When Tax Is Like Theft & When It Is Not

A friend asked the following question:

"If you don't pay tax you end up in prison. Therefore is tax theft, or is it the price we pay for a civilised society? If it's the price we pay for a civilised society, then it's not one we ever had a say in. Therefore it's a kind of theft, but one we appear to allow to happen to us?"

The best way to answer questions like this, I find, is to reverse the method of questioning somewhat. In asking whether tax is theft, or synonymous with theft, we are actually looking at the properties of something definitely bad and asking whether the other thing shares some or all those properties.  

On top of that, when we consider what is wrong with something, and enquire as to whether the other thing is comparable in terms of wrongness, it is often useful to compare its fundamental principles to other things in society. I will do both those things in this blog post.

The second one first. If at school you deliberately break little Johnny's mum's window, your parents should compensate them. If you break someone's window as an adult, you should compensate them. This has an analogue with some of the negative externality taxes like pollution.

On the other hand, if the local gangster goes round small businesses and obtains money through a protection racket, or if poor Tom takes some of rich Jack's lunch money in the school playground, this doesn't seem so good, even though it is tenuously analogous to how the state treats its citizens.

Apart from in spirit, the local gangster forcing restaurant owners to fund his own lifestyle is not hugely different to how the state forces me through taxation to invest in services I seldom or never use and policies to which I am wholly opposed.

To that end, I'm afraid the properties of taxation do all too often share some of the fundamental properties of theft. If Jack steals Jill's laptop, then Jill is the victim to about the same extent that Jack is a beneficiary. But the wrongness of theft is the moral wrongness that harms society, plus all the other negative spillover effects that I'll come to in a moment.

The wrongness of taxation is that it forces consumers to spend our money on things like establishment pay, layers of bureaucracy, small business subsidies, bailouts and transportation projects that we otherwise would not. To that end, a lot of taxation is a little like theft in terms of the consequences to the consumer, but it more closely resembles a protection racket (but not wholly, as we'll see in a minute).

The other thing that tax and theft have in common is that they both impose value-robbing opportunity costs on society. When Jack designs a mousetrap, or provides a taxi service, or cooks pizzas, he adds value to society. When he steals Jill's laptop, he inflicts all the costs on society that crime imposes, but he also forgoes the opportunity to do something productive.

Taxation has similar opportunity costs. While taxation transfers funds from one place to another, and in a costly way, it doesn't produce very much. There is a small sense in which taxation sustains parts of society (defence, rule of law, and other public goods) that enables others to produce, but there are enormous opportunity costs to taxation that misallocate resources by being out of kilter with supply and demand, and as a consequence rob society of a lot of value.

Taxation and theft also rob society of value by diminishing the number of mutually beneficial transactions that occur, because they both increase the cost of trade, and therefore increase the prices that businesses have to charge. The opportunity costs of taxation and theft are the aggregation of all the forgone opportunities for trade - the mousetraps that don't get made, the taxi rides that never happen, and the pizzas that never get cooked.

Some people struggle with this notion, but it's easy to see its truth by imagining a more extreme example: a country ruled by a greedy dictator who taxes the life out his citizens and allows lawlessness to occur. The costs to the citizens are not just the taxes and the crime - the more acute costs are all the lost productivity and prospective innovations that never materialise because of the taxes and lawlessness.

In summary, then, taxation and theft share many of the same properties - but theft is a bit worse because theft always engenders net costs on society, whereas tax mostly does, but not in every instance.

Every instance where tax goes towards providing something that could, and should, be provided privately, taxation has similar properties to theft. Every instance where tax goes towards providing something, like a public good (defence, rule of law) that is more valuable to society than the cost of the tax gathered, taxation is a lot less like theft - it is more like a compulsory insurance policy that provides societal benefits that would otherwise be more difficult to obtain because of the free rider problem.

McDonnell's Fantasy Analogy

On The Andrew Marr Show this morning, Shadow Chancellor John McDonnell came out with a ludicrous analogy to try to explain the benefits of bringing services into public ownership. Think of it like buying a house, he said - you make the initial investment, get returns on renting it as an asset, and then further down the line it becomes a money-maker.

