Stumbling and Mumbling

Tax freedom: a paradox?

Today is Tax Freedom Day. This should draw attention to a fascinating paradox - that the powerful intellectual case for shrinking the state has only rarely translated into successful political programmes.
This intellectual case is not just theoretical. Asian countries like Japan and South Korea show us that relatively small governments are consistent with equality and good health and educational outcomes. And a recent paper by Ludger Schuknecht and Vito Tanzi has found that countries that did cut spending a lot generally benefited from doing so. They say:

Countries [that cut government spending] did not seem to have suffered from these large reductions either in a macroeconomic sense, or in terms of lower values for socio-economic indicators. On the contrary, ambitious expenditure reform coincides with improvements in fiscal, economic, human development and institutional indicators.

And yet, despite all this, there have been remarkably few ideologically-driven cuts in government spending in developed countries. Granted, as Tanzi and Schuknecht show, cuts in spending have been more widespread than you might imagine. But these have generally been prompted by economic crises rather than by intellectual conversion.
What's more, in the UK, public spending has largely resisted ideological efforts to cut it. During Thatcher's premiership, Tax Freedom Day actually got later. Falls in the ratio of taxes to GDP have come as much through rises in the denominator as cuts in the numerator.
So, why has the powerful intellectual case for smaller government not led to a similarly powerful political case?
One possibility lies in the dynamics of pressure group politics, as described by Mancur Olsen in this classic. Self-interested and narrowly focused pressures for higher spending defeat widespread but less intense pressures for lower spending.
The problem with this view is that some countries have been able to slash spending. This alone, say Tanzi and Schuknecht, "contradicts the pessimistic view that political economy constraints render ambitious reforms virtually impossible."
Another possibility is that government spending, like private consumption, is habit-forming. Maybe voters see high spending as the risk-free option, and just aren't brave enough to support cuts, unless some crisis jerks them out of their complacency.
A third possibility is that the people calling for limited government have simply failed to make their case well. In one sense, the very existence of big government shows that this is trivially true.
But what exactly have they done wrong? My theory is that they've failed to address the case for egalitarianism. Rather than show that small government is consistent with equality - because it allows tax cuts or higher benefits - they have preferred to rubbish the notion of equality. In doing so, they have given the impression - which is wholly incorrect - that limited government is merely the self-interest of the rich.

Dead trees, dead brains

The FT has discovered that the government can do magic. It can make costs disappear:

The London School of Economics has calculated that the [ID card] scheme will cost between £12bn and £18bn, making the average cost per card up to £300 unless the government is willing to shoulder some of the burden.

For crying out loud. If the “government” – by which they mean tax-payer – “shoulders some of the burden”, the average cost per card is still £300, assuming the LSE is right: £18bn divided by 60 million. It’s just that the taxpayer (that's me) pays instead of the card-holder (who's also me.)

Why does the FT not see this? Is it because it cringes too much in front of power to see the truth?

Or is it because the FT is an equal opportunities employer in the same sense that the BBC is – it employs people from any Oxbridge college, regardless of ability?

An unwanted American import

Irving Kristol has some advice for the Stupid Party. And by crikey it’s daft. He wants a return to 1960s cod-Keynesianism, in which governments thought they could boost economic growth by heavy borrowing, and to hell with inflation. He says:

Given the choice between the risk of inflation and the risk of unemployment, people will always choose the former…

France and Germany are societies that are ravaged by unemployed youth, and while Britain is doing better it still suffers from the same economic sickness. So I would urge Britain’s conservatives to put aside bankers’ economics, otherwise known as “prudent household economics”. The nation is not a household. In the modern world the nation has to be committed to economic growth in a way a household cannot be. To achieve such economic growth, a cut in tax rates - 10% is a good number to begin with but the prospect of further cuts must be kept in mind - is the beginning of economic wisdom. Economic initiatives must be encouraged for economic growth to happen.

Yes, the Treasury will say that you must cut spending to make this possible. This insistence will make tax cuts impossible. In America the Treasury has always been hostile to tax-cutting; it’s in the nature of the beast. Bankers’ economics is useless when defining the appropriate leverage of public debt arising from tax cuts.

Where do we start here?

First, a 10 per cent tax cut is £50bn, or over 4 per cent of GDP. Without spending cuts, this would take government borrowing to over 7 per cent of GDP, unless there is an immediate and big boost in economic activity and hence tax revenues.

