Banks, Bishops and Robin Hood

03/11/2011 2 Comments

Suppose you have £100 in your pocket. You know at some stage you are probably going to need to use it to pay for something but not today. Maybe tomorrow but not today, so you lend it to a bank for a day and they pay you some interest and tomorrow you get back £100.02.

The next day again you don’t need your money so you lend your £100.02 back to the bank and the day after you get £100.04. You continue doing this every day making a daily 2p profit until a month later the day comes when something crops up and you need to use your £100. In that period, because you invested you have made a 60p profit compared with having just kept the £100 in your pocket.

That’s all nice and easy. Now suppose that the taxwoman comes along and every time you transact with your bank she charges you 1p.

(Why do people always assume that a person working for the IRS is a taxman? This time it is a taxwoman – I am fighting for equal opportunities.)

With this tax in place it is still profitable to do the investment but your profit is reduced to 30p, having reinvested your money every day for 30 days and having been charged 1p each time.

If you are feeling a bit miffed at losing half of your profit there is an alternative. Rather than invest your money for one day 30 times in a row, you could invest it once for 30 days. Since you are now doing just one transaction instead of 30 you will pay just 1p to the taxwoman and walk off with a healthy 59p profit. Hoorah! Take that you thieving taxwoman!

There is a downside though. The nice thing about the first option was that each day you got your money back. If you needed it to pay an unexpected bill you could do so and if nothing unexpected came up you could just reinvest and have the same choice again tomorrow. By moving to the single 30 day investment you have in fact made a bet. You have bet that at no time in the next 30 days will you need to access that cash.* If after 20 days you do have an unexpected bill to pay then you’re in trouble.

In effect, what the taxwoman has done, in trying to raise revenue, is unwittingly made you take a risk. Having easy access to your money was very expensive compared with not having any access to it for a month. You thought it was worth the gamble.

Of course, the profit of 30p or 59p is unlikely to make anyone bother to invest at all but scale this up to the amount of excess cash a bank might have on a particular day, which could be tens of millions of pounds and suddenly the difference between the two options becomes something to think about. Should they invest it daily knowing that they’ll get it back the next day should they need it but making a small profit or should they invest it longer term knowing they’ll make a bigger profit but might be in a pickle if they need it unexpectedly?

Irrespective of what they decide, the taxwoman has given them a new incentive to take a risk.

This week the Archbishop of Canterbury came out firmly in favour of such a tax. He is backing a tax on financial transactions known as the Tobin Tax (after American economist James Tobin who first proposed the idea back in 1972).

While I think taking economic advice from a clergyman almost as absurd as taking it from a politician, I do see why the Tobin Tax, (recently rebranded in the UK as the Robin Hood Tax) has gained popularity. These are some of the things I have heard about it:

  • The tax is a good idea because it would stop banks taking risks
  • The tax is a good idea because it is only tiny in the grand scheme of things and it would still raise lots of money
  • The tax is a good idea because the banks caused the mess so they should pay to clean it up

I’ll take each of these in turn.

It would stop banks taking risks

As I showed in my simple example of investing spare cash (traditionally a low risk activity) this tax gives an incentive to move from a safer strategy to a more risky one. It is simple enough to see in this example but apply it to the complex things traded between banks (which 2008 showed us even they don’t understand) and we really don’t know what effect it would have on the market in terms of risk. It would most likely lead to fewer, bigger, longer term transactions and those are simply more risky not less.

The tax is tiny and will raise lots of money

That doesn’t make sense – they can’t both be true. Rowan Williams thinks the tax could raise $400bn each year. According to this McKinsey report, global banking profits last year were $712bn. Are we honestly saying this is a small tax that the banks won’t notice? That’s over half their profit!

Will it raise lots of money? Probably but remember, banks are experts in passing on the costs of something on to their customers. If you want to borrow some money when such a tax is in place, what is to stop the bank just giving you a worse rate to compensate? In doing so it isn’t the bank paying the tax, it’s you.

Banks caused the mess so they should pay to clean it up

The banks did cause the mess and they should pay towards the clean up. If you think that such a tax is going to recoup what they cost us though, think again. I would broadly estimate that the total cost of the problems caused by the banks will have a negative effect on the UK economy alone to the tune of several trillion pounds. Sorry, that’s never coming back.

Also, just because the banks should pay towards the clean-up doesn’t make the Tobin Tax a good way of doing it. If we decide to go after the banks a simpler way of doing it would just be to tax their profits. If we did that at least we wouldn’t push them towards risky trading strategies even if they would still probably try to pass the extra costs on to us.

You can therefore summarise from this that I don’t think it’s a particularly good idea. Please don’t misunderstand me – I would love to get some money back off the banks. I just can’t see this is a good way of doing it. Branding it The Robin Hood tax was a stroke of genius – take from the rich and give to the poor etc. It gives the tax a certain romantic quality and I think that’s where a lot of its political support comes from.

Sadly though, a tax is a tax and romance can play no part in differentiating a sensible one from a bad one.

RedEaredRabbit

*Additionally, putting money on deposit for a longer term opens the lender up to increased credit risk as if the borrower gets into difficulty during the period the lender can’t just decide to get their money back and reinvest elsewhere.

P.S. As with all of my posts this is purely my opinion and I’m not saying that my opinion is definitely correct or any better than anyone else’s. As always, whether you agree or disagree with me, I am happy to hear your thoughts.

Filed under Economics Tagged with , , ,

Creationist Economics

13/10/2011 13 Comments

Evolution is truly amazing.

The are two reasons I think this. Firstly, just look at the wonderfully diverse range of organisms to which it has lead. Elephants, dolphins, giant redwoods, kangaroos, scorpions, sharks, squid, salmonella, venus fly traps, honeybees and naked mole-rats. They are all stunning examples of what evolution has caused.

The second reason I find it amazing is that it is so simple:

  • An individual’s offspring will share similar traits with that individual
  • An individual with beneficial traits is more likely to have offspring
  • Therefore more beneficial traits are more likely to be passed on from one generation to the next than less beneficial ones

That is pretty much it and all you need to add is a bit of time.

A friend of mine disputed evolution recently, on the basis that the species we see today are just too complex to have come out about through such a process. This is how I thought about it. (This is probably why I don’t have many friends.)

Suppose that a particular species has a one year lifecycle and on average each new generation is about 0.001% better than the previous generation. It’s a very small amount – one one-thousandth of one percent better.

Over a period of 1000 years you would notice little difference – the current generation would be about 1% better than they were 1000 years ago. It’s very similar to compound interest – invest £1 for 1000 years at a rate of 0.001% and you will get £1.01 back at the end. Look at this though:

After 10,000 years it will be worth about £1.11
After 100,000 years it will be worth about £2.70
After 1,000,000 years it will be worth about £22,000
After 2,000,000 years it will be worth about £485 million
After 3,000,000 years it will be worth about £10.7 trillion
After 4,000,000 years it will be worth about £235 quadrillion

Back in terms of our evolutionary example, our species that improved at a thousandth of a percent per generation is 235 quadrillion times better than its ancestor of 4 million years ago whilst being virtually indistinguishable from its ancestor of a few thousand years ago. Pretty cool.

