosen centres on one of Britain's biggest companies. </div>
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GlaxoSmithKline (GSK) is a world-renowned pharmaceutical company. However in recent years it has also found itself in the media headlines regarding its tax avoidance strategies in various countries around the world. </div>
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In 2006 <a href="http://www.irs.gov/uac/IRS-Accepts-Settlement-Offer-in-Largest-Transfer-Pricing-Dispute" target="_blank">it settled a long-running transfer pricing case in the USA</a>, while more recently <a href="http://www.theglobeandmail.com/globe-investor/supreme-court-backs-glaxo-in-transfer-pricing-dispute/article4620345/" target="_blank">it won another transfer pricing case against the Canadian government</a>. However, last year a <a href="http://www.bbc.co.uk/mediacentre/latestnews/2012/panorama-truth-about-tax.html" target="_blank">Panorama programme for the BBC </a> highlighted a different type of avoidance scheme employed by GSK that specifically affects its UK operations. The scheme itself used intra-company loans to reduce GSK's corporate tax bill, but as the Panorama programme also highlighted, GSK is not the only company that has apparently used this type of scheme. The programme also alleged that <a href="http://en.wikipedia.org/wiki/Northern_%26_Shell" target="_blank">Northern & Shell</a>, the company run by Richard Desmond that owns Express Newspapers and Channel 5 has also operated a similar scheme. But the implications for this type of tax avoidance stretch much wider than the practices of these two companies as this type of avoidance is also closely related to other schemes used by companies such as <a href="http://en.wikipedia.org/wiki/Wales_%26_West_Utilities" target="_blank">Wales and West Utilities</a> and the holding companies of certain well-known football clubs that have been subject to corporate takeovers. These so-called leveraged buy-outs (LBOs) also rely on debt to reduce future corporation tax liabilities, and it doesn't stop there. Much of the housing buy-to-let market also exploits similar tax loopholes. The big question then, is how should the tax rules be changed so that such schemes can be permanently outlawed? </div>
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In the Panorama programme it was claimed that the GSK tax avoidance scheme worked as follows. The parent company in the UK sets up a subsidiary in an overseas tax haven (e.g. Luxembourg). The overseas subsidiary then loans the UK parent company a large sum (say £6.34bn) and the UK parent then pays interest (totalling maybe £124m) back to the offshore subsidiary. This interest is then deducted from the UK company's gross profits before it has to pay its corporation tax (at 28%). The scheme thus saves the parent company £34.72m in UK corporation tax. </div>
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Of course the money paid in interest to the offshore subsidiary will be taxed instead by the overseas tax authority (in this case Luxembourg ), but as the tax haven is chosen so that this tax rate is generally much lower than the normal rate of UK tax the net saving can be considerable. In this particular case the money GSK allegedly paid to its subsidiary in Luxembourg was apparently only taxed in Luxembourg at 0.5%, thereby representing a considerable saving. </div>
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Richard Brooks of Private Eye <a href="http://www.bbc.co.uk/mediacentre/latestnews/2012/panorama-truth-about-tax.html" target="_blank"> summarized such schemes as follows</a>: "<i>The company puts its money into Luxembourg and borrows it back. It just sends money round in a circle and picks up a tax break on the way</i>." </div>
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As a result, even to the most casual of outside observers, these schemes appear to be performing an "artificial" function. This "artificialness" arises from four distinct properties of the schemes that differentiate them from "normal" business loans. </div>
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(i) The lender and the borrower are essentially the same person, group of people, or organization. </div>
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(ii) The loan is issued by a company that is not necessarily a registered financial services company. </div>
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(iii) The interest rate of the loan is not market tested. In other words, the same loan from the same source and under the same conditions is not freely available to other borrowers or lenders. </div>
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(iv) The borrower is generally seeking to maximize the interest paid, not to minimize it. As a result the interest rate can in effect be set unilaterally by the borrower rather than through competitive negotiation with the lender. </div>
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Properties (iii) and (iv) are clearly evident in the loan arrangements of Wales and West Utilities. The company was created as a result of National Grid's decision to sell part of its gas distribution network in 2005. Since that sale National Grid has paid over £1bn in corporation tax, yet Wales and West Utilities has paid nothing on its similar activities over the same period. </div>
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The reason for this is that the holding company of Wales and West Utilities charges Wales and West Utilities an interest rate of 21% on the loan used to purchase the company. This interest rate is more than three times the standard market loan rate and coincidentally is just sufficient to wipe out the operating profit of Wales and West Utilities. Therefore it pays no tax. </div>
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<i><b>The Solution:</b></i> </div>
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This form of tax avoidance could be tackled quite simply by outlawing tax deductions for any loans that exhibit any of the features labeled (i)-(iv) above. Instead the following restrictions should be applied to the eligibility of all loan interest for tax relief in order to eradicate the problem once and for all. </div>
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(i) The company loaning the money and the company borrowing the money must have no significant commonality of ownership. They must have different directors and different shareholders, and one company cannot be owned in any significant part by the other, or be part of the same corporate group, even if one company is operating in a different tax jurisdiction. </div>
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(ii) The company providing the loan must be a financial institution regulated in the UK by the FSA or FCA. Loans from institutions outside the UK would then not be tax deductable. While some will argue that this might put up finance costs for legitimate loans, the counter argument is that using such overseas lenders increases the UK balance of payments deficit which is also undesirable. This condition is however essential if large multinationals are not to exploit their dominant position within the shadow banking system to further inflate their own already considerable stockpiles of cash at the expense of ever lower national tax revenues and greater wealth inequality. </div>
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(iii) The company receiving the loan must also be able to show that the interest rate is market tested. In practice this will mean that the company receiving the loan must be able to demonstrate that it is not the only customer of the company providing the loan but that there are many other customers of the same financial provider. </div>
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(iv) The company receiving the loan must be able to show that the interest rate has been set in line with the market rate and has not been inflated for its own benefit. In practice this will mean that the company taking out the loan must be able to point to tenders from other FSA/FCA regulated loan providers that are at a higher rate of interest. </div>
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If these measures were enacted and implemented then most of the loan schemes used by companies like GSK and Wales and West Utilities would immediately become either unworkable or unprofitable. None of this requires new tax treaties with other countries (although it may require existing treaties to be shredded - no bad thing!) All that is required is political will, a bit of intelligence from our elected politicians, and a new tax law.
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Cantab83http://www.blogger.com/profile/12485401571391377815noreply@blogger.com0tag:blogger.com,1999:blog-8416708843386784712.post-33540147871331428262013-04-16T15:45:00.001+01:002013-04-17T03:11:02.631+01:00The Big Lie #2 (Part 2): Small Govt = Higher Growth <div style="text-align: justify;">
<a href="http://cantab83.blogspot.co.uk/2013/04/the-big-lie-2-small-govt-higher-growth.html">In my previous blog post</a> I outlined some of my criticisms of the neoliberal stance against Big Government, and in particular the spurious arguments that are generally advanced in support of the concept of low taxes and the small state; arguments such as the Rahn curve. This is not to say that the Rahn curve is wrong <i>per se</i>. I doubt than many would argue that there should be no upper limit on government spending, or that politicians should always aim to make the public sector as large as possible. The real problems with the Rahn curve are twofold. </div>
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Firstly, it implies that the only variable that matters in determining economic growth is the quantity of government spending, and not what the money is spent on, or other factors within the economy such as levels of investment (public and private), education, consumer demand or inequality. </div>
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Secondly, it implies that there exists a single unique value for the ratio of government spending to GDP that is optimal for all countries irrespective of their size, their stage of economic development or their range of economic diversity. </div>
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For example, there are many developing countries with smaller governments and much larger growth rates than the UK: China, Brazil, India for example. But even if all developing countries with smaller governments than the UK have larger growth rates, that does not mean the UK would increase its own growth rate by following suit and reducing the size of the State. These countries have higher growth-rates than the UK because they are playing catch-up. They don't have to "re-invent the wheel" because other countries have already done that for them. Their growth is not constrained by the limited demand of their own consumers because they can piggyback on the higher spending capacity of consumers in more developed countries. And their governments are small because the disposable income of their citizens is small and so their tax base is small. Therefore the economies of these countries contain no lessons from which we in the UK can learn. </div>
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Instead much of the analysis tends to centre on comparisons between countries with advanced economies, particularly <a href="http://www.oecd.org/general/listofoecdmembercountries-ratificationoftheconventionontheoecd.htm" target="_blank">those in the OECD</a>. Yet even here there is much subjectivity in the comparative analysis. </div>