Will there be such a boost? Kristol gives us no reason to think so. And nor does economic theory. Sure, tax cuts make work more productive, relative to leisure, so they give us an incentive to work more. But they also allow us to get the same post-tax income with less work. The net effect on labour supply is ambiguous.

So, could we really afford to run a budget deficit of 7 per cent of GDP? It’s risky. Conditions recently have been remarkably favourable for budget deficits. Asia’s “savings glut” and supply of cheap goods are holding bond yields down. But you don’t have to be as gloomy as Brad Setser to believe these conditions might disappear. A revaluation of the renminbi or increased bottlenecks in China could well diminish them, sending bond yields soaring. Do you really want a record budget deficit when that happens?

But let’s say Kristol’s plan succeeds in boosting growth? What then? The Easterlin paradox tells us that growth doesn’t make us happier. And there’s no evidence that growth, on its own, will solve the problem of youth unemployment. To get unskilled youth into work you need microeconomic policies – incentives and education – not just macro policies.

Kristol seems oblivious to this, as he is oblivious to allocational efficiency. And it’s here that the case for cuts in government spending lies. The fact is that it is a gross misallocation of scarce resources to devote 40 per cent of our income to government “services”. What’s more, it’s immoral for bureaucrats to exploit us so. (Why don’t supporters of limited government use Marxian arguments against exploitation more?)

In failing to make this case, Kristol is being too defeatist. The fact is, it shouldn’t be hard to cut spending. You can make over £10bn of cuts straightaway by simply abolishing the DTI, Department for Culcha, Meeja and Sport, DEFRA and CAP.

Genuine populist conservativism would do this, rather than rehash 1960s nonsense of ambitious macroeconomic policies and the pursuit of growth.

The Stupid Party’s perfectly capable of coming up with crack-brained ideas on its own, without importing this tosh.

The economics of fat birds

Being fat costs women money. From the abstract of a new paper by Dalton Conley and Rebecca Glauber:

A one percent increase in a woman's body mass results in a 0.6 percentage point decrease in her family income and a 0.4 percentage point decrease in her occupational prestige measured 13 to 15 years later. Body mass is also associated with a reduction in a woman's likelihood of marriage, her spouse's occupational prestige, and her spouse's earnings. However, consistent with past research, men experience no negative effects of body mass on economic outcomes.

The finding that fat women have less chance of marriage is the sort of research that could come from the University of the Bleeding Obvious. What is puzzling is that being fat causes lower wages.

One possible explanation is that fatness causes ill-health. But if this were the case, you’d expect men’s earnings to suffer too – indeed, more so, as men do more heavy manual labour where a bad back can stop work. What, then, can explain it? Here are three theories.

1. Being fat is a signal that one lacks what Bowles, Gintis and Osbourne call “incentive-enhancing preferences.” These are personal attributes that make you work hard when your employer isn’t supervising you closely. Being fat signals that you are lazy or ill-disciplined. Why does this affect women’s earnings more than men’s? Perhaps it’s because we expect women to take more care over their appearance than men do. So a fat woman signals greater carelessness than does a fat man.

2. It’s an extension of the Daniel Hamermesh’s finding that ugly people earn less than beautiful ones. However, his first paper on this subject found that the beauty premium was bigger for men than for women. Why, then, should women be penalized more for being fat than just ugly? Could it be that the premium that beautiful women earn is diminished by the prejudice (which is wholly wrong in my experience) that beautiful women are less intelligent. No such amelioration exists for the lardy penalty.