Of course, like my friend, not everyone believes in evolution. Some favour Creationism. In Creationism you assume that there is a supremely intelligent being who made a supremely brilliant strategy for the development of species at the start of things and everything worked out from that brilliant strategy.

Now, I can hear you all saying, “That rabbit has really lost it this time, what the hell is he talking about now? I was expecting some sexy economics shit not a biology lesson.”

I am coming to that. I am a big fan of something that has come to be known as evolutionary economics. It works like this:

Suppose you want to achieve a certain outcome over a period of time in an environment with many unknowns. One way of doing it would be to work out the perfect strategy at the start and then run with it. Evolutionary economics would suggest that a better way of doing it would be to continually monitor and adapt your strategy, keeping the things that are working well, and replacing the things that are working badly with new things. Some of the new things will work and they’ll be kept. Some of the new things won’t work and they’ll be binned and replaced. Perhaps some of the things that worked well a while ago will stop being beneficial later. That’s fine, they’ll be adapted too. By doing this, the strategy continually evolves, adapting to the successes and failures along the way in order to ultimately succeed.

I strongly believe that in a complex environment the very best way to achieve success is by continually reviewing and adapting strategy. I do not believe that the very best way to achieve success is to come up with a strategy at the start and never adapt it in spite of how well it does.

Some people do though and they’re called politicians. When the Conservatives won the last election they did so partly based on the promise that they could cut spending and also achieve economic growth. The economic growth though, for one reason or another, has not materialised.

Some people will say, “You big muppet, George Osborne! You said we’d have economic growth and we didn’t! Your strategy was all wrong!”

I don’t agree with this way of looking at things. Sure, he’s a muppet but we are talking about the deployment of a strategy in a complex environment. The behaviour of the UK economy is not easily predictable – a huge number of unpredictable factors influence it. It is complex. His failure is not in his initial strategy, it is in being unable to adapt his strategy based on how well it is actually doing.

Imagine you are watching a horse race and horse number 3 is in the lead. You might say, “I think horse number 3 will win this race.” It would be a fair prediction. Horse number 3 might then take a fence badly and be overtaken by horse number 5. You might then say, “I think horse number 5 will win this race.”

You give your best judgment at a particular point in time and if the situation changes, you adapt your judgment. A politician does not do that though. When horse number 3 was overtaken, a politician would still back horse number 3 because that was what they said first. Horse racing is a brutal industry – when horse number 3 fell at the next fence, broke its foot and was shot by a vet, the politician would still back it to win.

In contrast to evolutionary economics, I have developed my own term for this kind of thinking – Creationist Economics. It’s impossible to get everything perfect first time around but politicians it seems, believe their strategies represent some kind of intelligent design.

At last week’s Conservative Party conference the general economic theme seemed to be, “We must keep doing what we’re doing because you can’t borrow your way out of recession.” (That’s actually not really true. You can borrow your way out of recession you are just left with more debt afterwards. What you can’t do is cut your way out of recession.) Either way, I am moving away from my point. George Osborne, favouring Creationist Economics, refuses to accept that his strategy has not realised the growth that he forecasted and instead stands by his policies through what I can only interpet as a matter of faith.

Of course, George isn’t the only disciple of the church of Creationist Economics. The Health Secretary, Andrew Lansley has an idea to reform the Health Service. Because the communicated benefits of his policy turned out to lack any basis in fact he had to work hard on a campaign of misinformation. (This is always preferred by creationist economists over accepting their strategy was wrong which is considered blasphemy.) Lansley found a couple of facts that if taken out of context he could use to make his strategy look like a good one. He didn’t exactly lie but he did intentionally mislead people, which I think is every bit as bad.

Let’s have a look now at Theresa May. Theresa’s new policy is scrapping the Human Rights Act. Unsurprisingly, this has come in for a huge amount of criticism from all sides. Like Lansley before her, Teresa was forced into telling a fib in order to maintain her creationist ideals. See if you can spot the fib:

What Theresa said:

We all know the stories about the Human Rights Act… about the illegal immigrant who cannot be deported because, and I am not making this up, he had a pet cat.

What Theresa said minus fib:

“We all know the stories about the Human Rights Act… about the illegal immigrant who cannot be deported because, and I am making this up, he had a pet cat.”

Let me summarise my thoughts:

  • It is not possible within a complex environment to devise a perfect initial strategy.
  • It is therefore necessary to monitor and adapt a strategy in order for it to be ultimately successful.
  • Politicians deny these things as they are creationist economists

You may not have realised this but most likely you are an evolutionary economist. Suppose you are making your first ever Sunday roast and when making the gravy you decide how much corn flour to add and it all goes thick and lumpy. Next time you do it you learn from your failed strategy and add less corn flour. Congratulations, you are an evolutionary economist. Would you ignore the evidence and continue to put the same amount of corn flour in your gravy forever? If so then you are a creationist economist.

To me it seems clear that our politicians are not governing our country in a particularly efficient way. It’s not just the current government – the opposition parties would and do embrace their own creationist themes. My complaint is with no particular political party it is with our system. If a politician tried evolutionary economics the media would crucify them for “flip-flopping”. It is much more beneficial for a politician to just get it wrong to start with, never waver from being wrong and spend their time and effort on misleading people into thinking they are right.

And while this is the case, we will all have to endure poor political strategies and politicians will have lumpy gravy every Sunday.

RedEaredRabbit

Filed under 10 Posts You Should Read, Economics, Politics Tagged with , , , , ,

The Greatest Democracy on Earth

22/09/2011 1 Comment

The United States is often marketed as the Greatest Democracy on Earth. I’m not sure I agree.

A couple of months ago there was a lot of worry in the global markets that the US was about to default on its debt. As I wrote about here, this was a very different situation to that of Greece who is very much in danger of default at the moment.

So, why is it different? After all, both of them need money. Let’s take a look.

The USA

Investors are banging on the door to lend the US more money.

Greece

Finding someone who wants to lend to Greece at the moment is harder than finding a dodo who can simultaneously breakdance, juggle six elephants and recite its seven times table in Welsh.

While both countries need money, investors believe that the US will be able to pay it back and Greece won’t. It is probably not a bad judgment.

So if the US isn’t a risk to lend to, if people are queuing up to lend it money – why was there ever talk of a default?

To understand this we need to look at US politicians. In the US (to all intents and purposes) there are just two parties, the Democrats and the Republicans and things are always very close between the two. With nothing to back this up, I am going to lazily say that 45% of the US public always vote Republican and 45% always vote Democrat. The remaining 10% decide who is in government and even they are often fairly evenly split.

Because of this the US always has a fairly evenly split Senate, which in turn leads to both parties needing to agree in order to pass changes to US policy. There’s nothing wrong with this in theory; in some ways it is quite good but it does require that to get anything done the two parties need to work together in a reasonably constructive manner.

That’s where the problem lies – they can’t. Or at least they don’t.