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For example, last year Martin Wolf of the <a href="http://www.ft.com/" target="_blank">Financial Times</a> analysed the growth rates of the 18 most advanced OECD countries over the 22 year period from 1989 to 2011 and <a href="http://blogs.ft.com/martin-wolf-exchange/2012/05/31/taxation-productivity-and-prosperity/?" target="_blank">published them on his blog</a>. The 16 OECD countries he ignored were: Chile, Czech Republic, Estonia, Greece, Hungary, Iceland, Israel, South Korea, Luxembourg, Mexico, Norway, Poland, Portugal, Slovak Republic, Slovenia and Turkey. </div>
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<a href="http://blogs.ft.com/martin-wolf-exchange/2012/05/31/taxation-productivity-and-prosperity/?" target="_blank"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiq8aZNfAuGcsGn0wH9okc865pRd1gwBNaQZslbaw4MLCPgnKORWM4cJhGhKREMQb49YdKD2XTfIR0j_q0y1wgy_dMdk3wxGnWosoQlKvDzRXULHw0DIzDs67tlQyx-AUZX-G2_w33OjIY/s1600/MWtaxchart11.jpg" height="440" width="640" /></a></div>
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The results (shown above) indicate that there is very little evidence that low tax economies yield higher growth rates. Martin Wolf's interpretation of the data was: </div>
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<i>The first conclusion is that there is no relation between the share of government revenue and the rate of growth of real output per head (that is, productivity) over the 1989-2011 period. The “regression line” is flat.</i> </div>
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I disagree. If you discard the data points for Ireland and Spain for the reason that their growth over the period was artificially inflated by transfers from wealthier EU nations (Martin Wolf also discounts the Irish datum as being an "outlier"); and also those of Australia and Canada because they atypically have economies based on mining and agriculture rather than industry, banking and services (so their growth is not endogenous but is inflated by rises in commodity prices driven primarily by growth in China); then the data actually points to a positive correlation between Big Government and higher growth. The regression line through the remaining data points is linear and has a distinct upward slope. In fact the rise in growth rate is about one percentage point for every 28% of GDP spent by government. Not bad! Not bad at all in fact! </div>
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Of course there are many other studies by right-wing economists and think tanks that claim to prove the opposite by selectively using different baskets of countries (often ones with wildly dissimilar economies and questionable political systems) or dubious statistical averages. The approach taken <a href="http://www.cps.org.uk/publications/reports/small-is-best/" target="_blank">here</a> by <a href="http://www.cps.org.uk/blog/q/author-73/" target="_blank">Ryan Bourne</a> and Thomas Oechsle at the right-wing Tory/Thatcherite think tank, the <a href="http://www.cps.org.uk/" target="_blank">Centre for Policy Studies (CPS)</a> is a case in point and one that I find particularly dubious for reasons that I might discuss in a future blog post. </div>
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One way to avoid the complication of comparing different countries is to stick to the same country but then compare its performance under different macroeconomic conditions. The history of economic growth in both the UK and the USA over the last 150 years is a good example. Over this period both countries experienced periods of small government (before 1929) and large government (after 1950). The neoliberals would have you believe that the earlier period, when government was small, was a period of dynamic and rapid growth, with the animal spirits of the entrepreneur freed from the later suffocating bureaucracy of the State. What rubbish!<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEinIKo_kX6-YiWSCsHCOffI11mwyGiL2uM3BmCIlJ8Er32LslPs4F4HPnhysQUOkCwPx5zt43AsRCT7UW7TKtf6FKbBSjCg93uEktFycwgNdKRtsjmfZCxrZpxtlj_hJ-1KH02QEeOCURg/s1600/UK1.jpg" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEinIKo_kX6-YiWSCsHCOffI11mwyGiL2uM3BmCIlJ8Er32LslPs4F4HPnhysQUOkCwPx5zt43AsRCT7UW7TKtf6FKbBSjCg93uEktFycwgNdKRtsjmfZCxrZpxtlj_hJ-1KH02QEeOCURg/s1600/UK1.jpg" height="388" width="640" /></a></div>
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The graph above illustrates the growth in real GDP per capita in the UK from 1850 to the year 2000 (green curve) together with the size of government (black curve). I have highlighted two distinct regions. The blue region is the period of small government where government spending was generally less than 15% of GDP (with a slightly higher blip during the 2nd Boer War). The pink region is the period of Big Government where government spending was generally above 35% of GDP. The period from 1915 to 1950 has been discarded from the analysis because the economy over this time period was dominated by war spending for the First and Second World Wars. Yet the contrast in GDP growth between the blue and pink periods is stark. </div>
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Firstly, GDP growth was more unstable in the blue period than it was in the more recent pink period. There were more recessions and those recessions were deeper. The twenty year rolling average of GDP growth (as indicated by the red curve) also shows two distinct patterns of behaviour. This data is shown again on the graph below for greater clarity. </div>
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhk5waITdMmTjlqAo6hzC7qDsdlEYm6D3DfWwEtKmx7Cp-MOHzE1ICKtA8x9NhMGAEH8t_mTRquNOPbF2UMZ_t6JdSg5NRHCFGPWnFjymVbQRc_GHvZLhmuDM-DLOs_rFM4RnZsnpHtCjE/s1600/UK2.jpg" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhk5waITdMmTjlqAo6hzC7qDsdlEYm6D3DfWwEtKmx7Cp-MOHzE1ICKtA8x9NhMGAEH8t_mTRquNOPbF2UMZ_t6JdSg5NRHCFGPWnFjymVbQRc_GHvZLhmuDM-DLOs_rFM4RnZsnpHtCjE/s1600/UK2.jpg" height="386" width="640" /></a></div>
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Before 1940 the twenty year rolling average of GDP growth never rose above 1.3%. After 1950 it rarely fell below 1.5%. The average growth rate over the 65-year long blue period 1850-1915 was only 0.94% per annum. For the post-war pink period of 1950-2000 it was more than 2.2% per annum. These are striking differences! </div>
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And yet they are not just confined to UK economic performance. Exactly the same trends are to be seen in the economic data of the USA over the same periods. </div>
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgSmoFCLuvIO_B_lDmKhgu00MHmxYr5WWRddXPtUFkuMuwLxNi1ptrwRSDz0n_ecnClwwM5Jq20QkNH0qaXlcpp_0EpoHxb4D-pgYYOQHhJymV00mcz8NribYmWig-p1WAn237ZQX3ZbHM/s1600/USA1.jpg" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgSmoFCLuvIO_B_lDmKhgu00MHmxYr5WWRddXPtUFkuMuwLxNi1ptrwRSDz0n_ecnClwwM5Jq20QkNH0qaXlcpp_0EpoHxb4D-pgYYOQHhJymV00mcz8NribYmWig-p1WAn237ZQX3ZbHM/s1600/USA1.jpg" height="386" width="640" /></a></div>
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When one looks at the economic data of the USA for the 25 years immediately prior to the 1929 crash one sees that US government spending averaged less than 10% of GDP. For the 25 years before that the average was even lower at barely 3% of GDP. In contrast, over the period 1950 to 2000 the average was closer to 35% of GDP. </div>
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For the period 1879-1929 real GDP was 5.5 times larger in 1929 than it was fifty years earlier. That equates to an average annualized growth of 3.47%. Yet for the fifty years after 1950 the factor was 5.6 and so the growth was actually slightly higher at 3.50%pa. However this neglects the effects of population growth. </div>
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Between 1880 and 1930 the US population grew by 150% whereas from 1950 to 2000 it only grew by 86%. So the annualized growth rates in real GDP per capita for the two periods are actually 1.6% and 2.2% respectively. Once again that is a big difference, particularly when continued over fifty years, although the difference is not as stark as in the UK. This difference over time can be seen in the plot of the 20-year rolling average of GDP growth in the graph below. </div>
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh4kcQh6dDmLyPSoq0q5VlDsq7KdQL0HuJVKBgEeNqF167bqYztwBBjXRUPYD66PnDvgF5h2aqq3D45iFhIr9CJMFRAUs_lxEhXdleqnsatITLN__5CVFx5dAzztG3DrcqUC7-zBdM5tac/s1600/USA2.jpg" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh4kcQh6dDmLyPSoq0q5VlDsq7KdQL0HuJVKBgEeNqF167bqYztwBBjXRUPYD66PnDvgF5h2aqq3D45iFhIr9CJMFRAUs_lxEhXdleqnsatITLN__5CVFx5dAzztG3DrcqUC7-zBdM5tac/s1600/USA2.jpg" height="388" width="640" /></a></div>
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However the benefits of higher public spending don’t end there. They are also seen in the volatility of the growth rate and <a href="https://www.blogger.com/%E2%80%9Dhttp://en.wikipedia.org/wiki/List_of_recessions_in_the_United_States%E2%80%9D" target="_blank">the frequency and severity of the ensuing recessions</a>, just as in the UK case. The striking thing about the GDP growth rate over the period 1879-1929 is its extreme volatility. One year growth could be over 10% and a couple of years later GDP is contracting by just as much. This happened repeatedly over that period. As a result the average growth rate was 3.6% but the standard deviation in this value was even greater at 5.2%.
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Contrast that with the second half of the twentieth century where the average growth rate was 3.5% but the standard deviation was actually much smaller at 2.3%. Not only that but this period also experienced recessions that were mild by historical standards with contractions in GDP of typically only 1%-2% each time. The period 1879-1929 on the other hand was blighted by repeated recessions where GDP contracted by 5%-10% or more. </div>
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What this demonstrates is the stabilizing effect of high government spending (plus of course the added benefits of a Federal Reserve Bank and deposit insurance instead of a system of free banking which existed for most of the 19th Century). It is easy to see why. If government spending is high and generally fixed, then the capacity for the economy to contract during a recession is reduced. So recessions are less severe, less capital investment is lost due to business failures and so when the recovery begins less new capital investment is needed to replace what was lost in the recession. Thus the economy functions more efficiently with higher overall growth rates. </div>
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Moreover, even in boom periods Big Government aids growth because it provides the private sector with guaranteed markets. That improves business confidence and therefore raises long-term investment. Not only that, but Big Government also increases the level of redistribution within the economy, thereby reducing inequality and raising aggregate demand, which also boosts investment confidence and growth. </div>
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So for those still hankering after small government I suppose the BIG question is this. Which type of economy do you really want to live in? </div>
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(i) An economy with more government that offers better public services, higher growth, fewer recessions, greater economic stability and security, less inequality and few if any depressions? </div>
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Or: </div>
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(ii) An economy with inadequate small government that can only offer poor public services, low growth, more recessions, greater economic instability with little long-term security, more inequality and regular massive depressions? </div>
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Wow! What a tough choice.