3. Maybe fat women can’t find nice clothes in shops, and so have less incentive to earn money.

Football and Americans

Tyler Cowen inadvertently reminds us of an important fact - that even the cleverest Americans know little about football. He asks: why is "soccer" not more popular in the US?
Here's some advice for Americans: never call it "soccer". Only public schoolboys do this - and whereas being American is forgiveable, even laudable in many ways, being a public schoolboy is certainly not.
Right, to business. Here are some of Tyler's claims:
1. "The British elite - led by 'gentlemen amateurs' - spread soccer through the empire with deliberately imperial goals."
Eh? We exported football to Brazil and Italy, neither of which had the benefit of being part of the Empire. And it is in our colonies and dominions - the Indian sub-continent, Canada, Australia (until recently) - that football has traditionally been weakest.
2. "The rise of nationalism in the early twentieth century boosted soccer as a means of expressing rivalries."
But it is only after the 1950s that the World Cup really took off. The first World Cup, in 1930, featured only 13 teams. Only 4 of them were from Europe. And two of these - Belgium and Yugoslavia - were hardly unified nation-states. One of those teams was the US. England didn't enter.
3. "The combination of hierarchical leagues and not-for-profit clubs, which has characterized soccer for the twentieth century, is poorly suited to the age of modern commercial sport. Its days probably are numbered."
Football clubs, with a few exceptions - most notably Barcelona - have always been run for profit. When 50,000 fans paid their shilling to watch players paid £10 a week in the 1950s, where do you think the money went? And  domestic leagues are getting stronger these days in Europe, not weaker - although the money goes to players rather than clubs.
4. "The bigger puzzle, in my view, is why anyone likes either sport [football or baseball] at all."
This is just incomprehensible.
The question, though, remains: why isn't football more popular in the US? It could be just a quirk of the American psyche, like bad spelling and the belief that David Letterman is funny. But here's a theory. Professional football in Europe was spurred on because it was a vehicle for city or religious rivalry: Madrid-Barcelona, Rangers-Celtic, and so on. Could it be that these rivalries are smaller in the US, and so professional football didn't have so much to leverage upon?
Another thing. That fluke on Wednesday has given us one of the most beautiful sights in the world - a miserable ManYoo fan.

War referenda?

Clare Short plans to introduce a private member's bill requiring a parliamentary vote before the UK goes to war. Doesn't this show how conservative the "soft left" is? Ms Short believes decisions to go to war should be taken by a tiny elite. The difference between her and supporters of the royal prerogative is merely about which elite it is to be.
But isn't there a good case for decisions about war to be taken by referenda? They are perfectly suited. The decision is a simple binary one - yes or no. A war is a pure public good (or bad). MPs are (generally) not elected because of their views about a war, and so have no mandate to take the decision; a war with Iraq was not an issue in the 2001 general election. MPs often have no great extra expertise than the general public on such issues; fundamentally, the question is a moral one. The general public is less likely than MPs to be swayed by irrelevant or even immoral considerations; tribal party loyalty or hope of ministerial preferment can sway MPs' decisions but less so the public's. And a specific decision taken by the public would confer enormous moral legitimacy upon the war - a fact of some importance for the poor sods who'll do the fighting.
The case against referenda is practical. Sometimes, a decision has to be made more quickly than can be done by a referendum. But how important is this argument? War should be a "last resort' (or should it?) taken after much thought. Isn't that thought best done in public?
Above all, though, shouldn't the so-called left be willing to trust more in democracy and the people? Or have I missed something? 

I spit on Beelzebub

Laban Tall offers up Barry Beelzebub as a potential replacement for Richard Littlecock. This won’t do. Take this effort. In lamenting the fact that 11-year-olds don't have enough anal sex, Beelzebub suggests:

Before any woman under the age of 25 is allowed to have a child, she must first obtain a Baby Licence. She will only be able to do this by first proving that she has the basic intelligence, the financial means, and the secure family structure that will allow her to bring up the child properly. Any tracksuit-wearing trollop who "falls pregnant" whilst not in possession of a licence will face a compulsory termination.

This is pathetic. It’s far too sensible.

There is a respectable utilitarian case for compulsory abortions. The empirical evidence has been provided by Steve Levitt. He’s found that the legalization of abortion in the US caused falling crime in the 1990s – because men who would have grown up to be criminals were in fact sluiced down hospital drains in the late 1970s.

If you’re serious about wanting to cut crime, then, compulsory abortion is one option.

But isn’t this grossly illiberal? No. Here’s John Stuart Mill’s On Liberty:

The fact itself, of causing the existence of a human being, is one of the most responsible actions in the range of human life. To undertake this responsibility – to bestow a life which may be either a curse or a blessing – unless the being on whom it is to be bestowed will have at least the ordinary chances of a desirable existence, is a crime against that being. And in a country, either overpeopled or threatened with being so, to produce children, beyond a very small number, with the effect of reducing the reward of labour by their competition is a serious offense against all who live by the remuneration of their labour. The laws which, in many countries on the continent, forbid marriage unless the parties can show that they have the means of supporting a family do not exceed the legitimate powers of the state; and whether such laws be expedient or not…they are not objectionable as violations of liberty.

The reference to marriage is a little dated here – because Mill did not foresee the possibility of many children being born out of wedlock – but the principle of baby licences is clearly hinted at.