The President of the United States, is often referred to as the most powerful person in the world. Evidence clearly shows this is far from true. Take that “almost default” example. Without the Senate agreeing, Obama couldn’t even make the decision to take the money that the US needed and not default on their debt repayments.

Instead the decision went to the Senate.

Defaulting on your debt when people want to lend you money very cheaply would be more than a bit daft. In fact it would be so daft that even the Republicans knew it would be much worse for the US than just borrowing the money that people wanted to lend it.

The Republicans also know though, that their votes are needed for the decision to pass so instead of just saying “Fine borrow the money, let’s move on to something important.” They instead said, “You can borrow the money only if you do something totally unrelated that we want.”

(For more on that read my charming, metaphorical story about Obama flying an aeroplane. Or should that be an “airplane”?)

Had the bill not passed, the people who would have lost out would firstly have been the US citizens as their economy went down the pan. Then everyone else in the world would have been in trouble (as the health of the US economy affects us all).

Although there was a lot of posturing and political bravdo thrown around by both sides, that situation can be neatly summarised like this:

The Republican Party held the US government to ransom with the American people as the hostages.

I’m not being theatrical, this is simply what happened. The Republicans wanted some spending cuts and held the country ransome to get them and it was truly shameful. A far better way of doing things (without causing global economic chaos) would have been to say:

“We all agree that we need to borrow some more and while we would like to discuss other fiscal measures we will do so once this is sorted out. After all whatever we agree on those items, paying our bills is essential.”

Unfortunately this isn’t a one off. Obama has recently announced a new bill aimed at boosting the US economy through closing tax loopholes for the wealthy and increasing government spending. It is actually a very sensible bill but it doesn’t matter – it will be shot down by the Republicans and it won’t pass.

Is that stupid? No, it is ludicrous. Republicans, hate taxes on rich people and hate government spending. Their political campaigns are funded by the rich and that is of more interest to them than doing something sensible to actually help sort out the problem.

The US government needs to act decisively but can’t because of their politicians and sadly, their economy will experience far lower growth than it should do and we’ll all be worse off because of it.

Have you ever wondered why the US can’t bring in public health care or cut greenhouse gas emissions? Same reason – any sensible policy can be easily blocked by a few right-wing half-wits with their own agenda.

In light of this, is the US the greatest democracy on Earth or a bit of a fucking mess?

It’s not just the US though. Europe is in a big mess too. Do you see any sign of some decisive action from European politicians to put forward a clear plan to sort their mess out? If you’ve spotted one then let me know, it must have passed me by.

Politicians just don’t seem to realise that part of the remit we gave them when we elected them was to be able to sort this stuff out. In the US, Obama is trying but he’s ultimately powerless in achieving anything. In Europe they’re doing nothing and hoping it blows over. (It won’t.)

So what of the UK? The UK government has favoured spending cuts and austerity over any attempt to boost the economy. With interest rates at the zero lower bound and unable to be cut further to offset the cuts, this is at best a dangerous game. Basic economics shows that spending cuts in such a situation will harm growth but the government crossed their fingers and hoped that the economy would somehow sort itself out on its own. In the long run it probably will but that’s hardly a reason to dismiss opportunities to sort things out now.

The IMF has said that if the UK is not going to meet the government’s 2011 economic growth targets (it doesn’t have a chance by the way) that it should reconsider its policy of spending cuts and look instead at a policy of stimulating the economy.

After the election in 2010 it would have been very difficult for any political party to forsee the future and build the perfect fiscal policy to cope with such unknowns. In such circumstances, the elected government should:

– Have used macroeconomic theory as the foundation for their policies. (They didn’t)

– Absolutely be prepared to adapt their policies to match the continually changing and unpredictable economic climate. (They aren’t.)

The government based their policy of spending cuts on the hope that economic growth would happen anyway. It hasn’t and now is the time for them to understand that blindly pursuing this will only cause further harm to the economy.

When looked at objectively, the ability to assess and adapt seems like common sense but asking a politician to consider changing policy is not so simple. A lot of that is our own fault. When a government changes its policy we all say, “It’s a U-turn! You got it wrong! You’re rubbish!”

That really is missing the point. An effective government will not be made up of fortune tellers. Therefore an effective govrnment needs to be able to continually adapt their policies to fit with a volatile and unpredictable world. If, next week, George Osborne says that he is going to scrap some cuts and instead focus on some policies to stimulate the economy, we should not all be criticising him as a weak policitian for changing his mind. If he does this we should be commending him as a strong politician – someone who is able to adapt their policies to fit the situation in which they find themselves.

Of course this is all wishful thinking. In reality what will happen next week is that:

  • Obama will bang his head against a wall because the Republicans will block his sensible policies
  • Angela Merkel will keep her head in the sand and hope it all goes away
  • George Osborne will fly in the face of logic and stick with spending cuts

The really sad thing is that now, more than any time in the last three years, it is easier to know what a good fiscal policy is.

It just seems harder than ever for a politican to spot one.

RedEaredRabbit

Filed under Economics, Politics Tagged with , , , , ,

The Tax Delusion

09/09/2011 5 Comments

Have you ever met a climate change denier? I wonder why they don’t believe in global warming. Using some fairly basic maths you can calculate the Earth’s surface temperature assuming no greenhouse effect exists – it’s about minus 18°C. The reason we’re not in a permanent ice age is because of the greenhouse effect.

“Rubbish!”  you say, “the greenhouse effect is something new, we didn’t have it before and it wasn’t that cold!”

The greenhouse effect is actually nothing new – it’s been around as long as carbon dioxide, water vapour and other greenhouse gases have existed in our atmosphere. The problem now is that our activities are increasing the concentration of these gases. Basic physics states that this should increase the Earth’s surface temperature and lo and behold that’s exactly what we observe. Of course there are many factors that affect our climate at any one time and while we cannot be 100% sure how much the greenhouse effect will affect the surface temperature in any one given year, we can be sure of these two facts, which are absolutely indisputable:

a) We are increasing the concentration of greenhouse gases in the atmosphere

b) Greenhouse gases increase the surface temperature of the planet

When the temperature starts going up in line with this it is surprising that lots of people choose to put their heads in the sand and deny what theory and evidence shows is very clearly happening. The reason I think, that this denial-phenonmenon exists, is simply that it is much more convenient for people to live in denial than it is for them to accept reality.

Accepting the true scale of the problem means significantly changing our lifestyles and a lot of people don’t want to do that. Pretending that climate-change skepticism has any basis outside cloud-cuckoo land allows people to continue doing what they’re doing and avoiding this massive inconvenience.

This blog isn’t about climate change though.

Have you ever met a supply-sider? Supply-siders have a lot in common with climate change deniers. I should explain what I mean by a supply-sider. It’s about tax though, so grab a coffee before you continue.

Cutting income tax has a positive effect on economic growth because people have more incentive to work and have more disposable income to spend. The problem though is that tax cuts need to be financed by cutting public spending and that has a negative effect on economic growth and a negative effect on people’s quality of life. As an alternative to cutting spending, we could borrow to cover short-term tax cuts but we can’t make permanent tax cuts and still have a functioning NHS, education system, armed forces etc. etc.