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Cantab83http://www.blogger.com/profile/12485401571391377815noreply@blogger.com0tag:blogger.com,1999:blog-8416708843386784712.post-60856017814875482102013-04-14T19:45:00.002+01:002013-04-16T15:50:26.875+01:00The Big Lie #2: Small Govt = Higher Growth (Part 1)<br />
Which is better for the economy: a large public sector or a small one?<br />
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This is a debate that has continued for decades but is now even more pertinent given the current government's zealous attack on public spending. For while "Slasher" Osborne and his colleagues may continue to claim publicly that their spending cuts are driven by a need to reduce the deficit, the reality is that for many in the coalition this course of action is driven more by ideology than economic reason. They are cutting the size of government because they want too, not because they believe they have to.</div>
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For many Thatcherites, neoliberals and old-fashioned Gladstonian Liberals, it is not just about the size of the current budget deficit, or even about the current budget deficit at all. It is about implementing measures that they believe will unleash a tsunami of entrepreneurial dynamism. In fact in both the Conservative Party and in the Liberal Democrats there exists a dominant strand of economic ideology that sees the move towards a small state as a necessary prerequisite for delivering higher levels of economic growth. Of course it is just a coincidence that reducing the size of the state necessarily involves reducing taxes, thereby allowing the rich to retain an even greater proportion of their wealth and income. </div>
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At the heart of this debate is the <a href="http://www.economicshelp.org/blog/447/economics/the-rahn-curve-economic-growth-and-level-of-spending/" target="_blank">Rahn curve</a>. Like its paramour the <a href="http://en.wikipedia.org/wiki/Laffer_curve" target="_blank">Laffer curve</a> which argues that there is an optimal tax rate that maximizes government tax revenues and is therefore used by neoliberals to justify tax cuts for the rich, the Rahn curve claims a similar relation between GDP growth and the size of the public sector. But there are other supposed justifications for a smaller state that are regularly wheeled out by the neoliberal Right. One is the concept of "crowding out" (the squeezing of supply to the private sector by excessive government demand), while the other comes from the various quotes of eminent historical economists (including some seen as being more on the left like John Maynard Keynes and Hyman Minsky) that "in their opinion optimal government spending should be less than 25%". </div>
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Of course in the case of eminent opinion context is everything. Keynes may have believed that an economy with 25% of GDP under the control of the State was bordering on excessive, but at the time there was no NHS, and manufacturing, mining and agriculture accounted for over 50% of GDP. Now that these sectors account for less than 20% of GDP can we really cling to the same old certainties or prejudices? Of course not! </div>
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A more realistic analysis would be to recognize that the size of the state is inextricably linked to the overall size of the services sector of which it is a major part. Thus as the relative size of production in the economy decreases, the size of services must increase and with it also the size of the State. Not only that, but as the means of production is concentrated into the hands of fewer and fewer workers, so the importance of the State will increase as a necessary means of redistributing the earnings from that production amongst the wider populace. Without it inequality would be greater, and as we are finding now, recessions would be deeper and more frequent. </div>
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In the case of the Rahn curve the justification is based on a logic that is derived from the Laffer curve. Yet there is a fundamental difference between the two curves when it comes to the veracity of the theory that underpins their underlying reasoning. </div>
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In the case of taxation and thus the Laffer curve, any level or rate of tax yields positive revenues for the government. But if the tax rate is zero, then the revenues collected must clearly be zero. However, if the tax rate is 100% then the revenues collected are also likely to be close to zero as there is no incentive for anyone to work, at least that is the theory (see below for a counter-argument). Thus in the case of the Laffer curve, the revenue curve must be zero when the tax rate is at either 0% or 100% and as the tax revenue must always be positive, the curve must be positive at all points in between. Therefore the curve must have a maximum somewhere in this region. The question that is continually being debated is, where exactly is that maximum? While the neoliberal Right claim it to be as low as possible (20% or less), there is a growing body of evidence to suggest it is much higher and may even be as high as 70%. </div>
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The proponents of the Rahn curve try to make an identical argument for GDP growth. Unfortunately their logic is flawed. They try to claim that when there is no government (i.e. government spending is zero), growth must be zero, but there is no reason why this should be true. If as the neoliberals claim, it is the private sector and only the private sector that can deliver economic growth, then they cannot at the same time demand a residual of government spending to make it happen. All that is required for a functioning capitalist economy is a well-defined currency and the rule of law, not government spending. </div>
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They also try to claim that when there is no private sector (i.e. government spending is 100% of GDP) growth must be zero again, but there is no reason why this should be true either. Even communist countries can have positive growth rates even if they are generally much lower. </div>
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Nor is it the case that growth rates must always be positive for all intermediate sizes of government between the two limits described above. Unlike tax revenues, GDP growth is not restricted to positive quantities. </div>
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Thus the Rahn curve is fundamentally flawed, but in truth so is the Laffer curve. As hinted at above, the upper tax limit of 100% will not discourage all work as the neoliberals claim. In practice most people will continue to work even when all their income is taken in tax as they know that the taxes they pay must be returned to them in the form of services and transfer payments, and thus the more they work the more that will be returned. So while a "nationalization of income" will reduce incentives to work harder, it will not completely remove them. Somewhat counter-intuitively, a tax rate of 100% is more likely to kill growth rather than government tax revenues as it removes the incentive for each individual to work harder than his neighbour. </div>
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Of course the attempts to intellectually justify the drive for a smaller state do not come purely from Rahn curve analysis. There are other macroeconomic justifications, the primary one being the concept of "crowding out". </div>
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The argument is that if the State hogs too much of the nation's resources, then this increases the demand for those resources and so increases their price. This then puts additional costs on the private sector which leads to reductions in growth. And the two resources for which the State has the greatest appetite are labour and capital. </div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
Thus if the State employs too many people, or too many of the most skilled people, then the cost of labour should increase. But if this happens we should see evidence of it in excessive growth in wages and subsequently in inflation and high interest rates. Yet for most of the past twenty years we have seen neither. </div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
Similarly, if the State absorbs too much capital through borrowing or taxing, the effects would be seen in the growing cost of borrowing for business. Again the last twenty years show little evidence of this. It is therefore difficult to justify any claim that crowding out has impeded growth over the last few decades. </div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
So much for the theory behind the Rahn curve and the principle of crowding out. As is we have seen, the curve itself has no mathematical integrity, while the economic data from the last two decades provides no substance to the claim that the State has been too big, or that it has had a detrimental impact on other economic indicators like wages, inflation and interest rates. But what about the comparative evidence with other similar economies, or for economies with different levels of government spending? </div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
In my next post I will show that contrary to the claims of the neoliberal Right, both the USA and the UK have experienced higher growth-rates in the post-war period where their government spending exceeded 25% than they did in earlier periods where government spending was much less than 25%. Not only that, but the increase in government size has contributed to greater economic stability and fewer recessions. In short: Big Govt. = Higher Growth!
</div>
Cantab83http://www.blogger.com/profile/12485401571391377815noreply@blogger.com0tag:blogger.com,1999:blog-8416708843386784712.post-84818266893089036042012-10-23T12:46:00.000+01:002012-10-23T12:47:32.246+01:00The taxing problem of tax avoidance #1: the moral question.<!--[if gte mso 9]><xml>
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<span lang="EN-US">It seems that hardly a week goes by these
days without the issue of tax avoidance hitting the headlines. First it was <a href="http://www.bbc.co.uk/mediacentre/latestnews/2012/panorama-truth-about-tax.html" target="_blank">companies like GlaxoSmithKline (GSK) that were in the firing line</a>
then it was poor old </span><a href="http://www.bbc.co.uk/news/uk-politics-18531008" target="_blank">Jimmy Carr</a>. Now, in recent weeks we have had both <a href="http://www.telegraph.co.uk/culture/tvandradio/bbc/9587937/BBC-complicit-in-tax-avoidance-for-household-names-say-MPs.html" target="_blank">the BBC</a> and <a href="http://www.guardian.co.uk/business/2012/oct/15/starbucks-tax-uk-sales" target="_blank">Starbucks</a> under the spotlight.</div>
<div class="MsoNormal">
<br /></div>
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<span lang="EN-US">Of course central to this debate is the
issue of what constitutes a fair tax system. To most that is one where those
that have the most pay the most. The reason why tax avoidance is seen to be so
invidious by many is that it distorts this principle. A millionaire can end up
paying a smaller fraction of his income in tax than his secretary or his
cleaner. Indeed in many cases he can end up paying no tax at all. It is not
just that he can end up paying less tax that is the problem. It is the fact that
he seems to be able to pick and choose which tax he would prefer to pay, and
when he would prefer to pay it. In short, it is because there are opportunities
open to him that are not open to the general population. Thus the playing field
is not flat and it is not fair.</span></div>
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<br /></div>
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<span lang="EN-US">It is probably to be expected that in times
of austerity for many (<a href="http://www.guardian.co.uk/business/2012/jun/11/executive-pay-soars-survey-shows" target="_blank">although not the few</a>) there will be a sense of moral
outrage directed at those perceived to be not paying their fair share, but it
should be remembered that the political issue of tax avoidance has been with us
for many years. It was a particular <!--[if gte mso 9]><xml>
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<![endif]--><!--StartFragment--><i><span lang="EN-US" style="font-family: Cambria; font-size: 12.0pt; mso-ansi-language: EN-US; mso-ascii-theme-font: minor-latin; mso-bidi-font-family: "Times New Roman"; mso-bidi-theme-font: minor-bidi; mso-fareast-font-family: Cambria; mso-fareast-language: EN-US; mso-fareast-theme-font: minor-latin; mso-hansi-theme-font: minor-latin;">cause c</span><span lang="EN-US" style="font-family: Cambria; font-size: 12.0pt; mso-ansi-language: EN-US; mso-bidi-font-family: "Times New Roman"; mso-bidi-theme-font: minor-bidi; mso-fareast-font-family: Cambria; mso-fareast-language: EN-US; mso-fareast-theme-font: minor-latin;">é</span><span lang="EN-US" style="font-family: Cambria; font-size: 12.0pt; mso-ansi-language: EN-US; mso-ascii-theme-font: minor-latin; mso-bidi-font-family: "Times New Roman"; mso-bidi-theme-font: minor-bidi; mso-fareast-font-family: Cambria; mso-fareast-language: EN-US; mso-fareast-theme-font: minor-latin; mso-hansi-theme-font: minor-latin;">l</span><span lang="EN-US" style="font-family: Cambria; font-size: 12.0pt; mso-ansi-language: EN-US; mso-bidi-font-family: "Times New Roman"; mso-bidi-theme-font: minor-bidi; mso-fareast-font-family: Cambria; mso-fareast-language: EN-US; mso-fareast-theme-font: minor-latin;">è</span><span lang="EN-US" style="font-family: Cambria; font-size: 12.0pt; mso-ansi-language: EN-US; mso-ascii-theme-font: minor-latin; mso-bidi-font-family: "Times New Roman"; mso-bidi-theme-font: minor-bidi; mso-fareast-font-family: Cambria; mso-fareast-language: EN-US; mso-fareast-theme-font: minor-latin; mso-hansi-theme-font: minor-latin;">bre</span></i><!--EndFragment--> </span><span lang="EN-US">in the
