We Are Presented With A Unique Opportunity


Emile Woolf, Going Postal
Boris Johnson, Secretario para Relaciones Exteriores del Reino Unido, G20 Argentina CC BY 2.0

There is a tide in the affairs of men.
Which, taken at the flood, leads on to fortune;
Omitted, all the voyage of their life
Is bound in shallows and in miseries.
On such a full sea are we now afloat,
And we must take the current when it serves,
Or lose our ventures.

Wherever you look right now, the predominant economic and political outlook is bleak, even to optimists. To realists, it borders on apocalyptic. But there is a saving grace: it offers a new beginning. The present opportunity lies in recognising that the current economic situation is beyond conventional remedy. But don’t worry: we are in the process of establishing new leadership, with unformed and uncrystallized policies, and the very lack of track record is actually a blessing because it avoids the disappointment that always follows expectation. Something fresh can emerge.

A few essays ago I noted that governments’ tenacity in applying well-worn sticking plasters is now entirely misplaced. Persevering with an outdated panacea will make matters worse when what is needed is a powerful purgative – nothing less than a clear-out of Augean Stables stuffed with failed economic dogma. What is required is a paradigm-shift in economic thought, guided by bold and determined, almost visionary, leadership – supported by a patient electorate. But the fractured system that has now, literally, been tested to destruction must first be consigned to overdue oblivion and Western democracies must view economic issues through a fresh prism.

Not just an action-replay

And its reach is global. I can think of scarcely one country that will stand unaffected by the economic convulsion that now looms – and it will, at very least, present governments with an opportunity to rediscover their role in society.

Nor is the impending economic shakedown merely a replay of the crisis that struck the financial world in 2008-2009. Ever since then uncomprehending central banks, blind to their own role in creating that crisis, have been applying policies of unbridled credit expansion in the belief that throwing more money at a mountain of debt will save the banking system from the consequences of its own follies. This debt, both national and corporate, has reached a level at which major defaults are virtually guaranteed – despite interest rates having been squashed into negative territory.

Debt and protectionism – a lethal cocktail

That, of course, sounds much like just another banking meltdown, comparable to that which occurred in 2008-2009. But, as Alasdair Macleod, Head of Research at Goldmoney, has recently observed, the credit cycle induced by this epidemic of money-printing is now reaching its peak at the very time that Presidents Trump and Xi are testing each other’s bravado by engaging in rampant and, ultimately, mutually destructive protectionism.

This conjunction of a massive build-up of irredeemable debt and the menacing spread of ultra-protectionist practices will break new territory in the field of economic terrorism. Use of the protectionist weapon for political bullying is evident close to home in the conduct of the EU, which threatens to impose tariffs on Britain for having the temerity to re-establish its own independence and accountability.

A managed economy will follow

When central banks are eventually compelled to face the fact that their loose-money device of unlimited bond-buying has run into the sand, the risk remains that a desperate government will step into the policy vacuum and, by default, fall back on age-old routines for managing the economy: wage controls; price controls; income controls; dividend controls; capital controls; sky-high tax levels – in short, state nationalisation of the means of production. We see that the inadvertent trajectory of central banks’ policy is effectively a starring role as Marx’s useful idiots.

This hell-bound progression can be reversed only by allowing real interest rates to rise to the point where they accord with consumers’ underlying time preference – as determined by financial markets freed from central bank meddling.

What is the role of government?

If the above represents an approximation of how governments repeat the same policy errors, it also highlights how they should not act. In identifying some the key principles our new leaders must hold to, and from which they deviate at their, and our, peril, I draw inspiration from Alasdair’s own encapsulation of how our new leadership can turn the economy round.

As Einstein noted, the difference between genius and stupidity is that genius has its limits. Take taxation. The governmental approach to taxation in the UK has departed from anything resembling principle and is entirely unfit for purpose. Taxation has become a tool of social engineering – for which there is always endless scope – virtually guaranteeing state bankruptcy. When excesses of waste and profligacy have ravaged its finances, both central and local, government’s knee-jerk reaction is simply to dream up new things to tax, rather than examine how it got into that mess in the first place, and learn how to cut its coat according to its cloth.

For instance, no matter how desperately short of tax-revenue it may be, it is not the function of government to tax fatty foodstuffs. If people exercise their choices in the direction of unhealthy indulgences, despite the nigh insane degree of ingredient-labelling regulation, and veer toward obesity and its concomitant heart disease, why should they, at the expense of fellow taxpayers, be shielded from the cost of those dire consequences?

Yes, yes, I know: if they finish up in hospital or worse, it will cost us all even more, initiating a fresh round of fiat money creation to bail out the health service. This insane logic takes us down the road to guaranteed state bankruptcy that no amount of money-printing can reverse. The end of this road is state domination in every sphere. Corbyn and his ilk relish that prospect, of course, but consider for one sane moment what its consequences have been wherever, and whenever, it has been tried.