That much is, again, basic maths and uncontroversial. Unless you are a supply-sider. Supply-siders believe that the effects of tax cuts is so ridiculously large that they more than pay for themselves – that cutting taxes actually increases government revenue and everyone becomes better off because of it.

Nowhere are supply-siders more prominent and militant than in America. When Bill Clinton took office he took over a large budget deficit. He responded to this by introducing tax rises on the middle-classes and wealthy. Supply-siders went mad – claiming that this would starve the economy and usher in financial disaster! In fact what happened was that the economy grew, unemployment went down and the deficit turned into a surplus.

Enter George W. Bush. As a supply-sider, Bush brought in an era of tax cuts and the richer you were, the more you benefitted. This, he assured everyone would make a massive boost to the economy. The surplus quickly turned back into a massive deficit.

Of course these are just two examples (albeit good ones) and there were many other things going on which would have contributed to these two outcomes. Importantly though, supply-siders said that Clinton’s policy to raise taxes on rich people to pay off the deficit would spectacularly backfire and they said Bush’s policy to cut taxes on rich people would boost the economy. In both cases they were 100% wrong.

Like, climate-change deniers, supply-siders ignore logic and evidence simply because the reality is inconvenient. Supply-siders organise huge campaigns to tell voters that their taxes are harming the economy.  They tell people that if they just paid less tax to the government and kept more money for themselves, we’d all be better off. This is voodoo economics. This is one of the ultimate examples of bad marketing. This is to economics what homeopathy is to medicine.

So we can see that while cutting taxes stimulates economic growth, it does not pay for itself. Cutting taxes will cost money and if it is the rich receiving the benefit, it is everyone else who is receiving the cost of it.

It was therefore, with sadness that I read this week’s story about 20 economists writing to the FT to campaign for a lowering of the top tax rate, stating that it was harming the economy.

I do agree we need something to stimulate the economy. As I’ve discussed before on here – we won’t get rid of the deficit without economic growth and there is precious little of it at the moment. I do though have a big problem with attempting to do this through a tax cut on the 320,000 richest people in the country. Don’t misunderstand me – I am not so much of a liberal that I want to advocate the punishment of rich people, I simply think that if you are in the top 320,000 richest people in the country you should not be at the front of the queue when it comes to government handouts.

The supply-siders’ excuse is that by giving rich people even more money we will boost the economy and it will filter down to the poor people.

So which of these boosts the economy more?

a) Giving 10 rich people £1,000,000 each

b) Giving a million poor people £10 each

The letter to the FT offered nothing more than vague anecdote to say why we should go for a). 24% of income tax, it said, is paid by the richest 1%. This could be because taxes are grossly unfair. It isn’t though.

The income gap between rich and poor has been rising for a long time and is now bigger than it has ever been. When a small number of people earn lots of the income, a small number of people pay lots of the income tax. On its own, that figure of 24% paid by 1% tells us nothing useful at all. (I wrote more about this here.)

I reread the letter a few times and couldn’t really understand how 20 economists (a few of them with senior academic positions) could so strongly advocate such a tax cut and only provide a weak argument of vague anecdote to back it up.

To say the least it was a wish-washy argument: “Some rich people might all move somewhere else with a lower tax rate.” Well they might indeed – we all understand incentives. I would have thought though – no I would absolutely have expected that 20 economists arguing for tax cuts for rich people, between them could have come up with something concrete to show why, in the circumstances, this is a good policy. The US has (and has had for a long time) a far lower top income tax rate compared with the large economies in Europe and they’re doing worse than we are. I haven’t see a huge number of UK companies abandoning ship and moving to the US.

Supply-siders argue that when taxes on top-earners are raised that top-earners find ways to avoid and evade the taxes. That’s also true, but it isn’t necessarily a reason to sort it out through a policy of:

“Damn those rich people, they’re so wiley! We’ll have to recoup that money from the less-wiley poor people!”

If our tax rules are this easily side-stepped by rich people then we should look at the tax rules and make them tighter. We should not be saying that poor people should be picking up the bill because we have loop-holes in our tax law.

A very important point that the letter ignored though is what people do with the extra money they receive through tax cuts. If we go with option a) and give 10 rich people £1,000,000 they might spend a bit of it but most likely a lot will go into their savings – they already have plenty of money to finance their lifestyles.

If we go with option b) and give 1,000,000 poor people £10 each they will spend it. When people are really struggling to get by on what they earn they don’t open a savings account.

This is very important because the key reason that tax cuts help to stimulate an economy is because people have more money to spend and in spending that money they stimulate the economy. If we make a tax cut where the extra money goes straight into people’s bank accounts then no economic growth is realised. These are two very basic and indisputable economic rules:

  • Rich people save a greater proportion of their income than poor people
  • Spending money stimulates the economy
It is therefore absolutely the case that option b) would lead to more of the realised tax benefits being pumped back into the economy. Wouldn’t it be a good idea to have at least mentioned this in the letter? Maybe shown how they could be so sure that the effect of the disappearing, tax avoiding rich people outweighed this effect?

Anyway, as it transpired, the 20 economists’ letter to the FT had been organised by a PR company. I’ve no idea why a PR company decided to set out to find 20 economists to sign their letter but something fishy is definitely going on.

Labour’s alternative is to make a temporary cut in VAT. This might work quite well as an economic boost – everything is cheaper for a year, buy it now! It isn’t a perfect way of targeting the poorest – VAT has a reasonably equal effect on everyone. The Lib Dems (remember them?) are said to favour raising the threshold below which no income tax is paid to £10,000. I like that one the best.

Let’s be clear, though – none of these ideas is going to suddenly pay for itself. Despite the claims of the supply-siders, all tax reduction policies would increase the deficit (or mean additional, unplanned spending cuts.) While increasing the already massive deficit is not ideal, I would be in favour of doing so if it kick-started some growth and simultaneously helped out the poorest people who are struggling the most.

If, when you started off reading this blog post you were an advocate of tax cuts for the rich and are now considering your position then this post has done its job.

If, when you started off reading this blog post you were an advocate of tax cuts for the rich and are not now considering your position then don’t worry, you’re not on your own – George W. Bush is on your side too.

RedEaredRabbit

Filed under Economics Tagged with , , ,

Scotland and Filettino

04/09/2011 Leave a comment

Yesterday I read this rather wonderful story in which the Italian town of Filettino, population 550, has declared independence from the rest of Italy in protest at the government’s austerity measures.

This got me thinking about whether the move was in fact a good one. Sure Berlusconi isn’t running things for them now but he has been replaced by someone whose first act was to print bank notes with his own face on so the jury will have to remain out on the leadership point for now.

Since I don’t know too much about Filettino, I decided to first think about a more familiar independence argument – should Scotland be independent from the United Kingdom? I wasn’t sure about this either so I do what I always do in such situations – I asked Twitter. I also cunningly asked respondees to give me their nationality.