boom years, and every year the public's expressions of outrage against it appeared
to grow louder. So too did the protestations of certain venerable politicians
that "Something must be done". Yet nothing ever was done, or so it
seemed. Instead what we got were a plethora of appeals to the moral conscience of
the perpetrators. Yet what many fail to realize is that morality doesn't come
into it, or even worse, that tax avoidance in many cases may actually be the
most moral action available. </span></div>
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<br /></div>
<div class="MsoNormal">
<span lang="EN-US">If you are a tax accountant it is your
moral (and legal) duty to do the best by your client. That means finding the
lowest tax rate for the client. If you are a company finance director your
moral and legal duty is to maximize the return to your shareholders. That
inevitably means minimizing the funds paid to everyone else including employees
and the taxman. So, when it comes to paying tax, morals are for individuals. When
you are handling the tax affairs of others, morality doesn't come into it. It
is about applying the letter of the law. So if politicians want to eradicate
tax avoidance, then surely the onus is upon them to legislate to that effect? Yet
nothing ever seems to change. Now why is that? Is it because it is really so
difficult to legislate against tax avoidance? I think not. </span></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span lang="EN-US">You see if you look at all the various schemes
on offer for the average man or woman with more disposable income than social
conscience, they all boil down to a handful of basic mechanisms. These schemes often
involve off-shore companies, but they also tend to exploit the use of loans,
rebates, rents, "gifts" or arbitrage to minimize the tax liability of
the company or individual. As I will outline in later posts, most of these
schemes could be closed down with the right legislation and a modicum of political will. </span></div>
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<br /></div>
<!--EndFragment-->Cantab83http://www.blogger.com/profile/12485401571391377815noreply@blogger.com0tag:blogger.com,1999:blog-8416708843386784712.post-12638915938304669432012-05-31T15:52:00.000+01:002012-05-31T16:12:14.941+01:00The Big Lie #1 - Austerity is needed to appease the bond markets<span class="Apple-style-span" style="font-family: Georgia, 'Times New Roman', serif;">It is often said that truth is the first casualty of war. It could equally be the first casualty of politics as well. Given the extent to which politicians have appeared to play fast and loose with language and semantics in recent times it is perhaps unsurprising that their collective credibility and reputation, both at home and abroad, appears to be following the same trajectory as that of a <a href="http://www.bbc.co.uk/news/world-asia-17698438" target="_blank">test firing of a North Korean rocket</a>. Whether it is politicians being "economical with the actualité", or <a href="http://en.wikipedia.org/wiki/Doublespeak" target="_blank">Orwellian doublespeak</a> of the type invoked by David Cameron recently where <a href="http://www.ft.com/cms/s/0/8b5333ce-9939-11e1-948a-00144feabdc0.html" target="_blank">the term austerity has been magically redefined to mean "efficiency"</a>, the first casualty of UK political debate now always seems to be the English language. Of course none of this is accidental. It is all designed to disguise the reality behind a particular policy or action so that the voters are hoodwinked into believing in an illusion. </span><br />
<span class="Apple-style-span" style="font-family: Georgia, 'Times New Roman', serif;"><br /></span><br />
<span class="Apple-style-span" style="font-family: Georgia, 'Times New Roman', serif;">One of the biggest fictions we are currently being expected to swallow is the one regarding the necessity of the current coalition government's deficit reduction measures and their apparent success. The argument that has been advanced by those on the Right on an almost daily basis since the last general election in 2010 is that the only way the Government can finance its deficit is if it can establish the confidence of the bond market. And the only way it can do that is if it slashes spending. And the central piece of evidence used to corroborate this claim has been the yields of government bonds or gilts. </span><br />
<span class="Apple-style-span" style="font-family: Georgia, 'Times New Roman', serif;"><br /></span><br />
<span class="Apple-style-span" style="font-family: Georgia, 'Times New Roman', serif;">Gilt yields are currently at historic lows despite the Government running up record budget deficits over the last four years. Now we are told that these low yields are a direct result of the confidence that the bond market has in the Government's economic strategy. We are told that the Government cannot, or dare not, borrow any more money to stimulate the economy otherwise gilt yields would rise dramatically. We are told that our economy would then go the same way as that of Italy, or Spain, or worse still Greece! But how much of this is really true? The answer is hardly any of it. The reality is that our gilt yields are low because our borrowing has been almost completely self-financed over the last four years. That self-financing has come in the form of Quantitative Easing (QE). </span><br />
<span class="Apple-style-span" style="font-family: Georgia, 'Times New Roman', serif;"><br /></span><br />
<span class="Apple-style-span" style="font-family: Georgia, 'Times New Roman', serif;">Up until April 2002 the last Labour government ran a financial surplus in its accounts. Then over the next six years this turned into a modest deficit of approximately £35bn per annum. While not ideal, these deficits were nevertheless sustainable in the long term as they typically increased the national debt by a smaller proportion than the corresponding annual increase in GDP due to economic growth. As a result the debt-to-GDP ratio was actually declining after 2006 despite the nominal debt level still increasing, and as a result it was actually more serviceable. It is therefore economic fantasy to suggest, as some on the Right have done, that these deficits caused the financial crash. The real cause was the set of economic policies implemented by the Thatcher and Major governments in the 1980s and 1990s, particularly with regards to the liberalization of consumer credit, laissez-faire bank deregulation and a wholly disfunctional housing policy. The result was the worst recession in living memory and a national debt that has increased to £1022bn. Of this total, over £500bn has been added since the start of 2008 - almost half the total. So why have gilt yields remained so low when the supply of gilts from the Government to the bond market has been so huge? The answer is QE. </span><br />
<span class="Apple-style-span" style="font-family: Georgia, 'Times New Roman', serif;"><br /></span><br />
<span class="Apple-style-span" style="font-family: Georgia, 'Times New Roman', serif;">Since 2008 the Bank of England (BoE) has "printed" an additional £325bn of new money in the form of Quantitative Easing and used this money to purchase UK gilts. Irrespective of the fact that this was done through the secondary bond market, the net result is that 65% of all the new gilts issued by the Government since 2008 have in effect been acquired by the BoE. That means that only about £180bn have actually been purchased by the private sector, or £45bn per annum. That is only fractionally more than were purchased each year prior to the crash, and this has been going on for nearly four years now. In fact QE has been operating for so long now that the financing of government deficit spending has become semi-detached from the bond market to such an extent that it is almost operating in a parallel economic universe. That is partly why yields are so low and as you can see it has nothing at all to do with the international financial markets supporting the deficit reduction plans of the coalition. </span><br />
<span class="Apple-style-span" style="font-family: Georgia, 'Times New Roman', serif;"><br /></span><br />
<span class="Apple-style-span" style="font-family: Georgia, 'Times New Roman', serif;">But that is not the whole story, for one of the additional consequences of the financial crash is that UK banks are now forced to hold more assets to strengthen their balance sheets. As a result UK banks have needed to buy more UK gilts themselves in order to increase their own financial stability. It is therefore highly debateable if there has been any significant increase in the purchase of UK gilts by overseas investors in recent years, yet capital flight from the PIIGS (Portugal, Ireland, Italy, Greece and Spain) has driven up the relative demand for UK gilts.</span><br />
<span class="Apple-style-span" style="font-family: Georgia, 'Times New Roman', serif;"><br /></span><br />
<span class="Apple-style-span" style="font-family: Georgia, 'Times New Roman', serif;"><a href="http://www.telegraph.co.uk/finance/financialcrisis/9301458/Spain-in-a-state-of-total-emergency.html" target="_blank">Only yesterday did we see further worries about the Spanish economy</a> driving yet more capital away from the Eurozone and forcing it to look for safer havens elsewhere. The result was a further drop in UK gilt yields. And all of this is happening at a time when the supply of UK gilts, contrary to popular opinion, has actually been significantly reduced, or has at least been far less than the headline figure of the UK government deficit. So, given these two complementing drivers, it should hardly be any surprise that UK gilt yields are so low, irrespective of the general state of the economy, which in case you had missed it, <a href="http://www.guardian.co.uk/business/2012/apr/25/uk-sinks-double-dip-recession-gdp" target="_blank">is lurching from one recession to another</a>. That is hardly the sort of performance that is usually associated with inspiring the confidence of international investors. </span><br />
<span class="Apple-style-span" style="font-family: Georgia, 'Times New Roman', serif;"><br /></span><br />
<span class="Apple-style-span" style="font-family: Georgia, 'Times New Roman', serif;">You can of course look at all this from another perspective: that of the balance between supply and demand and its effect on market prices. Low gilt yields are an indication of excess demand and insufficient supply. Consequently they represent a market price signal that says: "The market wants more!" In which case why should we not supply more gilts to the market, particularly when we can put those gilts to good use? Those who believe in the power of markets, and the price signals that they send, cannot have it both ways. If high yields are a sign that government borrowing is too high, then low yields can be a sign that it is too low. </span><span class="Apple-style-span" style="font-family: Georgia, 'Times New Roman', serif;"><a href="http://cantab83.blogspot.co.uk/2012/02/why-zero-interest-rate-equals-zero.html">And as I pointed out previously, when it comes to low interest rates you can have too much of a good thing.</a></span><span class="Apple-style-span" style="font-family: Georgia, 'Times New Roman', serif;"> Ultimately banks, including central banks, cannot push money out into the economy when there is no demand, or no cost to holding it. In such circumstances monetary policy is like pushing against of piece of string and a coordinated and complementary fiscal policy is then also needed. </span><br />
<span class="Apple-style-span" style="font-family: Georgia, 'Times New Roman', serif;"><br /></span><br />
<span class="Apple-style-span" style="font-family: Georgia, 'Times New Roman', serif;">Of course the real tragedy is that despite having access to what has effectively been free money for four years, both the last Labour government and the current coalition have failed to do anything effective or imaginative with it. Rather than using it to stimulate a programme of infrastructure investment, it has instead been used to refinance the banks, and indirectly to prop up house prices. Once again successive governments and the Bank of England have shown that they are more worried about negative equity than they are about unemployment; that they prize inflated asset values over real economic growth. As a result, all this free money has in effect been used to insulate the rich from the consequences of their own mal-investment rather than improving and protecting the lives of the poor. </span><br />
<span class="Apple-style-span" style="font-family: Georgia, 'Times New Roman', serif;"><br /></span><br />
<span class="Apple-style-span" style="font-family: Georgia, 'Times New Roman', serif;">The choice of austerity is therefore a political choice not an economic one. Just because there is a lot of debt in the economy does not mean that there is no money at all. It just means that all the money is in the pockets of the wrong people. The current government with its tax cuts for the rich and its attacks on the incomes of the poor clearly wishes to keep it there.