Fantasist John McDonnell has always been an intellectual lightweight, and today's analogy was no exception. Even if we're kind to him, and ignore all the obvious problems with the reasoning behind his analogy (which you can distil in previous blogs here, here, here and here), there's another obvious way that returning a service to public ownership is not like buying a house as an income-generating asset, which I'll explain.

McDonnell's analogy forgets the most important problem with bringing a service into state ownership: it creates all the downsides of monopoly power, and denies all the benefits and innovations of competition. Competition doesn't just keep suppliers in check in terms of price and quality, and consumers well served in terms of lower prices and increased efficiency, it is also the driver of new ideas and improvements on existent ideas.

A service run under a state monopoly has much less of an acute eye on commercial demand, and therefore pays suboptimal regard to price and quality too. In terms of investment, the opportunity costs of buying a house are the other forgone investments and their concomitant returns. Given that house buying is about the best asset-returning venture in the marketplace, the opportunity costs in terms of a return are all-but non-existent.

On the other hand, the opportunity costs associated with state monopolies in terms of forgone opportunities are about as overwhelming as it gets. And this in a week when there is indication that Labour's re-nationalisation project is going to cost an up front sum of around £176 billion (or £6500 for every household).

This is the dangerous fantasy economics of Corbyn and McDonnell: £176 billion for more expensive, less efficient, lower quality, innovation-stifling re-nationalised services. There is almost no analogue to buying a house here - not that we should expect anyone in the Shadow Cabinet to understand this.

Another Thing Corbyn Doesn't Get: Opinion Polls Are Deceptive About Our Preferences

Jeremy Corbyn's New Year speech was full of buoyancy about how he's a Prime Minister in waiting because the policies he endorses are popular with voters. The problem is, he misunderstands the most primary error in his evaluation: that opinion polls are deceptive about what people actually do want, as opposed to what they say they want.

Below is a recent poll showing the public appetite for the nationalisation of various services in the UK. As you'll see below, more people want energy, water, railways, post, health and education to be run by the state than not. The corollary is that although many people think Corbyn the man is a bit of a plonker, his policies are apparently more widely popular than they are unpopular. In this post I will show you why popular opinion ought to be meaningless in creating government policy.

Alas, the YouGov poll is fairly meaningless, because it doesn't tell us what people actually desire - it tells us only what people claim to desire when they don't feel the costs of those desires. I want a £4000 top of the range television if you are going to buy it for me; whereas if I'm buying my own television, I'll probably spend about a quarter of that.

Similarly, when a British citizen is asked if she wants more public money spent on health care, railways and the energy sector, and if she wants employers to be forced to lower their staffing levels so others can receive a minimum wage, she will quite happily say 'yes' if she doesn't have to bear any of those costs. She may have to bear a tiny proportion of the costs through increased taxation, but those costs are spread thinly enough that no one individual feels it very acutely.

Moreover, a poll asking you whether you support renationalisation of the railways is not very likely to have the result affected by your vote, so you are less likely to have spent much time analysing the pros and cons of a nationalised railway.

The only poll that genuinely covers your revealed preferences is the poll where you feel the full costs and benefits of your decisions - and that only happens when your decisions are market-based, with the full gamut of consumer surpluses and opportunity costs factored in. I would buy a £1000 television for the consumer surplus, and wouldn't buy a £4000 television because of the opportunity costs associated with that additional £3000 expenditure.

Polls, therefore, are fairly meaningless in telling us what politicians should do with our money, because the poll choices are divorced from the personal ramifications of those choices. To discover what British citizens really want you have to allow them to spend more of their money, and reveal their preferences in a market-based economic landscape. Unlike in state policy, the market will respond, as prices and quantity will adjust accordingly to supply and demand.

The Trojan Horse Of Public Goods: Beware Of Politicians Bearing Gifts

Government Minister Greg Clark, the Secretary for Business, Energy and Industrial Strategy, has unveiled a 255-page white paper explaining the party's industrial strategy for the nation. The government is promising to 'invest' in our country and increase productivity with taxpayers' money (although they never mention taxpayers' money, of course).

These are promises that should concern us - and the concern should be based on a well worn economic phenomenon that assesses whether the state should be involved in an industry at all, or whether it is doing more harm than good.

The assessment can be stated like this: if the provision of a good or service would have happened anyway by commercial demand, then it's better if private investors provide it (as I've explained before repeatedly). If the provision of a good or service would not have happened anyway by commercial demand, then it's costly to society for the state to take our money to provide it - even more so when you factor in all the crony capitalism, self-serving lobbyists and special interest groups distorting the market.