These were the results:

Votes for Independence for Scotland

Overall things are a bit mixed but we can say that the Scottish respondees were mostly against independence and everyone else was split about evenly. (Except in North America where Canadians were 100% against independence and US was 100% in favour. It was a small sample though.)

Quite a few of the English Yes votes were accompanied by a brief “we should stop paying for them” type quote. This always seems to be what the argument boils down to but the SNP argues that Scotland more than pays its way because of North Sea Oil.

Let’s look at this. If Scotland became independent and international waters were divided up according to standard methods then they would certainly have a far larger share of the North Sea oil per head of population than England. Scotland isn’t Abu Dhabi though, so is it enough for them to successfully function independently?

The price of oil is hugely volatile. It varies between $50 and $150 a barrel and seems to shoot between these two extremes all the time. Major oil producers like Abu Dhabi hold lots of oil in reserve and actually help to set the oil price by controlling its supply into the market. Scotland could not do that – if it based its economic independence on oil then it would have a very volatile income. Because the UK economy is much larger than an independent Scottish economy, this volatility in the oil price has a much lower effect on it. Scotland could however, get around this through borrowing money when the oil prices were low and paying it back when oil prices were high, it’s a more expensive way of doing things but probably not a big issue.

You could though, argue that oil is going to run out at some point and that relying on it for your income is not a particularly clever long term strategy. That’s true but like it or not, oil will be around for a while yet and there would be plenty of time for an independent Scotland to invest in other industries before the oil is all gone.

Anyway, back to the key question – is the rest of the UK funding Scotland or vice versa? More or Less on Radio 4 recently did the maths. They calculated that over the past 27 years Scotland had been subsidised by the rest of the UK to the tune of £20 billion. It might sound like a lot but £20 billion over 27 years is nigh on nothing. It’s about £741m per year, or to look at it another way it is equivalent to 20 tonnes of platinum at today’s prices. 20 tonnes of platinum is handily pretty much exactly a block of one cubic metre. (One cubic metre of platinum weighs 20 tonnes! Pretty cool, no? No? Oh.)

Why is that nothing to worry about? Last year the UK as a whole borrowed the equivalent of more than twice the height of Big Ben in such blocks – one block really isn’t an argument defining amount.

(If you just read that and said, “Actually Big Ben is the bell, not the clocktower, this RedEaredRabbit is an idiot!” then you are both a pedant and a poo.)

My point is that in reality, the rest of the UK does not fund Scotland and Scotland does not fund the rest of the UK. Ok, the rest of the UK funds it a little bit but everywhere outside London is like that. London is a huge, global financial centre – why should we not expect it to generate more money per head than other parts of the country? Of course it will. Accepting this is not having a dig at any particular region, it is just obviously going to be the case. On the other hand, saying that because London does produce a lot of money, it should keep it all for itself and not give anything to the rest of the country is frankly, a bit silly.

So we can see that with all things average, Scotland can take care of itself financially. Sadly though – things are not always average and I think an independent Scottish economy would have struggled more during the financial crisis than the UK economy has – not least because its two major banks HBOS and RBS failed in the most spectacular fashion. In tough times, being part of a major economy, with access to borrow an awful lot of money cheaply is very handy and that is probably my biggest economic argument for Scotland to stay as part of the UK.

I got sidetracked massively then. I was talking about Italy.

So then, what of Filettino? Well Italy’s national debt is about €31,000 per person and it’s going up all the time. I don’t really see that Filettino can declare independence and avoid taking its share of the debt so now the 550 people in Filettino need to pay off €17m on their own. If the town has a (very) disproportionately large economy then they can do this and they might be ok. If they don’t though they are going to find it extremely hard to continue borrowing at any reasonable rate. Although it’s a fun story, I can’t help thinking that the motives behind it were based less on economics and more on a crazy mayor with a power trip.

In conclusion, I don’t see economic benefit to a declaration of independence in either of these two situations but economics isn’t everything. I’ve grown up in the United Kingdom, I love it and I love all four countries. Of course they each have their own history and culture – I would never want it any other way and I think it’s a big part of what the UK is.

From my perspective, without any one of the four countries, it just wouldn’t be the UK any more. If Scotland receives a tiny bit more money one year and then pays a tiny bit more money the next year, should we really be talking about splitting up over it? I don’t think so.

I think we’re pretty good at the moment.

Besides which, when Andy Murray wins Wimbledon next year I want to claim some of the glory for myself.

RedEaredRabbit

Filed under Economics Tagged with , , , , ,

Debt, Deficit, Default and Bugatti Veyrons

15/08/2011 2 Comments

The other day @WH1SKS tried to bully me into writing a blog post. Normally I don’t give
in to cyber-terrorism but he has big muscles and he could snap me like a twig so I’ve broken the rules a bit.

I have forgotten exactly what the brief said but I think it was something like, “what would happen if the US and Europe didn’t repay their debt?” I couldn’t write it at the time as I had a hangover (because I am cool.)

I don’t have a hangover at the moment (I am still cool though) so I’ve briefly written down my thoughts. I should state that I don’t really know much about this and wouldn’t even have attempted it if @WH1SKS hadn’t made me, so it might be nonsense – these are really just my uneducated thoughts. I do think the US and Europe are very different though so I will look at each in turn….

The United States

The USA has about $14.6 trillion of debt. A number like that is impossible for the brain to comprehend so I’ll tell you what it looks like. The world’s most expensive road car is the Bugatti Veyron Super Sport (BVSS), which costs $2.4m and is 1.19m tall (that’s about $2,000 per millimetre). If you bought $14.6 trillion of BVSSs and stacked them on top of each other they would form a tower 818 times the height of Mount Everest.

(If you then drove them all forwards at the same time the one on top would probably achieve 30 or 40 million miles per hour which would be pretty cool. Still, it would almost certainly end in a nasty accident, so please don’t try this.)

I’ve forgotten my point. Oh, yes. The amount of money they owe is very big. So what would happen if they decided not to pay it back?

Firstly, the US would find it pretty tricky to borrow any money ever again because no one would trust them. You might wonder why this is a problem – they just became better off by $14.6 trillion so who cares? It’s a problem because even with the debt cleared off they would still have the deficit. The deficit is the amount by which their spending exceeds their income and last year the US added 95 Mount Everests worth of BVSSs onto their pile of debt. This means that if no one would lend them any money any more they couldn’t finance their deficit and would therefore need to take immediate action to make the books balance. You are all aware of Labour’s “too much too soon” argument against Conservative spending cuts. Labour’s position is that we are trying to reduce our deficit too quickly and by doing so harming economic growth thus costing us more overall.

When considering the size of the cuts being implemented by the Conservatives this point is debatable. But the Conservatives are not proposing to eradicate the deficit overnight or anything even close.

In our fictional scenario, the US would need to reduce it by 100% with immediate effect. They could do this by massively reducing spending or massively increasing taxes. Either way this would send their economy into a devastating recession, 100 times worse than the last one and they wouldn’t come out of it for a long time. Because the US is so important in the global economy we’d all be back in recession too and again it would be much worse than the last one.