So, if Beelzebub wants to be a mad right-winger seeking to destroy people’s basic freedoms, he’s going to have to try much harder. How about proposing that we spend uncountable billions on ID cards that won’t work?

But no-one would be mad enough to suggest that.

Openness and development

Tim and Jim are having a good set-to about the link between trade liberalization and development. It started when Jim objected to Stephen Pollard’s claim that: “The engine of growth, without which countries remain in poverty, is trade. Tariff protection keeps resources in unproductive low-return activities.”

Jim replies:

If he is right that trade liberalisation is the road to riches, wouldn't we expect the Third World region with the most liberalised trade policy to be the richest? But which one is the most liberalised? According to the World Bank, that would be sub-Saharan Africa.

Tim retorts that tariff barriers understate the barriers to trade in Africa; the problems there, he says, are bad transport and corrupt tax systems.

My take is that both Jim and Tim are right.

Jim’s right to reject the simple view that trade creates growth. The empirical evidence is weaker than you might think. Dani Rodrik’s classic paper (big pdf) concludes:

We are skeptical that there is a strong negative relationship in the data between trade barriers and economic growth…the search for such a relationship is futile.

More recent research by Roberto Rigobon has challenged this. But even this has merely shown that you need immense econometric spadework to find only a weak link.

There are two reasons for this lack of a robust relationship. One is that it is not necessarily the case, as Tim claims, that “it is trade, with the associated playing out of comparative advantage and the division of labour, that makes places rich.”

It’s theoretically possible that free trade would lead a poor country to specialize in industries requiring unskilled labour. If these are industries with poor growth prospects, such an open economy might well grow slowly. (This raises the question: what exactly are the links between allocative efficiency and fast growth?)

The second reason – and I think the more important one - is that it is not a closed economy per se that depresses growth, but rather all the things that are often but not always correlated with being closed. Once you control for these, the link between openness and growth weakens.

It’s here that Tim is spot-on. Bad transport or corrupt tax systems can both depress growth and cause economies to be closed. In such cases, low tariff barriers won't do much good. There are other examples.

A country might be closed because a dictatorial government discourages links with the outside world. North Korea is a poor closed economy. But it’s poor mainly because of a crap government, not merely because it’s closed.

Anything that depresses investment – lack of confidence, low education, insecure property rights, bad capital markets – will cause low imports of capital goods. In the data, it will look as if a closed economy (in the sense of a low import-GDP ratio) leads to slow growth – but again, the causal link is different.

Examples like these mean that if a government can provide secureish property rights, good education and confidence, it could get good growth even with tariff barriers - as China and India have shown. And conversely, a country with low tariff barriers but no other pro-growth factors in place won't grow.

So, maybe it’s not trade in itself that matters for growth, but rather the attitudes that generate trade – sound property rights, an interest in the outside world (including a willingness to attract FDI), and good government. As Roberto Rigobon put it: “It is openness in a broad sense – as part of the overall economic, policy, and institutional environment – that is conducive to growth.”

I’ll leave you with a question. Why do we need single simple big ideas here? Why look for a “one size fits all” strategy? In this paper (pdf) Dani Rodrik says we should abandon such ideological pretension, and just ask: what exactly is the main bottleneck stopping this particular country from growing? What’s wrong with this?

Another thing: If you accept the view that there's no link between tariff barriers and growth, it does not follow that you should support trade restrictions. There's a world of difference between believing tariff barriers in general don't retard growth, and believing that a particular tariff on a particular product will do positive good.

Shared equity stupidity

There is an atom of intelligence in Gordon Brown’s idea of shared equity schemes to encourage home ownership.

It’s because there is a missing market. Put it this way. Imagine a company wants to raise money but doesn’t have much cashflow. The obvious solution is to issue equities – a share in the (hopefully rising) value of the company. Why, then, shouldn’t cashflow-poor home-buyers be able to do the same – sell off a stake in their asset?

Brown is planning to plug this gap.

This raises the question. Why hasn’t the market already developed equity schemes? One possibility is just that mortgage lenders are stupid. Another is that they don’t want to take the risk of direct exposure to the housing market.

And this, in turn raises the question: why would they have to be lumbered with this risk? Why couldn’t they lay it off? There are two obstacles to them doing so.

One is that, initially at least, there will be few such schemes. That would make it difficult to securitize such equities – that is bundle them up and sell them on the open market, in the same way that company shares are traded in a secondary market.