The upshot is, when all the costs and benefits are weighed up, there isn't very much that the state should be doing. Consequently, a strategy that's based on all the things the government wants to do for us is going to be one that engenders lots of inefficient use of money that we'd be much better off spending directly out of our own pockets.

One exception needs bearing in mind though - and that is the kind of product or service that is widely desirable but may not be provided by the market - or could be, but may be better provided by the state. These are what are referred to in economics as public goods.

Public goods and private goods
The state provides some public goods from which we all benefit equally, like national defence and rule of law, but it also provides private goods like health care, education and pensions which would be better run under a 'consumer pays' model. The distinction is that we more or less want the same thing when it comes to national defence, but not so when it comes to health care, education and pensions.

Because the private goods and services that the state provides are devoid of a 'consumer pays' model, there is no measurement of consumer demand for the goods and services nor commercial value in how they are costed.

Before we get into this further, let me deviate for one moment to tell you a shocking fact connected to state provision. Once you factor in all the stealth taxes on top of the more transparent taxes, the state takes on average around 60% of our earnings in taxation. To put that into perspective, that means you have to work until roughly August 7th each year until you begin to earn money that the state doesn't somehow confiscate.

A left wing friend of mine said she thought this was good news because it shows how much we as a society are willing to show we voluntarily care for one another in the form of redistribution. As much as I love my friend, this is a strange view to have because it is just about the opposite of the truth. Tax is taken from us precisely because we otherwise would not voluntarily donate to these things (a point I illustrated before by using the example of foreign aid, and here regarding the welfare state). To explain, let me tell you a bit more about the concept of public goods in economics.

A public good is something that is referred to in economics as non-excludable and non-rivalrous, in that agents cannot be effectively excluded from it, and whereby if one person consumes the good it does make that good unavailable for others. Obvious things that do not qualify as a public good are things like a car parking space and a bunch of grapes. If Jack parks in the only available car parking space, Jill cannot also park there. If Jack buys the last bunch of grapes, Jill cannot buy them. The nice view of London’s skyline from Primrose Hill, on the other hand, is a public good because Jack can enjoy it without excluding Jill’s ability to enjoy it too.

The problem with public goods is that they have what’s referred to in economics as a free rider problem. That is, if a good is a public good it is difficult to prevent others from enjoying that good without having to pay anything towards its cost. Suppose there is an alley between two terraced houses owned by Jack and Jill in an area with a recent spate of burglaries. Jack says to Jill ‘Let’s go halves on a £500 gate to make our alley more secure'.

If Jill wants the extra security but figures that Jack will pay for the gate even if she does not pay her half, then Jill free rides on the security, and Jack foots the bill. Jack may therefore decide to not buy the gate, leaving them both with a less secure alleyway. If the situation was favourable, the government could tax the whole street and put up the gates in all the alleyways on the street. Of course if the alleyway gates are worth their cost to all the residents, then everyone on the street is better off.

But then you have to add further consideration, because in a scenario where only some people paid for alleyway gates, the people that didn’t are made more vulnerable because their unguarded alleyways are now more attractive to burglars. The same is true of burglar alarms; if numbers 1, 3 and 5 in a cul-de-sac install a burglar alarm, numbers 2, 4 and 6 that don't have burglar alarms are more likely to get burgled.

The key analysis with tax and government industrial strategy is assessing whether a good or service is like the alleyway gates, and whether everyone involved is better off by paying a tax and sharing the benefits, or better off being left to their own devices in a free market.

One obvious example of a public good that everyone benefits from is national defence: so effectively the nation is treated as a single consumer paying for this through taxation. Another example of a similar service is the police force, as is the infrastructure that provides the framework for the rule of law. There are people, such as David Friedman in his seminal Machinery of Freedom, who maintain that even things like defence, police and rule of law don't need to be provided by governments, but can be sustained instead by non-coercive market and charity-based systems. But we'll give the state the benefit of the doubt for now in terms of providing a few of these public goods, even if it is easy to envisage a time when things may be different.