So although paying back 818 Mount Everests of BVSSs it not pleasant it is actually much better than the alternative, so we could therefore say that if a country can pay off their debt then they will do. And in reality the US can afford its debt at the moment without any major risks. It’s a lot of debt but it is a very large economy and the markets are happy to lend it a lot more before they start to worry about its solvency. What the markets were concerned about (and what led to the S&P downgrade) was more a plausible situation in which the US made some interest payments late because its politicians were too incompetent to govern the country properly. The effects of this would have been far less severe than the situation described above where the US outright could not repay any of its debt.

That said it would still cause a major problem. Lenders would be much more nervous about lending going forward, so would require a higher interest rate to compensate for this. More expensive borrowing would slow down the US’s recovery further that alone might not actually be much a disaster were it not for the fact that markets always over-react to everything. The markets would see late payment as bad news and when bad news happens, people in the financial sector all turn into Beaker from the muppets and panic and make everything a thousand times worse.

A banker dealing with bad news
A banker dealing with bad news

So yes, it would be bad for the US to miss a payment but maybe the biggest problems would be caused indirectly by the market’s reaction, rather than from the direct problems of the person who didn’t receive the cash.

That’s America. Let’s move on….

Europe

Everyone has been talking about Greece. Greece’s situation is, I think, a lot worse than what’s going on in the US. Greece’s debt is only (!?) 19 Mount Everests of BVSSs but its economy is tiny in comparison with that of the US and there is a very real possibility of Greece not being able to make its debt repayments. The market realises this and unlike the US no one really wants to lend Greece any more money. This is why they are continually asking for bailouts to keep things going.

If Greece defaults on its debt then it will have serious implications for the rest of Europe. The Greek banks would all fail overnight but it’s worse than that. Most of the major European financial institutions have also lent a lot of money to Greece and some of them will most likely be in trouble. As we saw in 2008 when Lehman’s went bust, a major default causes the banks to completely lose trust in each other. As soon as they lose trust in each other, interbank lending stops and then they get into even more trouble:

  • Bank#1 needs to borrow some money from Bank#2 to pay back a loan to Bank#3.
  • Bank#2 has the cash available but doesn’t know if Bank#1 is ok or not so won’t lend it any money.
  • Bank#1 therefore can’t pay #Bank3
  • Bank#1 goes bust
  • Bank#3 didn’t receive their cash! Are they in trouble now too?
  • No one lends to Bank#3
  • etc etc etc

The other very shaky economies, Portugal, Spain, Ireland and Italy would be hit quickly afterwards because no one is going to risk pumping further money in there.

The European Central Bank would effectively be left holding the bomb when the ticking stopped and would only be able to stop those countries collapsing by printing lots of money (thus screwing the Euro) or by taking significant funding from the more healthy economies (Germany and France) which would screw them up quite a lot too.

The UK would probably be happy that it didn’t join the Euro but its banks would be severely hit and additionally, the EU is the UK’s biggest trading partner, so the UK economy would take a big hit too. I have no idea by how much but it wouldn’t be good.

Markets would react by everyone turning into Beaker from the muppets again.

So, in summary, I think the US is actually ok financially and its problems are caused more by its crazy politicians than by its debt. I am much more worried by Greece, Portugal, Ireland, Spain and Italy, a situation where there I think there is a significant risk of a second global financial crisis.

And if that happens we are not all going to be driving Bugatti Veyron Super Sports any time soon.

RedEaredRabbit

Filed under Economics Tagged with , , , , ,

Flying Economy

31/07/2011 2 Comments

In the cockpit, Captain Obama moved nervously in his seat. US Economy flight 2011 was about half way through its journey. After several hours of initial turbulence the ride had been smooth but Obama sensed that the excitement of the night was not yet over.

In the seat to his right sat Co-Pilot Mitch McConnell who was now starting on his fourth in-flight steak dinner. He had mashed potato on his nose and gravy on his collar. Captain Obama, observed him and sighed deeply. Since becoming Captain in 2008, Obama had been forced to work closely with Co-Pilot McConnell and he couldn’t help feeling that McConnell had been less focused on ensuring smooth flights for US Economy and more focused on being an asshole.

The jolt was sudden. McConnell’s steak dinner hit the cockpit roof and suddenly the plane was diving.

Captain Obama grabbed the controls and tried to pull the nose up.

“Mitch! Mitch! Help me pull up!”

Co-Pilot McConnel was trying to reach the remainder of his mashed potato which was now stuck to the flight controls above his head.

“Sorry, what?”

“We can pull out of this dive but I need your help. We just both need to pull on the controls together.”

McConnell thought for a moment. “Ok. I could help you stop this plane crashing, but what are you going to do for me?”

“What?”

“I mean, I could stop this plane crashing but I want something out of it too.”

Obama pulled hard on the controls. “What are you talking about? If the plane crashes it isn’t just bad for me, it’s bad for you and all of the people who put their faith in the two of us for being able to fly the plane.”

“Yeah, but it will be worse for you if it crashes.”

“What!!?” screamed Obama, “It will be disastrous for all of us.”

“Yeah, but history will show you were Captain when the plane crashed. It’s much worse for you – you will be remembered for this.”

“Well, what do you want?”

While McConnell considered, the plane lost another 20,000ft. “I want you to cut the price of our first-class tickets.” he said.

“Mitch, we’ve been over this. US Economy Airlines is losing money hand over fist. We need to raise our income, not reduce it.”

“No, we just need to spend less on plane maintenance.”

The plane continued to plummet towards the US Federal Reserve.

“Look,” said Obama, barely able to contain his frustration, “Could we not just stop the plane crashing now and talk about this afterwards. The two things aren’t even related.”

Co-Pilot McConnell engaged the intercom and addressed the panicking passengers:

“I want to help pull this plane up but Captain Obama won’t co-operate and cut the price of first-class tickets.”

Captain Obama engaged the intercom:

“I want to help pull this plane up but Co-Pilot McConnell wants me to make concessions which have no bearing on the current problem.”

McConnell re-engaged:

“I want to pull this plane up but Captain Obama is a poopey pants.”

Obama re-engaged:

“I want to pull this plane up but Co-Pilot McConnell is a poopey face.”

“I’m not a poopey face – you’re a poopey brain!”

“I’m not a poopey brain, you are!”

“You are!”

“No, you are!”

And as their plane dived closer and closer to the ground the passengers stopped screaming and wondered why they had asked these two to fly their plane in the first place.

RedEaredRabbit

Filed under Economics, Politics

Beating Up The Rich

08/01/2011 3 Comments

In amongst the knob gags and poo jokes, someone occasionally writes something serious on Twitter. The other day someone wrote this:

The top 10% of earners pay more than 50% of all income tax. When can we stop beating up on the rich?

It got retweeted and found its way into my timeline. I did try to start a debate with the originator but they didn’t seem to want to take part. Twitter is a fairly clumsy medium for doing so in any case.

