Stumbling and Mumbling

Tax cuts and wealth creation

In that post, Fraser Nelson writes:

When [Nigel Lawson] reduced the top rate to 40% he unleashed wealth creation and the government profited by taking a smaller slice of a much bigger pie.

In the absence of any elucidation, this is the post hoc ergo propter hoc fallacy. It is the case that the rich have gotten richer (pdf) in recent years, but it’s not obvious that Lawson’s tax cut caused this.
Take the data (excel, reported in this pdf) on the incomes of the richest 0.1% of the population, as complied by Thomas Piketty and Emmanuel Saez.  These show that the share in GDP of the top 0.1 per cent of the UK population actually rose more slowly in the seven years after the cut ( in 1988) than they did in the seven years before. If Lawson had “unleashed wealth creation” one would expect the opposite to have happened.
It’s only after the mid-90s that the incomes of the top 0.1 per cent really accelerated.
Also, the incomes of the rich rose even faster in the US and Canada after Lawson’s cuts. It’s unlikely that Canadians and Americans were motivated to work harder by cuts in UK taxes. 
All this suggests an alternative hypothesis. What “unleashed wealth creation” was not Lawson’s tax cuts, but the vast growth of the financial system.
This hypothesis is consistent with the fact that the incomes of the top 0.1% grew slowly from 1988 to the mid-90s - the City did not boom then - and faster thereafter. And it's consistent with the rise in top incomes in the US at the same time as the UK.
Granted, Lawson’s tax cuts might have contributed to this. But then again, they might not. Tax rates are higher in New York than the UK, and this didn’t stop rich Americans getting richer.
You might object that the incomes of the top 0.1% aren’t what Fraser means by “unleashing wealth creation.”
So, let’s look at an alternative measure - labour productivity in the whole economy. If Lawson’s tax cuts had stimulated the rich to work harder, you’d expect this to have risen since 1988 partly for purely arithmetic reasons - the rich’s labour counts too - and partly because greater effort by managers stimulated their staff to work harder.
Except that it hasn’t. In the last 20 years, productivity has grown by 1.8% a year. In the 20 years before Lawson cut taxes - a period that included the appalling industrial relations of the 1970s remember - it grew 2% a year*.
This suggests an alternative theory. Lawson’s tax cuts allowed high earners to retire earlier - because they reached their target level of retirement wealth quicker, and because their savings were taxed more lightly. This deprived the economy of a cadre of experienced workers and managers, with the result that productivity has suffered.
Is this theory correct? I don’t know. What I do know, though, is that the raw claim that tax cuts “unleashed wealth creation” is highly arguable. It has a strong basis in self-interest and prejudice, but a weaker one in  theory (ever heard of income effects?) and evidence. Not, of course, that the evidence matters.
* Code identifier LNNN here.

Regressive taxes and redistribution

Imagine a society of 100 people run by a rapacious dictator and his henchmen. This dictator has an income of 1000 and his four henchmen an income of 500. The other 95 people have an income of 10. And imagine too that the dictator has rigged the tax system so that he and his cronies pay 10% of their income in tax whilst the other 95 pay 20%.
Is this society just or equal?
Most of us would say not. Most of us, that is, except Fraser Nelson. He says:

The richest 1% of this country pay 23% of all income tax collected in 2008-09. The richest 5% pay 42% of the tax. These ratios should warm the heart of the most ardent redistributionist.

They shouldn’t. Think of the equivalent figures in my example. The richest 1% of earners - the dictator - pays 20.4% of all tax. The top 5% pays 61.2% of all tax.
But these ratios, and this society, would not “warm the heart” of any redistributionist.
My example shows that if inequality is high enough, even a regressive tax system will involve the rich paying a large share of tax.
What’s more, if inequality rises, so too will these ratios. If our dictator and his cronies rob the poor of half their income and divide it among themselves, the share of total taxes paid by the top 1% will rise from 20.4% to 24.7%, whilst the share paid by the top 5% will rise to 78.5%. By Fraser’s reckoning, our society has become more redistributionist. Which it has - but in precisely the opposite direction that Fraser would think.
So, the share of taxes paid by the rich tells us nothing about whether society is equal or the tax system progressive. To believe they do is to commit a plain logical error.
Stephen Pollard describes Fraser’s post as “incredibly important.” It is, because it shows just how badly the right can misunderstand what redistribution means.

