Slam the brakes on bailouts

February 17, 2013

Following the bailout of several banks, the government is now considering measures to ‘save’ the British car industry.
Such a bailout would be wrong in itself but would also set a very dangerous precedent. The political pressure to support other struggling industrial sectors will be immense. And given the impossibility of bailing them all out, how should the government decide which firms should survive and which should fail?

Politicians are notoriously bad at picking winners and there is a high risk that rent-seeking behaviour will play a bigger part in the decision-making process than economic considerations. But, even if that were not the case, government simply does not have the ability to decide which businesses have been unlucky but are sound long-term prospects and are therefore deserving of support.

Worse still, the increased government borrowing and higher taxes needed to finance further bailouts will remove capital from healthy businesses and some of those will fail as a result. Overall, a greater share of economic resources will be allocated to ‘lame ducks’ rather than vibrant, high-growth sectors.

Corporate failure is an essential part of the creative renewal that drives market economies forward. Moreover, firms that behaved recklessly must face the full consequences of their actions if moral hazard is to be avoided.

State rescues hamper this self-correcting adjustment process. They risk prolonging the downturn and creating perverse incentives that will make future crises more likely. Of course this all goes back to Bastiat’s distinction between the “seen” and the “unseen” – there is a action to save the noisy businesses who campaign for support but less obvious are the thousands of businesses that struggle as a result.

16 December 2008, IEA Blog

Filed under political economy Tagged with , , ,

The Pre-Budget Report: will Atlas shrug?

February 17, 2013

One of the most noteworthy elements of the 2008 Pre-Budget Report was the planned increase in income tax rates to 45% for those earning over £150,000. This measure is intended to help address the budget deficit once the economy starts to recover.

The tax increase is, however, likely to reduce the work incentives for the entrepreneurs that drive growth. Many of the brightest and best may choose to leave the UK for countries where tax rates are lower and their efforts are more generously rewarded. Britain will also be less attractive to highly-skilled immigrants.

Higher income taxes will also encourage wasteful tax avoidance strategies. Moreover, some high earners may eschew promotion and longer hours to avoid paying the top rate.

While the UK is unlikely to experience the kind of scenario described in Atlas Shrugged – where entrepreneurs decide to exit a society en masse – it is clear that the government’s tax plans will significantly hamper the production of wealth. Since it deters creativity, effort and investment, and therefore lowers economic growth, higher income tax is also likely to reduce long-term tax revenues – the opposite of its intended effect.

25 November 2008, IEA Blog

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Can we afford affordable housing?

February 17, 2013

Yesterday it was announced that the Greater London Authority (GLA) is to create 50,000 ‘affordable’ homes. But do such schemes actually increase the affordability of housing?

When developers are forced to allocate a share of their dwellings (or land) to social housing or part-ownership it reduces their returns, since these properties will not be sold at full market value. Since the financial incentives to build are reduced, fewer homes are likely to be constructed. This reduction in supply will make housing in general less affordable – and it should be remembered that most people, even those on quite low incomes, have to find accommodation in the normal market.

The effect is exacerbated because full-price buyers will pay less when they know their neighbours are likely to include housing association clients, who may be more likely to engage in anti-social behaviour because of the inability of so-called social landlords to have appropriate clauses in their letting contracts to ensure that tenants meet acceptable standards of behaviour.

And because ‘affordable’ homes are subsidised by government, it means taxpayers have less disposable income available to spend on housing.

There is also significant moral hazard, particularly when social housing is prioritised, as in the GLA plans. If social tenants are allocated brand new, high-specification dwellings – often in expensive, desirable areas – it increases the incentives for people to choose a life of welfare dependency rather than working hard to improve their living conditions.
The policy is also unfair to existing residents who live near Boris Johnson’s social housing projects. They will see their properties devalued and their neighbourhoods degenerate as social tenants are moved into their area. Under the current planning system they will receive no compensation.

Given that land supply is currently relatively fixed, the proposed schemes simply make housing more affordable for one group at the expense of another group and of general welfare. If there is subsidy to the housing sector as a whole then it simply encourages the sorts of bubbles that have got us where we are today.

If the GLA really wants to solve London’s housing shortage it must focus on increasing the supply of land to private developers. This means abolishing the green belt – much of which is not very green – selling off under-used parks and playing fields, and reforming planning rules that wastefully allocate valuable land to industry and warehousing. Tinkering with ‘affordable’ housing will only make the problem worse.