</span>Cantab83http://www.blogger.com/profile/12485401571391377815noreply@blogger.com0tag:blogger.com,1999:blog-8416708843386784712.post-87786216534530859082012-03-19T17:41:00.011+00:002012-03-19T20:02:17.602+00:00The Budget 2012: Should George Osborne learn from Barack Obama?<span class="Apple-style-span" style="font-family:georgia;font-size:100%;">This was the question that <a href="http://www.guardian.co.uk/business/economics-blog/2012/mar/18/budget-osborne-obama-keynes" target=_blank>Larry Elliott asked on The Guardian's Economics Blog</a> yesterday. He was of course referring to fact that the USA has implemented a major economic stimulus package whereas the coalition government here has instead (with the tacit encouragement of the Treasury) been implementing a policy of cuts and austerity. As a result the USA has had falling unemployment for most of the last year whereas in the UK unemployment is still rising. In the USA economic growth is well over 1% and approaching 2%. In the UK it is barely above zero. So has Obama got it right and Osborne got it wrong?<br /><br />To answer this we must first take stock of what it is exactly that the US government has done. Its stimulus package has in fact been in three parts. First it reduced its short-term policy rate (just as the Bank of England did). Then it introduced Quantitative Easing (QE), just as the Bank of England did. Then last autumn it launched <a href="http://www.guardian.co.uk/business/2011/sep/21/operation-twist-us-economy" target=_blank>Operation Twist</a>. This involved buying long-dated bonds to bring down long-term interest rates and replacing them with short-dated bonds, but as Operation Twist is such a new initiative can it really be held responsible for a US recovery which has been underway for over a year now? Probably not, and <a href="http://www.guardian.co.uk/business/2011/sep/21/operation-twist-us-economy" target=_blank>as Larry Elliott suggested in his column</a>, it is difficult to see how Operation Twist could really effect aggregate demand. So is the real explanation for the difference in recovery rates between the US and the UK just down to the size and length of the stimulus. Perhaps not.<br /><br />Perhaps the real reason that the US economy is growing faster is not just down to the federal stimulus. A point that is too often overlooked has been the scale and the effect of the housing crash in the US over the last four years. Unlike in the UK where house prices fell by only about 20% from their 2007 peak and are still at historically high levels, in many parts of the US the fall has been much more dramatic. Could this be part of the reason that the US economy has seen a better speed of recovery?<br /><br />In case you had forgotten, <a href="http://cantab83.blogspot.co.uk/2009/10/real-issue-is-house-prices-not-bank.html">it was the boom in the housing market in both the USA and Britain (and Ireland and Spain for that matter) that led to the financial crash in 2007, rather than just a failure of bank regulation</a>. In all of those countries mentioned the housing bubble was the result of either rising inequality or increasing economic imbalances and, in the case of the US and UK, stagnant growth in real wages for the less well off as well. As a result an excess of investment funds got misdirected into creating bubbles in asset prices (i.e. property) instead of being use to create new means of production.<br /><br />What is different about the US response to the crisis, compared to the UK one, is that the US allowed their housing bubble to implode. We did not. In fact government policy in the UK is still more concerned about supporting house prices than it is about keeping people in work. That is the big mistake. Negative equity is only an economic problem if people start losing their jobs.<br /><br />In the USA by contrast, by allowing the housing market to crash the policy makers have forced the debt holders to take a "debt haircut" and thus allowed the economy to partially reset itself. Thus the USA has benefited from a combination of a debt haircut and a stimulus. In the UK we have had a weak stimulus primarily for the banks but no haircut. In the Eurozone (e.g. Spain and Ireland) they might get a small debt haircut but no stimulus. Thus it is the combination of stimulus and debt write-off that is the necessary remedy. Those countries that only take half the medicine either take much longer to recover, or don't recover at all.<br /><br />However it is not just about the size of the stimulus either. It is also about the shape of it. The correct economic response to the current crisis is not just to provide a stimulus, but to direct that stimulus towards correcting the original cause of the problem, namely the housing market. By building more social housing the government would not only have created jobs, it would also have reduced house prices and private sector rents and thereby increased disposable incomes for the majority of families. That would have magnified the effect of the stimulus and helped to eradicate the core problem. Instead we are having to endure an economic policy that protects the haves at the expense of the have-nots. That is just a repeat of the very economic policies that caused the whole sorry problem in the first place.</span>Cantab83http://www.blogger.com/profile/12485401571391377815noreply@blogger.com0tag:blogger.com,1999:blog-8416708843386784712.post-27799578086968264272012-02-21T00:29:00.004+00:002012-05-31T16:12:38.059+01:00Why a zero interest rate equals zero lending<span class="Apple-style-span" style="font-family: georgia;"><span class="Apple-style-span" style="font-size: small;">Adam Posen is an American economist who currently sits on the Bank of England’s (BoE) Monetary Policy Committee (MPC). This is the committee that sets the UK’s interest rates in order to control CPI inflation, or at least that was the original idea behind the formation of the MPC in 1997 when Gordon Brown was Chancellor of the Exchequer. I mention this because a couple of weeks ago Mr. Posen was <a href="http://www.telegraph.co.uk/finance/economics/9057692/Bank-of-Englands-Posen-attacks-banks-for-failing-to-deliver-value-for-economy.html">quoted in an article by Philip Aldrick in The Daily Telegraph</a> as described British banks as “reluctant, risk-averse jerks”. He may be right, but is that such a bad thing, particularly given the reckless lending that preceded 2007? I thought we all wanted banks and bankers to be boring again. Obviously not!<br /><br />It occurs to me, however, that one of the issues that both the Daily Telegraph article and Adam Posen’s recent comments apparently fail to highlight is the possible causal effect that low interest rates can have in reducing bank lending. The point that virtually no-one in economics and the political media has so far cottoned onto is this: when base rates are high banks are forced to lend virtually all the deposits they receive in order to pay the interest that they owe to their savers, but when base rates are low there is no such necessity. To understand why, consider this simple example.<br /><br />In normal economic times bank base rates may be about 5%. So, suppose a bank receives deposits of £1m for which it must pay interest at a savings rate of 4.5%. If the bank is required to maintain a capital adequacy ratio of let's say 10%, it will only be able to lend out 90% of its deposits. But it must also lend sufficient money at a sufficiently high rate of interest so that it can bring in enough revenue through loan interest repayments in order cover the interest it owes to its depositors. At the very least that means it must lend all of the available deposits (£900,000.00) at a rate of 5% just to break even. It could of course lend out less (say £750,000.00) but then it would need charge a higher loan rate in order to make a profit (in this case over 6%).<br /><br />When you add in the effects of competition between banks, that competition will have two effects. Firstly, it will force down loan rates (or force up saver rates); and secondly, that will then force banks to lend more and more of their available deposits in order to cover costs and maximise profit. This inevitably means that banks will be unable to sit on deposits. Instead they will be incentivised to make those deposits work as hard as possible, possibly to the extent where some banks try to circumvent the rules on capital adequacy. That of course was what happened during the credit boom with disastrous consequences. But that is not what is happening now.<br /><br />Today base rates are anchored at 0.5% and look like staying there for several more years to come. As a result savers typically receive an interest rate of about 0.2% if they are lucky. Yet most loan rates still exceed 4%, while for credit cards and unsecured loans they are much higher still. Under circumstances such as these banks would only need to loan out about 5% of their total deposits in order to break even. The net result is that they can pick and choose with even greater selectivity than before who they choose to lend to, and how much they choose to lend. The credit market therefore becomes highly skewed in favour of the lender. So that would appear to explain, at least partially, why current levels of bank lending are apparently so weak. In which case is Adam Posen right to criticise the banks in this way? Or should some of the responsibility for this lack of lending also lie with Adam Posen and his colleagues on the MPC? After all, it is they who set the BoE's base rates and, as I have shown, it is those base rates that help to drive bank lending.<br /><br />With UK interest rate policy set as it currently is, what has in effect happened is that lending rates have become decoupled from savings rates. Once you realize that then it becomes apparent that having base rates at 0.5% serves very little purpose as far as the wider economy is concerned. It certainly has no effect in stimulating increased loans to small businesses, and while that may not be the only reason for the poor lending record of banks, it is probably a contributory factor. The result is a credit crunch or liquidity trap where those with spare cash refuse to either lend it or spend it. The critical issue here is the same one you get in price deflation in a depression. Both are caused by the tendency of the rich to hoard cash when there is no financial penalty for doing so.<br /><br />Normally, hoarded cash loses it value through inflation. That is why a small amount of inflation actually benefits the economy as it helps to drive the circulation of money through spending, investment and consumption. Similarly, un-loaned bank deposits normally lose value for the banks due to the costs of interest they incur that must be paid by the banks to their depositor customers. When inflation and interest rates are negative, however, these conditions no longer apply, and the cash or credit stops flowing. In short, when savings rates are close to zero the banks effectively have access to free money.<br /><br />Of course there are other reasons for the general lack of lending to small businesses. One of the main ones is the competition for funds from house-buyers via the mortgage market. In the period immediately prior to 2007 over 75% of bank lending was on mortgages, with only about 6% being made available to small businesses. This represents a classic case of "crowding out". That is why part of the long-term solution has to be the establishment of a network of locally based investment banks in the UK based on the German model of financial support to its <i>Mittelstand</i>. What is clear is that the more choice banks have over where they lend their money, the less likely they are to lend it in support of the real economy. It is simply a question of reducing the number of options or degrees of freedom banks have. <a href="http://www.telegraph.co.uk/finance/economics/9057692/Bank-of-Englands-Posen-attacks-banks-for-failing-to-deliver-value-for-economy.html">As Adam Posen is also quoted as saying</a>: "We've got to change the competitive pressures on them, change the rules on them so they're forced to do the job right."<br /><br />What the above statistics also show, though, is that like most of the UK's economic problems, the ongoing problem of underinvestment by UK retail banks in the rest of UK business is intrinsically linked to the <a href="http://cantab83.blogspot.com/2009/10/how-to-control-house-prices-guide-for.html">perennial UK problem of property speculation and house price inflation</a>. So you will never solve the investment problem unless you also solve the housing problem.</span></span>Cantab83http://www.blogger.com/profile/12485401571391377815noreply@blogger.com0tag:blogger.com,1999:blog-8416708843386784712.post-79160691344267848342011-07-30T21:52:00.003+01:002011-07-31T12:30:25.810+01:00Home ownership and economic mobility<span class="Apple-style-span" style="font-family:georgia;"><span class="Apple-style-span" style="font-size: small;">A couple of weeks ago James Gregory of the <a href="http://www.fabians.org.uk/" target="_blank">Fabian Society</a> published an article on the Fabian Society’s <a href="http://www.nextleft.org" target="_blank">Next Left</a> blog where <a href="http://www.nextleft.org/2011/07/contrary-to-popular-opinion-home.html" target="_blank">he discussed the impact of increased home ownership on the economy, and the labour market in particular</a>. The central tenet of the article was that the continuous increase in home ownership seen in the UK over the last thirty years has reduced the capacity of the labour market to respond flexibly to economic changes. Rather than complementing and enhancing the legislative changes introduced by the Thatcher and Major governments that were supposedly designed to liberalise the labour market in this country and increase growth, his argument is that increased home ownership has instead acted, at least partially, to neutralise many of those changes and thereby presumably retard growth.