Bradford & Bingley: the underlying questions

Bradford and Bingley lived for 149 years as a mutual company. It lasted just eight years as a quoted firm. Halifax survived for 144 years as a mutual, but just 11 as a quoted company. Northern Rock lasted 157 years as a mutual, 11 as a quoted.
Not a single building society that demutualized in the 90s now survives as an independent company.
Does anyone see a pattern here?
What went wrong? John Kay gives a good answer. I’d pick out three elements:
1. The quoted firms overlooked the virtue of tacit knowledge, and the unarticulated wisdom embodied by traditional ways of doing things. For years, mutuals stuck to the trusted 3-5-4 rule: borrow at 3%, lend at 5%, be on the golf course at 4. Demutualized firms thought they could do better.
2. They took tail risk. In borrowing in wholesale markets rather than relying upon deposits, Northern Rock and B&B exposed themselves to the tiny probability of a drying up of credit.
3. They overlooked monopoly power. The mutuals could use local loyalty as a source of deposits. The demutualized firms thought they could make money doing what any AAA-rate firm could do - borrow cheaply.  They didn’t ask: do we have an advantage in this business?
The upshot, as John says, is that "The pursuit of shareholder value damaged both shareholder value and the business."
The question is: what, if anything, is the meta-narrative here? Were the demutualized firms just very unlucky (point 2)? Or were they reckless - a charge that’s easy to make with hindsight?  Were the demutualized bosses just bad managers? Was there a principal-agent problem - a failure of owners to control managers? Or could it be that owners were complicit in the disaster? Bosses thought they could improve upon 150 years of tradition, and shareholders - or at least fund managers and analysts - went along with this managerialist ideology. But maybe managers don’t know better.
Whatever it is, shouldn’t we be asking questions about ownership structures and the nature of management?

Bevan or Thatcher: who's relevant?

At the end of Greg Dyke’s programme on Nye Bevan, Michael Heseltine says Bevan is “irrelevant today.” I can only hope that remark was made some time ago, because from where I’m sat, it’s gibber. Bevan is a highly relevant figure.
I mean this in three senses.
 1. Bevan was, of course, firmly opposed to the “anarchy of laisser-faire society.” “The amoral climate of the  business world exposes the psyche of the individual to unreasoning compulsions” he wrote in In Place of Fear. Everyone who’s calling for tougher regulations of banks, to rein in their swings in mood from greed to panic is, in this sense, a little bit Bevanite.
2. Bevan wanted greater nationalization:

It is a requisite of social stability that one type of property ownership should dominate. In the society of the future it should be public property.

Few will go quite that far. But Henry Paulson has taken big steps in Bevan’s direction, by nationalizing Fannie and Freddie and AIG on punitive terms. Indeed, there’s bipartisan sympathy for Bevanism. Paul Krugman writes:

If the government is going to provide capital to financial firms, it should get what people who provide capital are entitled to — a share in ownership.

Bevan would surely approve.
3. Throughout his life, Bevan thought that public spending was necessary to ensure full employment. Neither he nor his contemporaries thought monetary policy was much of a stabilizing device; under the 1945-51 Government, Bank Rate did not change at all (pdf).
Recent conditions have made this view more plausible. The three cuts in Bank Rate we’ve had in the last 12 months have not led to any change in three month Libor, which is still 6 per cent - which suggests monetary policy has been pushing on a piece of string. Meanwhile, low gilt yields mean that higher government borrowing  is feasible.  If you think macroeconomic stabilization policy is desireable, perhaps there’s something to be said for the “old Labour” use of fiscal rather than monetary policy.
So, in at least three respects - scepticism about competitive markets, support for public ownership, and a preference for fiscal policy over monetary policy - Bevan is, rightly or wrongly, relevant today.
Maybe it is instead Thatcher who’s irrelevant.