21 November 2008, IEA Blog

Filed under welfare Tagged with ,

The case for lifting prohibitions

February 17, 2013

The last century has seen a steady expansion of the ‘nanny state’, a process that has arguably accelerated in the last decade. A ‘banning culture’ has developed, with numerous restrictions placed on what individuals are permitted to do with their own bodies on private property.

The economic and social costs of such policies are enormous: the prohibition of recreational drugs is responsible for a high proportion of crime; the ban on trade in body parts indirectly kills tens of thousands every year and raises healthcare costs; restrictions on prostitution put women in unnecessary danger, pushing the trade onto the streets and blighting many residential areas.

Taxpayers spend vast sums enforcing bans and dealing with their effects. A Home Office report estimates the overall cost of crime in England and Wales – much of it drug related – at £60 billion per year.

Lifting prohibitions is not an issue of morality but of prudence. It is simply imprudent to ban everything we might regard as immoral. Ending current restrictions would bring banned activities into the formal sector, with reputable businesses paying taxes and investing in the quality and safety of their products and services. Drug dealers would no longer have the same incentives to supply more addictive forms; the poor who sell their body parts would have legal redress if they were exploited; and lifting the ban on handguns would undermine the profitable black markets run by criminals.

11 November 2008, IEA Blog

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Welfare reform needed to prevent long-term dependency

February 17, 2013

According to official figures, almost two million people are now unemployed in the UK. That number is rising rapidly as the economy shrinks.

This means extra expenditure on welfare benefits, putting further financial pressure on a government already deeply in debt.

More worrying still, hundreds of thousands of families will now be at risk of falling into long-term welfare dependency, with negative implications in terms of crime, family breakdown and ill-health.

Many of those made redundant, particularly the low-paid, will face strong disincentives to re-entering employment once they start receiving benefits. For every pound they earn above a certain level, they may lose 65p in housing benefit and 20p in council tax benefit. They must also pay significant income tax and national insurance – even at minimum wage rates.

There is therefore a real danger that the economic slowdown will lead to a structural rise in the number of long-term benefit claimants. Before the slump there were already around five million working-age individuals on various out-of-work benefits.

The depths of recession may seem like the worst possible time to reform radically Britain’s welfare system. Yet it is in periods of mass redundancy that change is most desperately needed to avoid growth in dependency. It is therefore essential that the government adjusts tax and benefit rates to improve the financial incentives for unemployed people to return to work. 

All the talk is about demand management. We must remember that how long unemployment continues rising for will depend, largely, on whether there is supply-side reform. Deregulation, lower and simpler taxes, benefit reform and a reconsideration of the level of the minimum wage must all be on the opposition and government’s agenda.

3 November 2008, IEA Blog

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A Keynesian spending spree won’t lead the economy out of recession

February 17, 2013

Alistair Darling’s proposed spending spree on bringing forward major capital projects suggests the government is prepared to sacrifice the economy’s long-term interests for short-term political gain.

Anthony Hilton rightly points out the sums involved are too small to save us from recession. Yet they are significant in terms of the budget deficit. As the public accounts slide even further into the red, private investment will be crowded out and before long taxes will have to rise to pay for the Chancellor’s largesse. These effects will delay the private sector’s recovery and threaten to make the current slowdown more like the prolonged Japanese slump of the Nineties than the short, sharp adjustment experienced by the UK in 1981.

Only private enterprise can lead the economy out of recession. Rather than increase government spending, the Chancellor should focus on making life easier for British business.

There needs to be a huge bonfire of red tape to lower costs. Burdensome new environmental and employment laws should be abandoned and the minimum wage scrapped to address rising unemployment. Given the perilous state of the public finances, radical deregulation is now the only practical option.

23 October 2008, London Evening Standard

Filed under regulation Tagged with ,

The government should ditch Crossrail to help balance the books

February 17, 2013

The British government unwisely entered the current slowdown with a sizeable budget deficit. Recent bank bailouts are likely to push the national accounts further into the red and increased borrowing may put upward pressure on interest rates. Yet the obvious solution, increasing taxes, would harm businesses and hinder economic recovery. Cutting public spending should therefore be the preferred policy option when the Treasury takes action to balance the books.