I hope I am not doing the originator a disservice but I think the case being made was one I have heard on several occasions – that because such a large proportion of tax is coming from a relatively small proportion of the population they must be more than paying their way and it would be unfair to ask them for even more.

The point I wanted to make was that this statistic on its own doesn’t really tell us enough to know whether we should stop beating up the rich or not.

(I think we are talking about a metaphorical beating up here. I want to make it explicitly clear that I do not condone the beating up of rich people irrespective of the income tax rate for high earners. Except perhaps Duncan Bannatyne and even then no more than a wedgie and a titty twister.)

So why does this statistic not tell us enough on its own?

Reason #1

Let’s look at two fictional economies:

Thatcherland

The country of Thatcherland has 10 residents. Nine of them earn £10,000 per year. One earns £10,000,000 per year.
Income tax is a flat 30% irrespective of salary.

=> In Thatcherland the richest 10% of earners pay 99% of the total income tax.

Getoffmyland

The country of Getoffmyland is populated by 10 farmers. Nine of them earn £10,000 per year. One earns £30,000 per year.
In Getoffmyland, income tax on salaries up to £20,000 pay income tax at 10%. For anything over £20,000 income tax is 40%.

=> In Getoffmyland, the top 10% of earners pay 40% of the total income tax.

If we simply assume that a higher proportion of income tax paid by the rich is equivalent to fairness then Thatcherland comes out as a brilliantly fair economy! Look, that lovely rich person is paying almost all the income tax. The other 90% of residents only have to find 1% between them!

Of course, it isn’t fair though because we just neglected to take into account the income gap between the rich and the poor: If the income is unevenly distributed in the first place then it should not be a big surprise to anyone that the income tax is too.

Reason #2

The statistic tells us only about income tax and we can’t make a valid judgment without taking into account all the other taxes we have to pay. e.g.

  • In Getoffmyland there is another tax which farmers have to pay based on the size of their farmhouse. The bigger it is the more they have to pay.
  • In Thatcherland, this tax has been replaced with a poll tax where all residents pay the same.

Even if the income tax were fair in Thatcherland we would be fairly rash to declare the whole tax system fair without taking the poll tax into account.

Let’s forget about our fictional economies and move to a real one. The UK government is currently in the process of implementing fiscal austerity. At the highest level they have two ways to do this:

  • Decrease Government spending
  • Increase Taxes

It seems to me they are a lot keener on adjusting the former than they are the latter and I do have a big concern about this. In August the IFS published an analysis of the government’s emergency budget and found that contrary to George Osborne’s claims the policies were not progressive. i.e. they proportionally penalised the poor more than the rich. (You can read the post I wrote about that here.)

This shouldn’t be a big surprise. If you hugely reduce the budget of local councils then libraries close, public transport services reduce etc and those services benefit the poor more than the rich who buy their own books and have their own cars. Additionally there have been much publicised cuts to both housing benefit and tax credits and despite what the Daily Mail says, people who claim benefits are not all millionaire hoodwinkers.

Strangely though, throughout all of this, no one has seemed to consider for 5 minutes financing any of this through a rise in income tax on the wealthy (metaphorically beating them up) and I really don’t for the life of me understand why. Austerity in the current climate is foolhardy but if you are dumb enough to want to implement it, why not start with the people who aren’t going to starve?

Prior to the downturn the UK economy had enjoyed 15 years of sustained growth and a great many people benefited because of this. Now the economy is in a bad way, why is a government hell bent on austerity, not considering going back to those who have benefited the most and asking them to contribute more? It seems especially odd when the alternative is asking the poor to foot the bill.

I must though, be fair to the government and highlight a progressive policy they are implementing – the freezing of the television license fee. It is just a shame that David Cameron had to get in bed with Rupert Murdoch to come up with one.

Leaving the rich untouched and taking it all from the poor just increases the income gap, pushing us still further towards the economy in Thatcherland.

And as we approach Thatcherland, the richest 10% will pay more and more of the income tax.

And things will be more and more unfair.

RedEaredRabbit

Filed under Economics, Politics Tagged with , , ,

The Baroness, The Cark Park and The Smell of Burning Pants

10/10/2010 6 Comments

I started this blog back in May. Prior to that, although I enjoyed reading other people’s blogs, I had never seriously considered bothering to do one myself.

Then one day, something came along which was so utterly stupid I felt like I needed to tell the world. The country’s finances were in a big mess, we were about to go through a general election and no party standing for election had told us what they were going to cut in order to sort this out.

In all of this the thing which really got my goat, the thing which frustrated me into setting up a free WordPress account and typing – actually typing, was the Conservative policy on raising the inheritance tax threshold. In the circumstances probably the most mind-numbingly stupid thing that could conceivably have been conceived.

You can read that first post here but to summarise it, the ONS had published very clear figures showing the state of the nation’s finances. The IFS had published a very clear paper showing that each of the three main parties required significant, unidentified spending cuts in order to make their sums add up and despite this, the Conservative party were advocating a tax cut which would only benefit very rich people and, in order to pursue their agenda of lower public spending would have to be funded by even more cuts elsewhere.

The IFS’s paper showed that the Conservative Party, in their manifesto, had identified a mere 17.7% of the spending cuts they would actually need to make to in order for their figures to balance. This was well known, clearly calculated and in the public domain.

Now, before I continue, I want to make something absolutely clear. I did not hack into a top secret government server to get this information. I did not take it off a laptop I found on a train, I just downloaded some reports from the websites of the two most bloody obvious places to look for it.

Fast-forward to Thursday last week and that evening’s episode of Question Time on which, representing the Conservative Party, was Baroness Warsi.

“Why didn’t you tell the public you were going to cut Child Benefit?” she was asked.

Pop Quiz, assholes. Was her answer:

  • Well, we had no idea how bad the financial mess that Labour left behind would be.
  • We didn’t want to tell anyone before the election in case they didn’t vote for us but it’s too late for that now! We won! Ha Ha!

Sadly, she went with a). This is very strange though because everyone else did know very accurately how bad the financial mess was and furthermore, I seem to recall a certain political party making it the major point of their election campaign.

If Baroness Warsi says she didn’t realise our finances were a big mess then I conclude that either:

  • She is not taking her job very seriously.
  • Her pants are on fire.

Judging by the audience’s reaction they were opting for answer b).

Later, Baroness Warsi got onto the subject of Big Society. Big Society is the coalition’s spoon full of sugar to help the cuts go down and if you don’t think too hard about it, it has a lot going for it. The idea is that the state will motivate society into taking responsibility for their own lives and get involved in building and improving the community. Such will be the Utopia that we create that no one will even remember spending cuts. It does have a fairly big down side though – no one will actually bother to do it.

Warsi was asked what the Big Society initiative would actually achieve. She recounted a charming tale of some people who had once cleaned up a car park. The next step for Big Society, she said, would be reforming our educational system, our police force and our health service.

Hmmm…..

That does seem like rather a big next step. Just because the average group of people possesses the skills to clean up a car park does not mean that the average group of people knows how to set up and run a school or a hospital. In fact, I would go as far as to say these things are in no way related.