Effects of east European migration

The decision to open the UK labour market to immigrants from the former Soviet bloc  was “a stroke of genius.”  So says the MPC’s David Blanchflower in this new paper.
He shows that migrants from the A10 countries are much more likely to be in work than native Brits, and less likely to claim benefits; only 4000 of the 850,000 claimed Jobseeker’s Allowance, though 100,000 got child benefit.
Also, there’s “no credible statistical evidence that the arrivals from the A10 had any perceptible impact on unemployment.”
What they did do, though, is raise the fear of unemployment and so keep wage growth down. Which means they have improved the trade-off between growth and inflation.
What’s more, immigration might not slow down even as the UK economy weakens, says Blanchflower. The repulsion effect of weakening labour demand here is offset by the fact that the A10 economies are weakening too. What’s more, the fact that there are already big numbers of migrants here makes it easier for even more to come, as they have networks in place enabling them to find jobs and settle in.
All this is one reason - though not perhaps the main one - why Blanchflower has been alone on the MPC in calling for interest rate cuts. It’s because migration is a force for lower inflation.

Negative wages

What’s the lowest wage you can legally get in the UK?
This is a no-brainer. It’s the national minimum wage, which is £5.52 an hour. Isn’t it?
Would that it were. Tens of thousands of people face much lower wages than this. Some of them face negative wages - they pay for the right to work.
Let’s define wages as the income you get from working, relative to not working.
Then look at table 2.2c (p114) of the latest Tax Benefit Model tables, the DWP’s full description of our tax and benefit system, published today.
This shows that if a single person moves off the dole and into a 16-hour a week job at the minimum wage, he gains  just £8.42 a week. That’s a wage of barely 50p an hour.
And if a married couple are unemployed and one takes a part-time minimum wage job, they lose - yes, lose - £6.63 a week. They have negative wages.
The main winners from moving off the dole and into minimum wage jobs are single parents. They get over £2.50 an hour.
In his speech yesterday, Gordon Brown used the word “fairness” 22 times.

Paulson and the rhetoric of fear

Henry Paulson said yesterday:

The market turmoil we are experiencing today poses great risk to US taxpayers. When the financial system doesn't work as it should, Americans' personal savings, and the ability of consumers and businesses to finance spending, investment and job creation are threatened.

How true is this? There is some empirical evidence here - the last 12 months. And this seems to undermine the more alarmist senses of Paulson’s claim.
The Fed’s flow of funds data (table 1 of this pdf) show that  between Q2 2007 and Q3 2008, net borrowing by the non-financial sector fell by more than half - the biggest annual fall for 50 years. Borrowing by households fell from an annualized $950bn to $197.3bn. Borrowing by non-financial companies fell from $846.5bn to $390.3bn.
The financial system, then, hasn’t been working as it should.
And yet the economy hasn’t collapsed. Real GDP grew 2.2% - low enough to raise unemployment a little but not a catastrophe.
Of course, you could argue that there are lags between collapsing lending and the economy; it‘s quite likely GDP will shrink in Q3 or Q4. But - for what it’s worth - most forecasters, at least before the latest turmoil, were expecting an upswing during 2009.
Now, I’m not coming over all John McCain here. I’m just pointing out that there’s a distinction between a dramatic meltdown in the financial system on the one hand and much less dramatic events in the overall “real” economy on the other. The classical dichotomy has been especially sharp recently.
One reason for this is that the real economy has had other supports: the weakish dollar, looser fiscal policy, reasonable profitability, demand from the Brics and (which is not to be under-estimated) force of habit. All but one and a bit of these is still with us.
Which raises the question. Might Paulson be pulling a rhetorical trick here? It’s hard to sell his plan on the basis of efficiency, necessity or justice. So he’s appealing to fear instead.

In defence of the inflation target

Adam at the TUC thinks pure inflation targeting is a bad idea. We should, he says:

Rewrite the remit of the Monetary Policy Committee to allow it to balance growth and employment against inflation when setting interest rates rather than focussing on inflation alone. This could be a temporary measure based on the principle that the remit was never written with a stagflationary period in mind.

I’m not sure about this, for four reasons.
1. The MPC can already do this. For one thing, when it foresees weaker growth (as now) it holds interest rates down, simply because slow growth leads to lower inflation. Also, the MPC does accommodate stagflation, in the sense that it tolerates rises in inflation in response to temporary shocks such as higher oil prices. As the Bank says:

A target of 2% does not mean that inflation will be held at this rate constantly. That would be neither possible nor desirable… Instead, the MPC’s aim is to set interest rates so that inflation can be brought back to target within a reasonable time period without creating undue instability in the economy.