<br /><br />What I found surprising about the article though, were its starting assumption that most people (or perhaps only most of the current political class?) believe that home ownership increases economic mobility, and secondly what I perceive to be the article's failure to fully describe the true extent of the causes and impact of this immobility. As a result some of what I would consider to be potential remedies were neglected. For by omitting some of the causal factors, it is undoubtedly more likely that some of the most effective solutions will also be overlooked. However what the article does do is once again highlight the negative impact that current housing policy (such that any active policy actually exists in the UK) has on the British economy. <br /><br />Given the well-known problems of transaction costs (estate agent fees, stamp duty, surveyor fees, re-mortgage fees, conveyancing etc) and the logistical problems associated with the home moving chain, I was more than a bit surprised that "popular opinion" was perceived to be as the article implied. I have certainly never been of the opinion that home ownership may actually make workers more economically mobile. In fact I suspect that most people are not, and do not even desire to be economically mobile. This conjecture is probably borne out by the average time between re-sales for domestic property in the UK (currently about 20 years). You can see the immobilising effect of home ownership by comparing this value with the average length of time most tenants stay in the same property (often for only a few months). Doubtless, much of this difference is due to what James Gregory referred to as <i>"psychological attachment"</i>. Homeowners have a lot of emotional as well as financial capital invested in their homes that is generally absent for many tenants. <br /><br />James Gregory also rightly points to the principal contradiction in UK economic policy: <i>“why have we spent the past 20 years actively pursuing ‘flexible’ labour market policies whilst, simultaneously, seeking to push more and more households into homeownership?”</i> The answer, he claims, lies partly in the myth <i>“that owner-occupation is a vehicle of social and labour market mobility.”</i> It may well be that owner-occupation advances the former. Unfortunately, it most certainly acts against the latter. In addition to the transaction costs described above, there are a number of other reasons why owner-occupation acts to reduce labour market mobility. James Gregory highlighted in particular the pressure some homeowners face to keep up their mortgage payments. Such pressure can often trap homeowners in jobs thereby reducing or removing their ability to change career or relocate. However, I think there are some other pressures that are perhaps even more problematic, not just for the individual, but for society as a whole. <br /><br />The first is the rise in, and the impact of, double income households. The high cost of housing (both home-ownership and rental) is forcing more families to send both adults out to work. This in itself acts to reduce mobility even more as the probability of both adult partners with different careers being able to find suitable jobs in the same part of the country at the same time is always going to be less than the probability that each will find work independently.<br /><br />This then leads to a second problem: an increased tendency for skilled labour to cluster in regions of high employment density such as the South East where both partners are more likely to find suitable employment. This in turn leads to greater regional inequality and overheating of some local economies. This positive feedback mechanism then further exacerbates the original effect (i.e. high house prices) that gave rise to the problems of low mobility and employment clustering (caused by a move towards double income households) in the first place.<br /><br />This clustering then also impacts on employers. Many firms, particularly those that depend on highly skilled labour, have already recognised this problem. As a result they also tend to cluster in regions where the skilled labour is already situated, thus adding to regional inequality. Moreover there is a growing tendency for many of these firms to actively reject job applications from outside their local area because of worries about mobility and relocation problems, thereby adding to the imbalance.<br /><br />The result of all of this is that regional disparities in house prices are exacerbated. This also acts as a further impediment on labour mobility, at least for those trying to move from poorer areas to wealthier ones.<br /><br />Finally there are the issues of short-term and part time jobs. These may give employers greater flexibility, but the cost is borne by the worker (and to some extent the State). Just as it is more difficult for a family of two adults to move and find new employment for both of them than it would be for a family with just one wage earner, so it is also more difficult for an individual with several part time jobs to move and replace all of those jobs simultaneously than it would be to replace a single full time position.<br /><br />These then are some of the additional problems that I would seek to highlight. Unfortunately I can see little reason why the remedies that James Gregory proposes would make much difference. For example, providing more advice and assistance to those with mortgage problems will at best only slightly ameliorate an already abysmal situation. In fact it could actually make the situation worse by giving artificial external economic support to home owners who having inflated the housing market are unfairly supported within it through taxpayer support. What is needed is a set of policies that tackle the underlying problems.<br /><br />The first of these problems is excessive house prices that force families to work longer hours than is socially desirable and which have wider consequences that are economically undesirable. Until a government commits itself to delivering stable and reasonable house prices this problem will not go away. This requires an economic policy that delivers such stable and reasonable house prices (<a href="http://cantab83.blogspot.com/2009/10/how-to-control-house-prices-guide-for.html">as I have previously outlined</a>) so that families can reclaim a more socially desirable work-life balance, and more of their disposable income can be recycled within the productive economy rather than being sunk into unproductive fixed assets. <br /><br />The second problem to be addressed is the issue of regional inequality. For this we need progressive tax rates for employers (NICs, land tax and business rates) that vary regionally and decrease with distance from London. We also need more investment in the regions that doesn't just increase employment, but provides high value jobs. For this we need to look to France and Germany and establish a network of research institutions akin to the <a href="http://www.mpg.de/institutes">Max Planck</a>, <a href="http://www.fraunhofer.de/en/about-fraunhofer/">Fraunhofer</a> and <a href="http://www.helmholtz.de/en/">Helmholtz Institutes</a> in Germany (of which there are more than 150) or the <a href="http://www.cnrs.fr/en/aboutCNRS/overview.htm">CNRS</a> in France (of which there are over 100 separate facilities). These policies would indeed attract high value jobs back into the regions and do so far more effectively and more sustainably than the current system of regional development grants.<br /><br />Finally we need to actively reduce the number of part time jobs in the economy. Flexibility is OK in good measure, but the balance has clearly gone too far. <a href="http://www.newstatesman.com/economy/2011/06/jobs-sector-million-risen" target=_blank>There are currently about 1.2 million people working in part time jobs while actively seeking full time positions</a>. Much of this increase in part time working is driven by the way employers' National Insurance contributions (NIC) are levied. Employer NIC exemptions for jobs that pay less than about £110 per week should be limited to companies with less than five employees. The purpose of these exemptions should be to help a very small company take on the one or two extra staff it needs to meet fluctuating demand. They should not be used by large chains of stores to reduce their tax bill. Large companies should already have sufficient employment flexibility by virtue of the size of their workforce. Currently too many are exploiting this tax loophole for their own financial advantage, but to the detriment of the wider economy.<br /><br />These then are some of the solutions that the Left should be complementing. First, though, it needs to recognise the wider impact that the housing market has on the UK economy. Building more houses, or providing more social housing, is not enough. Neither is simply setting up a few advice networks for distressed home-owners. The problem is much wider and more entrenched than can be solved by such simplistic solutions.<br /><br /></span></span>Cantab83http://www.blogger.com/profile/12485401571391377815noreply@blogger.com0tag:blogger.com,1999:blog-8416708843386784712.post-76642573255703725662011-07-02T11:51:00.008+01:002012-05-31T16:13:05.645+01:00Time to auction work permits?<span class="Apple-style-span" style="font-family: georgia;"><span class="Apple-style-span" style="font-size: small;">Once again the government is getting itself in a muddle over work permits and immigration. This week the Work and Pensions Secretary, Iain Duncan Smith, has been <a href="http://www.bbc.co.uk/news/uk-politics-13984512" target="_blank">urging UK businesses to employ young Britons</a>, rather than relying on foreign workers. This comes after a <a href="http://www.telegraph.co.uk/news/uknews/immigration/8585750/Frank-Field-Migrants-take-nine-out-of-10-jobs.html" target="_blank">recent article by Frank Field MP for the Daily Telegraph</a> highlighted that the majority of new jobs created in the UK both in the last year, and also over the last ten years, have gone to overseas workers. Yet such pleas from government ministers calling on business leaders to act are hardly likely to make much difference unless they are backed by legislation. After all, why should any business act against its own perceived interests in this way. <br /><br />The usual response of employers to the immigration issue is that British workers 'lack skills' and have a 'poor work ethic'. They also claim that they are only employing foreign workers because they are looking to employ the very best international talent. The problem is that none of this is really true. It is difficult to argue that this country suffers from a shortage of talent when it has at least <a href="http://www.timeshighereducation.co.uk/world-university-rankings/2010-2011/top-200.html" target="_blank">three of the top ten science-based universities in the world</a> within its borders. It is also difficult to argue that there is a shortage of technical talent when the relative size of the industrial base in this country is so small compared to other top OECD countries. As for the question of work ethic, there is more than a suggestion that this is shorthand for people in this country being asked to work long hours for low pay. If this country needs to import talent, then surely it should be in the form of people with skills that are comparable to the best this country has to offer. Yet even in our universities you will struggle to find foreign academics from the best overseas universities such as Stanford, MIT, Caltech and the Ivy League. So we may be importing talent, but it is not generally world-class talent.<br /><br />The problem with the current system is with the rules and how they are implemented. So if a government doesn't like the result that ensues then it should change the rules. Those rules were based on a points system linked to workers' skills. Now the government wants to cap numbers. Unfortunately both systems are flawed because neither is sufficiently based on quality, and neither places any incentive on the employer not to demand foreign workers over British ones. Nowhere is this more prevalent than in our university sector where there is an abundance of overseas graduates, but very few from the <a href="http://www.timeshighereducation.co.uk/world-university-rankings/2010-2011/top-200.html" target="_blank">top ten research institutions in the world</a>. However the same is true for much of industry. As there was no premium for a degree from a truly world-class institution under the points system, there was no incentive to import talent from those institutions in order to raise the average quality of talent in this country. As a result in many cases overseas graduates acquired a kudos that was undeserved and was used to displace domestic graduates from the UK jobs market. <br /><br />Moreover the points system itself was deeply flawed. Not only did most university degrees from most countries carry more or less the same intrinsic points value, but additional points were added for existing earnings rather than for any future earnings from the intended UK-based job. For example, a Ph.D. graduate (worth 50 points under the points-based scheme) who was under 30 years of age (worth another 20 points) would only have to be currently earning over £25k under the old system to acquire the necessary 75 points for a Tier 1 visa. If they had a batchelor's degree (worth 30 points) and had previous UK experience (5 points) then they would need previous annual earnings of over £35k to qualify. Yet even this amount could be exaggerated by the 'uplift calculator' which artificially raised the earnings of applicants from low GDP per capita countries. The result of all this is that virtually any graduate qualified. <br /><br />Nor is the capping system much better. Such a cap would also fail to distinguish between workers of different skill levels and quality. It would probably be implemented on a first-come-frst-served basis that would do little to improve the technical excellence of the UK. As a result places would end up going to hairdressers instead of nuclear physicists. <br /><br />What is needed instead is a market system that is biased in favour of high quality talent over lower quality talent. One that forces employers to balance the cost of employing a foreign worker with the cost of not doing so. It also needs to be a system where the cost increases with demand in order to limit demand to the most valuable workers with the most valuable skills. The obvious solution is therefore one based on an auction mechanism where the quantity of work permits is constrained, but excess demand forces up the price so that they are only economically viable for the highest paid jobs. The question then is, who should pay? The worker or the employer?