If you didn’t see the episode and think I am misrepresenting things, I urge you to have a look at it on iPlayer. This bizarre extrapolation really was done.

When Labour came to power in 1997 they enjoyed a long “Honeymoon” period. Judging by Baroness Warsi’s performance, the coalition’s is over as quickly as it began. I actually don’t believe the government could possibly be as incompetent as you’d believe from watching her but they do seem to put her on TV a lot so their judgment at least is fairly awful.

Her claim regarding the economy, essentially ‘we didn’t know what we were getting in to’, is frankly no better than Bob Crow using the fact that tube drivers have to work underground a lot of the time as one of the reasons that they should be paid more. Call me a cynic but I’m pretty sure they knew that when they applied for the job and probably they thought the hugely inflated salary, minimal working hours and generous holiday allowance made up for it. Or maybe they really didn’t already know this when they applied for the job of tube driver on the London Underground.

In truth the state of the nation’s finances were well known by everybody. Any party seeking election knew exactly what they were taking on and as such the elected government should be able to stand behind their policies, not hide behind a lie.

The claim that these cuts weren’t expected and are just the result of not realising that our economy is weak, is frankly insulting because it is so easily shown to be false. The current government will no doubt have more, as yet, unidentified cuts ahead. If they have even the tiniest amount of respect for their electorate then they will learn to be accountable for their policies. If they think their electorate is a bunch of idiots then we have this excuse to look forward to for the next four and a half years.

This all sounds hugely depressing but I assure you – it’s not all bad. Somewhere, wherever it may be, we have a clean car park.

RedEaredRabbit

Filed under Economics, Politics Tagged with , , ,

When the History Grad took on the IFS…..

25/08/2010 1 Comment

It was interesting to read today’s publication from the Institute for Fiscal Studies regarding their analysis of George Osborne’s emergency budget. At the budget, you may remember, George Osborne presented his policies and stated that they would proportionally impact the poor less than the rich.

I like the IFS because it is independent of any political party but is extremely well equipped to analyse their economic policies and give us a viewpoint unbiased by any political persuasions.

The IFS have spent lots of time looking at George Osborne’s policies and doing their own sums. They have included lots of things that George Osborne didn’t include in his model. Things like the cost of mortgage payments do actually affect poor people, as do cuts in housing benefits and tax credits. They have also included the years 2013 and 2014 in their analysis which were missing from George Osborne’s.

At this point, I would have liked the government to thank the IFS for their analysis, review it in detail and decide, based on this review, whether or not they should change their policies. This wasn’t what happened. Within hours, the government had given a press release stating that the IFS had missed some important things from their analysis, such as economic growth and if they had included these they would have come to a different conclusion. This is a bit odd, because the IFS have included more things in their analysis than the government did in theirs. They haven’t as far as I can see missed out anything which they government included in their model, they have just added things the government forgot to include. To my mind, this doesn’t make it a worse analysis, it makes it a better analysis.

If George is going to get into a verbal ruck with the IFS about economics, I worry his modern history degree won’t help him out much but there is a bigger concern that I have. For the government to have so quickly found a the flaw in the data presented by the IFS they would have had to take the IFS model, incorporate the things they felt had been missed and then recalculate everything on that basis. i.e. they would have to have an even better analysis already prepared and ready to go. If they have this analysis then they should publish it so the IFS, you, me and everyone else can read it and respond. I suspect this analysis has not been done and their reaction is purely a defensive one.

In an ideal world a government would form policies by gathering the available evidence, analysing it and then determining the best policy based on that analysis. Before they implemented it they would determine the way in which they would measure its success or failure and if it were not behaving as expected they’d adjust the policy accordingly. This might seem an unattainable idealism but actually we are all doing such an exercise in our every day lives all of the time.

Supposing you live in Wimbledon and you get a new job in Canary Wharf. You now have to decide how you will get all the way across town and back every day. There is nothing direct so you have lots of combinations of options. You could take buses, tubes, mainline trains or even river boats.

You start off by typing your journey into your iPhone app. It suggests that the quickest route is taking the District Line through Earl’s Court, changing at Monument and taking the DLR. You try this for a while but realise that every morning you get stuck outside Earl’s Court for 20 minutes because the people who manage the arrivals and departures there are half-witted. The model on your iPhone app didn’t take this into account so in this situation you would try a couple of the other suggested journeys a few times and after a while, based on your experience, you’d settle on the route which worked the best for you.

The government equivalent is to decide that on the first day of work, they need an emergency iPhone app journey plan. After this, no matter how inconvenient it becomes they will stick to the route they took on the first day and claim it is the best.
When newer better apps become available they accuse them of not including something their original model had never included anyway like “leaves on the line” and stick to sitting outside Earl’s Court for 20 minutes every morning, pretending they meant to do it.

No one would go in for this nonsense with their journey to work so why do politicians insist on it for something as important as the economy? The difference is this:

How much would it cost you to admit you were wrong?

Sadly we live with a political system which overly punishes this natural human trait. When the apple fell on Newton’s head his reasoning didn’t go like this:

I need an emergency gravity law. It is very important to get this out asap. Thinking it through would be an unnecessary waste of time.

…and then…

My emergency gravity law is that apples are attracted to heads, through a strange new force.

And then refuse to change his law when someone pointed out it was a bit more generic than that and in fact everything was attracted to everything else.

Of course he didn’t. Science would hardly be where it is if all scientists were to all insist that the first thing they ever thought of were the absolute truth. Politics a bit different though. For one there is the opposition. Imagine there were someone employed for the sole purpose of taking your job off you. If there were, would you want to admit you’d got something wrong? Also there is the press. Every newspaper has a political agenda, and while I think being able to learn from experience and adjust accordingly is a good trait, the press seem to call it a “U-Turn” and think it makes you a weak politician, not fit to do the job. All this gives an incentive for governing politicians to refuse to admit their mistakes and pretend the policy they first thought of was the best one.

I admit though, the comparison with Newton was harsh because politicians are under a lot more time pressure than Newton was. As important as Newton’s theory of gravity turned out to be, it wasn’t as though anyone at the time was having a terrible time directly because they didn’t have an equation to explain why they were sticking to the Earth. The new government didn’t have that luxury. When they came to power they were under immense pressure to put in place some policies to start addressing their finances – after all they had promised to do so and been elected on that basis. I don’t have a problem with them doing this, as long as they could have a process to continually review what they were doing, take on board other people’s opinions where necessary and adjust their strategy accordingly when they were wrong.

The reality is a long way from this though and the best model available to us today, from the IFS, suggests that our current economic policies are punishing the poor more than the rich. The government deny this but haven’t produced a better model to show how they can be so sure.

Would it be so bad to have a political system where a government could take constructive criticism of their policies into account and improve upon them because of it?

Wouldn’t that benefit to the country as a whole?

Would it really be so terrible of them to at least read the IFS publication with an open mind before responding?

I don’t think it would be terrible. In fact, I think they should read it. It is rather good.

RedEaredRabbit

Filed under Economics, Politics Tagged with , , ,

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