Ill-starred vote-catching – protecting the High Street

Nor is it the state’s role to interfere with the march of robotics and other forms of artificial intelligence by overtaxing on-line shopping in order to protect the High Street. Small businesses can fend for themselves quite ably if they do not have to contend with arbitrary and discriminatory business taxes.

Rather than allow consumer needs to manifest and express themselves on every High Street, the burdens of business rates, VAT and employment taxes penalise small businesses so that their viability is under constant threat. Marginal businesses flicker between survival and failure at the whim of rent and business rate reviews when they should be given every rational encouragement to gain an economic foothold.

Government must desist from the lure of grubby vote-catching schemes as if it were their money that they are throwing around. How smugly George Osborne crowed when he announced his hare-brained Help-to-Buy scheme to assist poorer families struggling to get onto the property ladder. It has had modest success, but its main achievement has been to fuel an unprecedented boom for the top house-building businesses – particularly their bosses. Companies like Barratt, Bovis and Persimmon are declaring record profits – achieved by courtesy of state beneficence, not by building houses. All utterly predictable – but to know that you would need a smattering of economic nous!

Spending our money

Government should exercise great caution when making spending decisions with our money. The exercise of lashing out on infrastructure – whether it’s to construct highways, runways, bridges, dams, rail links or power stations –  is virtually doomed in terms of achieving a commensurate return. This is as close you’ll get to a formulation of economic law: “government expenditure is not susceptible to economic analysis”. The reason? Because it’s not their money, and there are no objective commercial criteria for assessing success or failure.

At root, central government’s approach to taxation should be principled and balanced, based on the ethic that (i) low taxes will keep state expenditure in check, and allow markets to deploy the economy’s resources effectively without state direction; and (ii) the resulting economic stimulus will expand the tax base, allowing for even lower rates in due course. In pursuit of this ethic, tax cuts must be financed by reducing state spending rather than increasing the deficit (which is precisely what the latest spending review will do).

Escaping the welfare trap

Taxes applied to welfare must be closely monitored and judiciously vetted by reference to genuine need. Its dispensation should never engender a wide sense of entitlement, nor hazard an increase in the level of dependency upon state resources.

Western democracies, almost without exception, are now firmly in the grip of a culture of dependency in which people generally, healthcare-institutions and public authorities have developed an irrational expectation of state support that bears no relation to the discipline of affordability.

What better way is there to relieve the state of the impossible burden of such widespread dependency, than to leave people with enough of their earnings to become more self-reliant? But this becomes possible only with tax policies that allow people to grow their savings by keeping more of what is truly theirs anyway. For example, if ever there was a tax ripe for abolition it is inheritance tax, a divisive intergenerational pestilence that penalises families for passing on savings accumulated over decades, after they have already been taxed.

By the same token, capital gains tax, which entered the statute book as recently as 1965, should go. The “gains” on which CGT is levied are notional anyway, not being based on earnings or real values. Effectively, it is a tax on the inflation that governments themselves generate through their mania for money-spinning profligacy. Annual tax “reliefs” apply, of course, but that doesn’t alter the irrational nature of taxing something conceptually ephemeral and remote from any legitimate tax target. The same goes for all counter-productive taxes whose effect is to destroy the savings that alone can lift the community to true independence.

How to fund state expenditure

Wiping out the panoply of destructive taxes begs the question of how the necessary expenses of state are to be funded, a question I addressed fully in Economic Perspectives 57. In essence, the classical principles established by Mill, Smith and Ricardo are as valid today as when they were formulated. They take the line that the capacity of businesses to bear taxation arises from the “economic rent” that those businesses enjoy by virtue of their proximity to the community that provides their customer base; access to communications on which they depend for survival; and the ready availability of a full range of essential services.

That “rent” or economic surplus, or “added value” in modern terms, is the fairest and most rational base on which to levy taxation, and because it is a huge number, a low rate will suffice. A shift in this direction would (i) remove the burden of taxes on employment such as PAYE and NI; (ii) release the vast army of tax inspectors, lawyers, accountants and the whole tax-avoidance jamboree from the grind of this unproductive chore, providing them with a new experience: work that creates value; and (iii) bring home to government, and citizens, that the natural size and scope of the state is more limited than today’s bloated behemoth would suggest.

Free trade

Facilitating free trade is equally critical for achieving an economic renaissance. Columnists persist in promulgating the notion that trade imbalances between countries arise from currency differentials. It is therefore essential to recognise that trade imbalances between countries, which are normal and unavoidable, arise from the law of comparative advantage, the very same law that explains the division of labour in the workplace.

None of us is self-sufficient in respect of economic needs and abilities. Quoting Alasdair Macleod again: “If people are allowed to buy what they want from providers of goods and services irrespective of location, capital resources will quite naturally flow towards their most efficient use”.

This brilliant encapsulation is echoed by  Liz Truss, Secretary of State for International Trade, who expressed it thus: “At its heart, the case for free trade is the case for freedom. It’s the ability for people to improve their lives by exchanging goods and services without undue interference from the authorities.”

© Emile Woolf September 2019 (website)

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