The other is that there are few longer-dated property derivatives. IG Index and City Index tried to set up a market in house price spread bets, but have since suspended them. Goldman Sachs offers property warrants (pdf), but these are short-dated and don’t insure you against longer-term housing risk.

Now, if Brown were merely developing ways to solve these problems - for example by following this lead, I’d applaud. It is, I think, a reasonable function of government to develop markets.

But Brown isn’t doing this. His solution to mortgage firms’ reluctance to take on home equity risk is not to develop ways to lay off this risk, but for the government to take it on. The crucial paragraph is on pages 3-4 of Extending home ownership (pdf):

If a property is sold at below the original purchase price the full outstanding value of the standard mortgage is paid back. This is followed by the full outstanding value of the mortgage provider’s equity loan. A proportion of the government’s equity loan stake is paid back only if there is a surplus after these first and second charges are met (my emphasis).

This makes a huge difference. It means the government is subsidizing home ownership. Worse still, it is subsidizing mortgage companies – because these will be able to make profitable loans they would not otherwise make. No wonder they welcome the idea.

But why should we tax-payers subsidize private companies? Why should we take on housing risk? The question gains force because we are exposed to this already. If house prices fall, not only do we lose money directly, but also we have an increased danger of losing our jobs. Why should Gordon Brown add to these risks? What are we getting in return for them?

Sadly, the answer is obvious. Insofar as the scheme supports house prices, all of us home-owners are getting a benefit. I know, it’s intended to help only first-time buyers. But it goes further. If a prospective first-time buyer can buy a place, it follows that the prospective seller can sell. He can then use this money to buy a more expensive place. And the seller of that place…you get the picture.

Brown is, therefore, putting tax-payers’ money at risk in order to support rich home-owners.

This reveals two things. First, that Brown has no conception of the proper role of government, or the proper uses for tax-payers money. Second, that egalitarianism always comes a bad second to headline-grabbing gimmicks.

There’s more. Why did Mr Brown pre-announce his plans on Sunday but only publish the Extending home ownership pamphlet yesterday? Could it be that he didn’t want the newspapers to quote the paragraph I have, or to scrutinize the plans too closely? If he did, he seems to have succeeded. The dead trees are easily manipulated.

And more: One way in which the government could develop housing derivative markets would be to give long-dated call options on a house price index to all 18-year olds. This would be egalitarian relative to shared equity schemes - as it would also benefit the very poorest - and it would help develop a market which doesn't now exist.

Richard Littlecock, superstar

Richard Littlecock's move from the Sun to the Mail is likely to cement his position as Britain's best-paid newspaper columnist; he's reputed to have been on £350,000 a year at the Sun - 11 times what the average journalist is paid.
This is an example of superstar economics, pointed out by Sherwin Rosen in the early 80s - the process  whereby tiny superiorities in ability lead to huge differences in salary.
The ability that matters here is not the skill to produce well-written right-wing bile. Loads of people can do that.
Instead, the difference between Littlecock and those guys - at least in the opinion of the Mail which is what counts - is that he can deliver readers.  And it only takes a small ability to do this to warrant a big income. If Littlecock's two columns a week attract - say - 40,000 extra readers (an increase of only 1.7 per cent) then if these generate an extra 10p each of net income for the Mail, he'll be worth a wage of £8000 a week.
So, what is it about Littlecock-type ability that generates such rewards?
The key feature is that his services are easily duplicable. Once he's written an article, it can be distributed relatively cheaply to millions of people; Littlecock can, in effect, duplicate himself and serve millions of clients. This is why you get "superstar economics" in entertainment or sports but not medicine; the best doctor in the world can (for now) only perform a limited number of operations. That limits his income.
A second feature, said Rosen, was that average ability was a poor substitute for high ability. This explains superstar salaries in sport; an average striker is a poor substitute for Thierry Henry, because Thierry's superior ability leads to much greater on-field success.
I'm not sure, though, that this explains  income differences in media or music. No-one  thinks the callipygous J-Lo (why does writing about Littlecock make me think of arses?) is a better singer than, say, Kate Campbell. What J-Lo  has is greater brand recognition - just as Littlecock has greater brand recognition than, say, Peter Briffa. It's this - not writing or singing talent per se - that generates income.
Now, here are my questions. One is: how do people convert ability into brand recognition? Secondly, is technical change really increasing the importance of superstar economics? Or will the rise of blogging eventually reduce the earnings of people like Littlecock, by allowing his potential competitors to develop brand recognition which they can sell to the old meeja. Here's hoping...