Crossrail, a project to improve links between East and West London, should be one of the first casualities of tighter fiscal conditions. The cost has been estimated at £16 billion. But given the disastrous history of big government projects it’s possible this could rise to £20 billion or even £30 billion – mostly paid for by taxpayers.

Despite the huge sums involved, and even if its very ambitious service targets are met, the scheme will deliver only a relatively small enhancement to the capital’s transport capacity. The time savings are limited in most instances and the project will drain resources from more cost effective incremental measures, such as speeding up existing tube lines by closing under-used stations.

The most efficient way of tackling congestion on London’s public transport network is to use the price mechanism. Peak-time fares, including season tickets, should be raised where overcrowding is a problem. This would encourage economic activity to disperse to quieter times and less congested locations, making better use of the existing network. Passengers rather than general taxpayers should also pay maintenance and improvement costs.
 
Having dispensed with Crossrail, the government might also consider whether the 2012 Olympic Games should be run on a wholly commercial basis.

9 October 2008, IEA Blog

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The hidden cost of environmental scares

February 17, 2013

Environmental scares have a long history. At the end of the 18th century, Thomas Malthus predicted that rapid population growth would lead to war, pestilence and famine. Almost 200 years later, the 1972 Club of Rome report, The Limits to Growth, pointed to similar consequences due to rising populations, pollution and the exploitation of finite natural resources.

But the disasters failed to materialise. In flexible market economies the price mechanism incentivised consumers to use scarce resources more efficiently. Entrepreneurs found lower-cost substitutes and developed new technologies to improve productivity, for example through the new crop varieties that facilitated the green revolution. Nevertheless, the ideological climate created by The Limits to Growth contributed to the implementation of some unpleasant sterilisation programmes in developing countries in an attempt to reduce birth rates.

These consequences were relatively minor compared with the effects of Rachel Carson’s 1962 book Silent Spring. The resulting assault on pesticides lead to the banning of DDT in the USA and the steering of foreign aid to prevent its use in tropical countries. As revealed in Malaria and the DDT Story, this green crusade contributed to the death of up to 100 million people, as efforts to eradicate the disease were hampered by controls on spraying.

The world is now gripped by another environmental issue: climate change. The latest IEA monograph, Climate Change Policy: Challenging the Activists, describes how the policy agenda has been captured by quasi-religious ‘global salvationists’. Even more than in previous green campaigns, dissent has been ruthlessly suppressed. Organisations like the Intergovernmental Panel on Climate Change (IPCC) are dominated by ‘true believers’ and the political process is noticeably biased towards socialist-style initiatives based around central planning and detailed regulation.

In the worst case scenario, global warming will provide a rationale for state officials to increase dramatically their control over households and businesses, in terms of their freedom of movement, housing choices and energy consumption. Entrepreneurship and innovation will suffer and economic growth rates will fall. Intrusive bureaucracy will thrive. This will cause discomfort in the West, but it will be disastrous for developing countries. Even a small cut in their growth rates will condemn millions more to poverty and disease.

As the authors of the book explain, climate change can be addressed by relatively low cost policies that reduce emissions without significantly reducing the dynamism and flexibility of market economies. The ability of individuals, businesses, communities to innovate and adapt can be retained. Accordingly, calls for central planning and heavy regulation should be strongly resisted.

30 September 2008, IEA Blog

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The economics of windfall taxes

February 17, 2013

The imposition of a windfall tax on energy companies is supported by a majority of the public and many politicians. Revenues would be used to support low-income households struggling to pay gas and electricity bills following a series of steep price rises.

Yet consideration of the economic impacts of such a measure should lead to its outright rejection. Firstly, the arbitrary imposition of an extra payment would increase the risks to businesses of investing: as a result, they will demand higher returns on their investments or choose not to invest at all. Secondly, the tax would reduce the dividends paid out to energy company shareholders. These companies are not owned by “fat cats” but by us all through pension funds and insurance companies. Finally, it would reduce the funds available for investment in new sources of supply, thereby increasing energy costs in the long term.

Given the above effects, a windfall tax could harm many of the people it was designed to help and actually reduce long-term tax revenues. More generally, harsh though it may seem, it is a very slippery slope trying to protect parts of the population from particular price increases – especially in the energy sector. That is the way to stop people adjusting to a new environment of greater scarcity and is precisely the best way to induce shortages of supply in the future.