<br /><br />In a recent article on the <a href="http://www.iea.org.uk/blog/if-there-is-to-be-an-immigration-cap-the-government-should-sell-that-limited-number-of-work-per" target="_blank">Institute of Economic Affairs (IEA) blog</a>, Eamonn Butler of the <a href="http://www.adamsmith.org/blog/" target="_blank">Adam Smith Institute (ASI)</a> suggested that work permits should be auctioned to the highest bidder. For once I agree with him. He also suggested that the immigrant employee should pay as they were the ones who were in line to benefit. That though is where he and I part company. The problem I have with many proposals that come out of both the IEA and the ASI is that they tend to place higher costs on the ordinary worker or citizen, while seeking to exempt the owners of business from similar costs.<br /><br />The problem with asking the employee to pay for the work permit is two-fold. Firstly, in any free market the best workers will always migrate to countries with the highest incomes and the lowest cost of entry. If a country wishes to avail itself of the best talented labour from abroad, large immigration fees applied to those migrant workers would be self-defeating. They would drive the best talent elsewhere. After all, why would an immigrant worker be prepared to pay £30k or more to work in the UK, when they could get visas or work permits for similar jobs elsewhere in the EU and the USA for free?<br /><br />The second problem with forcing the immigrant employee to pay is that it will not reduce immigration levels. If the price of the visa or work permit goes up then migration from richer countries will indeed go down. However it will almost certainly be replaced by migration from poorer countries (or less talented individuals from richer countries) where the wage differential with the UK is greater. Thus net migration will be unchanged, but the quality will be reduced. <br /><br />Fundamentally though, this policy should be about internalising externalities. In this case the externalities are the adverse social costs that are currently passed on to the taxpayer and the State as a result of immigration. These can include higher unemployment, additional costs on public services (such as education and health), the lowering of domestic wage rates, and a reduction in workplace training. <br /><br />The impact on workplace training is of particular importance. In this regard the UK’s record is lamentable, and immigration makes it even worse. It allows bad employers to undercut good employers by utilising low cost foreign labour instead of improving the skills of their existing employees. This lack of workplace training is not a new phenomenon in the UK. As Will Hutton pointed out in his book "The State We're In" back in 1994 (see p187), British employers in 1988 only invested about 0.15% of their turnover in training. Companies in Japan, France and Germany invested about ten times that amount. That was the main source of the UK skills shortage then, and it probably still is now. <br /><br />The solution, therefore, should be to make employers pay more for immigrant labour than they would have to for retraining their existing UK workers. It is employers who should bid for these work permits in monthly auctions not the migrant workers. Perhaps then employers would be incentivised more to invest in their workforce instead of continually carping to government ministers about the supposed skills shortage in this country. To put it in simple terms, if migrant workers are really that essential to the well-being of the UK economy, then employers should be prepared to pay a premium for their services.<br /><br />No doubt many employers will complain vigorously about this and claim it will make the UK uncompetitive. This is a poor argument, not least because most of the UK economy is based on services, and service industries in the UK cannot in general compete for custom against similar companies overseas. Their market is internal, and so their only competitors are internal. If higher wage costs push up their service costs then they are free to pass them on. Far from damaging the UK economy, such actions would increase GDP by increasing the spending power of the low paid, much as the minimum wage has done. Britain's future prosperity lies in being a high wage economy, not a low wage one. As for manufacturing, higher wage costs would be offset by a higher quality of employee and therefore a higher level of innovation and international competitiveness.<br /></span></span>Cantab83http://www.blogger.com/profile/12485401571391377815noreply@blogger.com0tag:blogger.com,1999:blog-8416708843386784712.post-38352816042992842422011-04-03T20:09:00.002+01:002011-04-03T20:15:51.022+01:00Feminism and social mobility<span class="Apple-style-span" style="font-family:georgia;"><span class="Apple-style-span" style="font-size: small;">The Universities Minister David Willetts (aka "Two Brains") has found himself in political hot water this week for daring to suggest that a </span></span><a href="http://www.telegraph.co.uk/education/educationnews/8420098/David-Willets-feminism-has-held-back-working-men.html" target="_blank"><span class="Apple-style-span" style="font-family:georgia;"><span class="Apple-style-span" style="font-size: small;">lack of social mobility within the male population over the last 40 years is a direct consequence of feminism</span></span></a><span class="Apple-style-span" style="font-family:georgia;"><span class="Apple-style-span" style="font-size: small;">. His argument appears to be that greater equality between the sexes has led to women, who would otherwise have been housewives, taking university places and well-paid jobs that instead would have gone to ambitious working-class men. There may be some truth to this analysis, but is this an example of a decline in social mobility? I would argue not for two reasons.<br /><br />Firstly, because I would argue that feminism IS a form of social mobility. Before feminism, a woman's only hope of social advancement was by marriage. Now with feminism she has at least a chance of improving her lot by virtue of her own ability, just as any man has.<br /><br />Secondly, but more controversially perhaps, I actually see very little evidence that there has ever really been any real social mobility in this country. This may be a highly contentious view, but it is one that I believe is consistent with the analysis of David Willetts in regards to the effects of gender equality on the life chances of men.<br /><br />The conventional view of Britain's recent social history is that in the immediate aftermath of WWII Britain experienced a period of sustained improvement in social mobility. During this period members of the lower classes were able to gain access to better paid jobs, and so move up the social ladder. This upward mobility has generally been attributed to the improved access to education for the poor and the raising of the school leaving age following the 1944 Education Act, and in particular to the role of grammar schools in allowing the brightest children of the poor to receive the same high quality education as the children of the rich. Consequently, the subsequent introduction of comprehensive schools in the 1970s at the expense of grammars, and the perception of a decline in social mobility in the years that followed, has been seen as evidence of the superior value of grammar schools in fostering improvements in social mobility, meritocracy, and egalitarianism. There is, though, an alternative argument: that social mobility never existed at all.<br /><br />Under this alternative view the growth in social mobility that was allegedly observed in the 50's and 60's was instead a manifestation of an entirely different phenomenon: social expansion (for want of a better term). This period was characterized by massive technological changes, and therefore also a change in the nature of work. As more jobs were created that needed specialist skills and a high level of education, employers were forced to look beyond the confines of their existing and narrow pool of talent in order to fill these new posts. Thus the perceived rise in social mobility was a direct consequence of changes to the labour market, and the inability of the upper classes to breed fast enough to fill the growing numbers of prestige jobs that were now being created. Employers were, therefore, reluctantly forced to extend their recruitment policies to include the children of the hoi polloi and other assorted 'oiks' that had previously been overlooked as being wholly unsuitable for such lofty positions of responsibility.<br /><br />Unfortunately, once the expansion in new places at the top table of society ground to a halt, then so too did social mobility. Thus, social mobility was not driven by merit in this instance, for if it were then it would have continued indefinitely and those moving up in society would have seen equal numbers of the upper classes passing them in the opposite direction. No, instead it was driven be a temporary expansion in places. That is why it would be better termed as 'social expansion'.<br /><br />In this context, the impact that feminism has had on social mobility according to David Willetts can be seen as being nothing more than an extension of what has always happened. It has merely provided an additional pool of socially acceptable labour for the upper class elite to tap into before they countenance expanding their social horizons. So in this regard I agree with Willetts. Unfortunately, it does not follow that without feminism social mobility would have improved in this country. Perhaps the illusion of it would, but not the reality.<br /><br />Of course the ultimate myth is that full social mobility can ever be achieved by improvements to education alone. How can a more egalitarian society ever be achieved if the </span></span><a href="http://www.thisismoney.co.uk/work/article.html?in_article_id=522795&in_page_id=53928" target="_blank"><span class="Apple-style-span" style="font-family:georgia;"><span class="Apple-style-span" style="font-size: small;">best jobs are not given to people based on their ability</span></span></a><span class="Apple-style-span" style="font-family:georgia;"><span class="Apple-style-span" style="font-size: small;">, but rather on </span></span><a href="http://www.dailymail.co.uk/news/article-1356469/Cash-internships-Tory-backers-pay-2k-time-buy-children-work-experience.html" target="_blank"><span class="Apple-style-span" style="font-family:georgia;"><span class="Apple-style-span" style="font-size: small;">the wealth of their parents or on their political affiliations</span></span></a><span class="Apple-style-span" style="font-family:georgia;"><span class="Apple-style-span" style="font-size: small;">? Actions such as </span></span><a href="http://www.guardian.co.uk/commentisfree/2011/feb/17/internships-elitism-conservative-auction" target="_blank"><span class="Apple-style-span" style="font-family:georgia;"><span class="Apple-style-span" style="font-size: small;">this</span></span></a><span class="Apple-style-span" style="font-family:georgia;"><span class="Apple-style-span" style="font-size: small;"> can only lead to a society where the division of wealth and power is demarcated ever more strongly along class and party political lines.</span></span>Cantab83http://www.blogger.com/profile/12485401571391377815noreply@blogger.com1tag:blogger.com,1999:blog-8416708843386784712.post-41339706054863699862010-06-17T04:13:00.002+01:002012-05-31T16:13:40.255+01:0020 questions for the next Labour leader - part 2<span class="Apple-style-span" style="font-size: small;"><span class="Apple-style-span" style="font-family: georgia;">Having just watched the Newsnight debate between the five contenders for the Labour leadership, I have to confess that I am still not much the wiser. With Jeremy Paxman seemingly more interested in trying to get the candidates to talk about the past (e.g. Iraq, Gordon Brown's leadership) than the future, there was precious little time for the candidates to outline future policy changes. Paxman's attempt to try and get Ed Balls to knife Alistair Darling over his last budget was particularly emblematic of much that is wrong with the way politics is conducted inside the Westminster/media bubble. Then Michael Crick had the audacity to claim that Ed Miliband had underperformed because he had "..failed to put forward the kind of visionary ideas..." that he had outlined at previous hustings. Well of course he failed, Michael, because he wasn't given the opportunity. In fact none of the candidates were.<br /><br />In a <a href="http://cantab83.blogspot.com/2010/05/20-questions-for-next-labour-leader.html">previous blog I outlined five of the top twenty questions</a> that I think need to be addressed in this leadership debate. Only the first of these (why you?) and the last (civil liberties) were really addressed in the Newsnight debate. The issues of housing, inequality and the candidates' own policy priorities were largely ignored. Yet the previous debate hosted by the Fabian Society seemed to be much more policy oriented. As a result it is slowly becoming apparent that there are some distinct differences between the various candidates, but we will only be able to fully appreciate what these are when we find out where each candidate stands on a range of different issues. Many of these critical issues will be in policy areas where the last government was found wanting, both by its supporters and by the electorate as a whole. <br /><br />6) Clearly electoral reform is one such issue. The media think this is only of relevance to political anoraks, but it is becoming clear that it is central to issues of social justice and inclusion. It also impacts on the way political parties position and differentiate themselves and hence on amount of choice voters are given at elections. This was one of the <a href="http://www.nextleft.org/2010/06/all-five-labour-leadership-candidates.html" target="_blank">key policies that was addressed at the Fabian meeting</a>. It now appears that most of the candidates are signed up to electoral reform. Ed Balls is even in favour of a written constitution, which brings me on the the next point.<br /><br />7) Constitutional reform. <br />One area where the last government lost trust was over its refusal to grant the people a referendum on the Lisbon Treaty. So would a future Labour government grant a referendum on all future EU treaties? This question is even more important given the role that such treaties appear to be playing in forcing the UK government to contract out public services and possibly privatise the <a href="http://cantab83.blogspot.com/2009/10/is-it-time-for-new-business-model-for.html">Royal Mail</a>.