2. If financial markets thought the inflation target would be relaxed in bad times, they’d require a higher inflation risk premium in gilt yields. And this would be unwelcome in two senses. It’d make it more expensive for the government to borrow in hard times, thus increasing the costs of fiscal stabilization. And it’d raise the cost of capital, thus - at the margin - depressing investment and growth.
You might object that the US copes well enough with the Fed having the dual objectives of promoting employment and keeping inflation down. But it has the luxury of being able to attract very cheap finance. It’s a little tougher for the UK.  
3. Stabilizing GDP is not enough, even if it can be done. Even in stable economic times, tens of thousands of people lose their jobs each week. Macroeconomic stability, then, does not achieve what really matters, which is security for individual workers. This requires better pooling of risks, either by the state or markets.
4. Every single worthwhile socialist objective - greater equality, the extinction of the boss class - can be achieved at low inflation. So there’s no gain from tolerating higher inflation.
Update: Frederic Mishkin agrees with me.

The crisis, and Nudge

Does the financial crisis undermine David Cameron’s big idea?
The idea I have in mind is Nudge. This presumes that people are irrational - chapter one of Nudge is “biases and blunders” - and so their behaviour can be influenced by the right design of choice architecture.
In other words, rulers and experts know more than ordinary people.
But this is precisely the presumption which the crisis rejects. Whether you think the crisis is the result of bad or excessive regulation, incompetent and hubristic bosses, poor risk management, over-optimistic traders, or ignorance of the complexities of mortgage derivatives, the fact is the same - so-called experts are fallible. Years of experience, multi-million dollar salaries and high-flown PhDs were no guarantee at all of good judgment.
Indeed, experts might be worse than ordinary people. Take one example from Thaler and Sunstein - the question of whether people save enough for their retirement.
As they say, this is a “complex and controversial question.” Although some think people are indeed saving too little (pdf), other research suggests they’re saving enough (pdf); the retirement consumption “puzzle” is small or non-existent.
So, when it comes to financial decision-making, ordinary people might be better than experts - in the sense that matters, of making sensible provision against the future.
Which poses the question for Cameron: if ordinary people are at least as smart as “experts”, why should the latter presume to influence the former’s behaviour?

Yes - it's an ownership crisis

For what it’s worth - which is pitifully little - Alistair Darling agrees with me, that the financial crisis is a crisis of ownership, a failure of shareholders to control their companies. He says (about 3’30” in):

[The FSA must] make sure you don’t inadvertently - or even by foolishness - have a system than encourages people through a bonus system to be taking risks that subsequently can prove disastrous for the institution….

But of course, there has always been a group that has a strong interest in avoiding this - shareholders. They don’t want people taking money - their own money - out of a company whilst taking risks that jeopardize its survival.
It’s only because shareholders were unable to exercise this preference that there can possibly be a role for the FSA. What Darling is saying, therefore, is that our existing ownership structures failed.
(Though the FSA will probably fail too - but that’s another story.)
Whilst I’m on the subject, some people have objected to my theory by pointing out that Long-Term Capital Management managed to go bust without any outside shareholders. This is not refutation of my thesis at all:
1. The cause of LTCM’s trouble was a conjunction of rare, unforeseeable events. First Russia defaulted upon its debt. Then spreads between off-the-run and on-the-run Treasuries widened, and liquidity dried up. The upshot was that LTCM lost money on two bets it thought was uncorrelated, and was unable to get refinancing.
Of course, we know now that rare events happen, that low correlations subsequently rise, and that liquidity risk is important. But we know all this precisely because we‘ve learned from LTCM‘s experience. It was less appreciated at the time.
There’s a massive contrast with our present troubles, which are the result of a wholly foreseeable event - a fall in house prices.
2. The LTCM collapse was quite easily solved by a massive injection of central bank cash, and was one-off and short-lived; within a few weeks, stock markets were back to pre-collapse levels. By contrast, this crisis has lasted over a year, involved many more institutions, and has required much more policy intervention.
 3. I never said that owner-controlled businesses are 100% safe. They cannot be. As I said, men have countless ways of losing money. My point is merely that a separation of ownership and control reduces one constrain upon folly and hubris. Nor am I saying it is the only cause of our troubles - merely one of them. I stress it because it has been overlooked.