9 September 2008, IEA Blog

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Despite all the pain, we must not bail out the struggling banks

February 17, 2013

The news that HBOS is likely to merge with Lloyds TSB is further evidence that the credit crunch will completely transform the UK banking sector. Effectively, this will be a takeover of HBOS by Lloyds TSB. The former bank has seen its share price dive in recent days, raising fears about its future.

Given the recent collapse of Lehman Brothers, creditors are understandably cautious about lending to other vulnerable institutions.

Assuming the merger goes ahead, it could be bad news for the employees of both banks, including those at the HBOS offices in Yorkshire. Significant job losses are inevitable as the new bank seeks productivity gains by purging the organisations of waste and duplication. Undoubtedly, a high proportion of branches will close.

Unfortunately, this comes at a time when unemployment has begun to rise sharply. It will not be easy for former bank employees in Yorkshire to find relatively well paid jobs that reflect their skills and abilities, particularly at a time when other financial institutions are shedding workers.

In the short term, the outlook is grim.

Yet such rationalisations will be necessary to help the banks rebuild their capital and restore profit levels. And the economy as a whole will gain from such consolidation in the long term as the efficiency of the banking sector increases. Such “creative destruction” is often painful for the individuals concerned, but it is essential for continued economic growth and higher living standards.

Another issue is the effect on customers. In 2001, the competition authorities prevented Lloyds TSB from taking over Abbey National. The merged entity would have accounted for a quarter of the retail banking market. HBOS and Lloyds TSB combined are likely to make up a similar share, and will control 28 per cent of mortgages. However, the Government is determined to avoid another Northern Rock style bailout, and under the circumstances competition concerns will be waived.

This is the right decision. The UK has a large number of banks, including several former building societies, that offer a wide range of services to customers. The sector is also open to competition from overseas banks, as demonstrated when Spanish group Banco Santander entered the market through the acquisition of Abbey National. Accordingly, there is little prospect that the merged bank will significantly affect the choices available to consumers. And, of course, the alternative option would be far worse.

In the event that HBOS faced collapse, it would almost certainly be bailed out by the Government, following the precedent set by Northern Rock. The effects would be disastrous.

Millions of small shareholders, many of them workers, or savers who were allocated shares when the Halifax converted from a building society into a bank, would get next to nothing. Their confidence in the Stock Market would be shattered. Investment in other banks, even by large financial institutions such as pension funds, would probably be negatively affected. Starved of capital, it would take the banking sector longer to recover.

Taxpayers would be faced with liabilities that dwarfed those of the much smaller Northern Rock, perhaps running into hundreds of billions of pounds. The budget deficit, which already breaches the so-called “golden rule”, would be sent even further into the red.

At a time when the economy may be entering recession, this would severely limit the Treasury’s room for manoeuvre. In the absence of politically difficult cuts in public spending, it would put upward pressure on both taxes and interest rates.
There are also longer term implications from governments bailing out banks. Such actions may encourage riskier behaviour among bankers by reducing the downsides associated with failure.

At the same time, bank customers, reassured by both bailouts and deposit protection schemes, have reduced incentives to deposit their savings with conservative, risk averse institutions.

Given that the Government has effectively guaranteed their money will be safe, they will tend to patronise whichever bank pays the highest interest rates, even if it engages in the kind of risky lending practices that brought down Northern Rock.

Another danger is that expensive bailouts will provoke calls to increase the level of financial regulation. These should be resisted.

The banking sector is already very heavily regulated. In the United States, strict rules that forced banks to lend to risky borrowers in the sub-prime market helped cause the current problems. And regulations also incentivised bankers to create the complex financial instruments that are now proving so difficult to unravel.

Perhaps most importantly, more red tape will raise costs and reduce the flexibility of banks to deal with the current crisis. In the longer term, it will also stifle competition by making it more difficult for new entrants to begin trading in the banking sector.

The UK is fortunate to possess well developed financial markets. Providing the Government can avoid the temptation to over-regulate, these markets will continue to provide the best solutions for the current banking crisis, whether through rights issues, acquisitions, or mergers. Expensive government bailouts should be avoided at all costs.

19 September 2008, Yorkshire Post

Filed under finance

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