<br /><br />8) Then there is the euro. Given the current problems in the eurozone it is imperative that we know under what circumstances (if any) each candidate would countenance the UK joining the euro. It is also important that we find out to what extent they each understand the <a href="http://cantab83.blogspot.com/2010/06/how-to-prevent-euromess.html">potential economic consequences</a> of doing so. One of the biggest economic consequences of joining the euro would be in the effect it had on the UK financial sector.<br /><br />9) So would any of the candidates be prepared to reform the banking system to make it more competitive and reduce the risk of another financial collapse? Are they prepared to break up big banks? What other financial measures would they introduce? And how would they prevent the most disadvantaged in society being excluded from access to bank services as banks seek to increasingly make customer pay annual fees for bank accounts?<br /><br />Of course it is not only our banking system that is prone to excessive executive pay and a disproportionate bonus culture. The same is true of much of British industry. <br /><br />10) So how would each candidate improve shareholder democracy and Company Law in order to reduce corporate fraud, tax evasion and avoidance, and excessive executive pay and bonuses? <br /><br />11) How would they <a href="" ref="http://cantab83.blogspot.com/2009/11/hostile-takeovers-distort-free-market.html">regulate takeovers</a> in order to maintain market competition, improve consumer choice and protect British businesses and jobs from unfair competition and commercial predators? There is no doubt that the takeover of Cadbury by Kraft cost Labour many thousands of votes, both around Birmingham and elsewhere. <br /><br />12) Wealth and Mansion Taxes.<br />Which candidates would support a Mansion Tax of the type outlined by Vince Cable? Such a tax is far more redistributive than income tax and could generate up to £20bn, as <a href="http://cantab83.blogspot.com/2010/02/why-is-labour-afraid-of-mansion-tax_24.html">I pointed out a few months ago</a>. That is nearly ten times the amount that inheritance tax currently generates. It is also far more than is currently generated by stamp duty and CGT. <br /><br />So, twelve down and eight more to go. <br /><br /> </span></span>Cantab83http://www.blogger.com/profile/12485401571391377815noreply@blogger.com0tag:blogger.com,1999:blog-8416708843386784712.post-28689165422650749862010-06-01T23:36:00.005+01:002010-06-05T01:13:10.255+01:00How to prevent a Euromess<span class="Apple-style-span" style="font-family:georgia;"><span class="Apple-style-span" style="font-size:small;">So, the euro is in turmoil. A crisis that started in Greece is now spreading to Spain, Portugal, and possibly even to France and Italy. However, as the Nobel prize-winning economist <a href="http://krugman.blogs.nytimes.com/2010/02/09/anatomy-of-a-euromess/" target=_blank>Paul Krugman pointed out on his New York Times blog</a> a few months ago, the real story is in Spain, not Greece. This is partly because Spain is the much bigger economy. It is also because, for most of the first seven years of this millenium, Spain kept to the rules and maintained its budget deficit well with the 3% limit demanded by the Maastrict Treaty. In fact, over that period it actually ran a small cumulative budget surplus (see <a href="http://krugman.blogs.nytimes.com/2010/02/09/anatomy-of-a-euromess/" target=_blank>Paul Krugman's blog for details</a>). That, though, did not save it from the effects of the credit crunch and the financial collapse of late 2007. Greece on the other hand is a totally different kettle of fish. Unlike Spain, it didn't even try to play by the rules, so it is hardly a surprise that it is in the economic mess that it is. <br /><br />The lesson to be learned from the experiences of these two countries is that the problems of the Eurozone are two-fold. Firstly, there are some countries that were admitted to the club (probably for political reasons) that were fiscally irresponsible and failed to obey the rules. In short, they probably shouldn't have been there in the first place. Then there were other countries, like Spain and Ireland, that generally obeyed the rules, but suffered from what Krugman terms asymmetric shocks. It is how the euro deals with these asymmetric shocks in the future that will ultimately determine whether the euro can survive in its present form. In my view, the measures so far proposed do not address the real issues, or provide any real solution. In order to understand how these asymmetric shocks can be prevented you need to understand their cause. In the cases of both Spain and Ireland, the primary cause was (surprise, surprise!) a massive property boom, driven in part by large speculative capital inflows, which then led to excessive local price inflation. So, no stable solution will be found unless it addresses the problems of capital flows, and local inflation in wages and house prices. <br /><br />The problems in Spain started with the property boom. This led to massive inflows of cash into the economy that meant that Spain ended up running a massive current account deficit. This inflow of cash also stimulated the economy to such an extent that it caused inflation in local goods and services, and particularly in wages. The critical factor, however, is that the property boom ultimately led to a boom in GDP and thence to a huge increase in government revenues. So the government was able to spend more without either raising taxes, or borrowing to fund a deficit. The problem was, this extra spending then fuelled the boom in GDP even more, thereby exacerbating the underlying problem. However, because the economy was expanding and the government was still balancing its budget while its spending increased, few people saw the impending crisis looming. Unfortunately, when the property bubble burst, as it inevitably had to, government revenues collapsed with GDP, while government spending rose even further to fund the consequences of rising unemployment. The result is a massive deficit of over 12% of GDP. That, then is the history, as <a href="http://krugman.blogs.nytimes.com/2010/02/09/anatomy-of-a-euromess/" target=_blank>Paul Krugman outlined previously on his blog</a>. The question for the euro though, is how could it all have been prevented?<br /><br />Of course, it is patently obvious that central to this whole mess is the inflation in asset prices that occurred during the boom, mainly in housing and other real estate property. <a href="http://www.adamsmith.org/blog/tax-and-economy/what’s-a-grecian-urn%3f-not-much%2c-thanks-to-the-euro/" target=_blank>Now it has been argued by some at the Adam Smith Institute (ASI)</a> that the flaw in the whole euro project is the common interest rate set by the European Central Bank, and it was this that caused the property boom because the bank rate was set too low. Unfortunately there are two major flaws to this argument. <br /><br />For a start, the argument that housing booms are, or can be, effectively controlled by changing interest rates is not well supported by historical economic evidence. Governments and central banks are generally reluctant to raise interest rates in order to dampen house price inflation for fear of strangling economic growth or strengthening the currency too much. <a href="http://cantab83.blogspot.com/2009/10/how-to-control-house-prices-guide-for.html">As I pointed out a few months ago, the only way to effectively control house price inflation is by controlling mortgage lending</a>. Secondly, Britain and the USA suffered from their own housing bubbles without being in the Eurozone. They had the freedom to adjust their interest rates upwards to counter their own housing booms, but chose not to. Finally, it should also be remembered that the property booms in Spain and Ireland started long before either country joined the euro.<br /><br />An alternative possible solution currently being touted is to go for greater fiscal integration in the EU. This is the approach that was suggested by the German government recently. Unfortunately, such a policy would reduce the ability of member states to run their own domestic affairs. It could lead to outside agencies (like the European Commission) telling member states how they should spend their own money. It would inevitably lead to greater tax harmonisation across the Eurozone (something favoured by Germany), together with a reduction in democratic accountability and plurality. It would also make the EU more like the USA. Of course one way the USA deals with fiscal imbalances between member states is to tax nationally and then redistribute money to the different states via federal grants. There is, though, no political appetite in the EU for a similar strategy. <br /><br />The USA is also a more integrated economic region than the EU, with greater geographical movements of people. <a href="http://krugman.blogs.nytimes.com/2010/02/09/anatomy-of-a-euromess/" target=_blank>Paul Krugman has suggested</a> that one solution to the Spanish problem, and asymmetric shocks in general, is an increase in "fiscal and labour integration". In other words to make the EU more like the USA. The problem with this is that there are deep structural barriers in Europe to the free movement of labour: language, culture, education and recognition of qualifications. In reality, it is far more likely that companies will move jobs to regions of low wages and high unemployment, than people will move between countries to find jobs.<br /><br />There is, however, a third option that has so far been ignored. Rather than the EU taxing all citizens, as happens in the USA, it could tax all member governments in the Eurozone. The tax rate would be designed to counter the capital inflows that Spain enjoyed, and which led to its inflation rate exceeding the Eurozone average. By using this rate of surplus inflation in Spain as the figure of merit (i.e. the difference between local Spanish inflation and the Eurozone average), and calculating the tax due by applying that rate to the current value of Spanish GDP, such a measure would effectively counteract the effects that the capital inflows had in distorting the economy. <br /><br />For example, <a href="http://krugman.blogs.nytimes.com/2010/02/09/anatomy-of-a-euromess/" target=_blank>the data in Paul Krugman's blog</a> shows that local inflation in Spain between 2000 and 2007 was on average about 4% more than in Germany (and the Eurozone average). At the same time the current account deficit varied between 4% and 10% of GDP. So, if the European Central Bank (ECB) were able to tax the Spanish government at a rate of 4% of GDP for that period, the Spanish government would then have been forced to pass on that tax to the population via tax rises, or spending cuts, in order to maintain its budget balance within the 3% Maastricht limit. Both of those measures would have acted as a dampener on economic growth in Spain, thereby counteracting the effects of the housing boom. Moreover, the tax revenues generated by such a measure, and thus acquired by the ECB, could then be used as bailout money for Spain in any future banking or economic crash. In fact such a policy would have resulted in Spain building up capital reserves at the ECB equivalent to around 25% of its GDP in the period up to 2007. That would have funded its current deficit for at least two years and thereby negated much of the economic crisis that it now finds itself in. This policy would therefore eliminate most of the potential for asymmetric shocks within the Eurozone while also providing the financial means to compensate for any shock should it ever occur.<br /><br />There is, however, another issue that needs to be addressed if the euro is to work effectively, namely, how to regulate the banks. What this crisis also demonstrates is that EU member governments need adequate tools to be made available to them that allow them to regulate the lending policies of their local banks, and to the control the level of indebtedness of their own local populations. The problem is, the single currency zone of the euro and its single interest rate make that virtually impossible for any individual government. This though, is not just a problem with the Eurozone. It is also a problem that has its roots in how the European single market is constructed. You only have to look at the difficulties that Britain and the Netherlands had in regulating Icelandic and Irish banks to see that. As <a href="http://www.adamsmith.org/blog/tax-and-economy/what’s-a-grecian-urn%3f-not-much%2c-thanks-to-the-euro/" target=_blank>I have pointed out previously to those at the ASI</a>, that can only be achieved if the EU allows member states to restrict lending of local banks to local customers, as at least used to happen in the USA.<br /><br />The problems with the euro that I have described above, not only represent an important economic issue, but also an important political issue. The debate over whether Britain should ever join the euro may have been consigned to the cryogenic freezer now that Cameron is PM (given that the Tories will probably never agree to it), but it could still resurface as a major issue for the Labour Party, either in the forthcoming leadership contest, or in any future coalition with the Lib Dems. That is why it is important that the Labour Party has a coherent policy in this area. The question is, what should that policy be?<br /><br />It is no secret that the issue of joining the euro strongly divided the last Labour government. It could also strongly divide the main leadership contenders. While large parts of British industry may be in favour of joining the Eurozone, that in itself is not sufficient justification. Moreover, part of the attraction of the euro is historical. It dates back to the 70's and 80's when Britain was a country of high inflation, and Germany was the epitome of monetary stability. That justification has now been rendered largely redundant. For the last twenty years Britain has enjoyed low inflation as well. In addition, because the Eurozone now includes fifteen countries, that is fourteen fewer currencies that British companies need to deal with, so the euro has already greatly simplified the problem of foreign exchange for British industry without the UK needing to join the euro, even if it has not completely eliminated it. What is clear, though, is that both the euro and the single market need substantial reform of the type I have outlined before Britain can even consider joining the euro. At the moment, that looks a long way off.<br /><br /></span></span>Cantab83http://www.blogger.com/profile/12485401571391377815noreply@blogger.com0