When taxes are paid to provide things that the government can provide more efficiently than the market then we should support them. But that is the only condition under which a public service like defence or policing is preferable to a private service. As I reminded people in a recent blog post, public services cost about 30% more to provide the same equivalent service provided privately, therefore it is desirable that anything that can be provided by the market is done so, which doesn't leave the state that much it should be doing, because there are not many things it can provide better than the market.

Of Course Tax Provides Less Value Than Spending The Money Yourself

Ha-Joon Chang's latest pratfall is an attempt to expose the so-called myth that tax is a burden:

"The Conservatives are clear about this, proposing to cut corporation tax further to 17%, one of the lowest levels in the rich world. However, even Labour is using the language of “burden” about taxes. In proposing tax increases for the highest income earners and large corporations, Jeremy Corbyn spoke of his belief that “those with the broadest shoulders should bear the greatest burden. UK needs £15bn in cuts or tax rises to clear deficit by 2022, says IFS. But would you call the money that you pay for your takeaway curry or Netflix subscription a burden? You wouldn’t, because you recognise that you are getting your curry and TV shows in return. Likewise, you shouldn’t call your taxes a burden because in return you get an array of public services, from education, health and old-age care, through to flood defence and roads to the police and military."

Dear oh dear, you really would expect someone who teaches economics at Cambridge University to have a better grasp on why this argument is wrong. But alas, Ha-Joon Chang appears oblivious to the key difference between services received through taxation and services received through private subscription.

Here's the principal difference Chang is missing. Market transactions like curries and Netflix subscriptions are a benefit to the consumer because they get exactly the thing they want when they purchase it. Taxes are not like this - they amount to all kinds of funds being taken from one group and given to another, which ensures that people's spending is not aligned with their revealed preferences.

George's tax goes to pay to prop up the railway networks he never uses, because he prefers to drive (an activity for which he also gets taxed). His taxes go towards paying for many things that are not in alignment with his own preferences: he can work extra hours but end up forking out for increased leisure time of people that prefer to bum around watching daytime television; he can live a healthy and conscientious lifestyle and yet fund health care for people who abused their body far more than he did.

There are countess examples of this kind - taxes taken from pacifists go towards funding nuclear programs they do not support; taxes from sporty people go towards funding gastric bands for the unfit; taxes from ordinary citizens go towards wars to which they defiantly object; taxes from people uninterested in sport go into sporting projects; taxes taken to fund green energy subsidies are taken from people that do not support these ventures; taxes from people that live in urban high-rise apartments are taken to fund flood defences for people that live by rivers in rural communities, the list goes on.

I am not making any comment here about the intrinsic merits and demerits of the tax-funded initiatives, I am simply trying to show that Ha-Joon Chang is confused when he tries to suggest that taxes are about as un-burdensome as our market transactions because we 'get an array of public services in return'.

For the whole purpose of consumer surpluses and producer surpluses is that both buyers and sellers each try to obtain maximum mutual value from the transaction. That is, buyers try to pay as little as they can for something at a price that's furthest away from the most they would pay, and sellers do the same but the other way around.

It is this process that not only creates as much market value in society as possible, it is the process that has given us the greatest human enrichment the world has ever seen over the past couple of hundred years. Contrary to what Ha-Joon Chang thinks, taxes are very much not like this. Yes they do some good, but they also misallocate many resources that would otherwise be spent much more closely in line with what consumers actually want to spend them on.

What We Should Hate Most About Election Campaigns

If you're starting to feel fed up with the electioneering, it's probably because the party leaders are merely churning out litanies of insipid and meaningless phrases, with all the wit, erudition and charisma of a clapped out old moped sold to you for a fiver by a buck-toothed wheeler dealer called Terry.

For me, the worst thing about run-ups to general elections is that they provide a daily reminder of how politicians are trying to sell us things we shouldn’t want to be buying. Every day we hear lots about what politicians can do for us – create jobs, invest in the economy, make prices higher or lower – but the reality is, the best thing the government can do for us is to promise to do much less, and then stick to that promise.  So much so, that the government should only provide services that the market cannot provide (which, as I’ve argued in many previous blog posts, isn’t very much).

Let me explain why when the government provides things the market can provide we all lose out. This principle is what we might refer to as the deadweight losses of market interference, which basically means the costs politicians impose on us in what would otherwise be unimpeded economic transactions.

Suppose I am willing to pay no more than £12 per hour to have some work done, and the workmen at the lowest rates are willing to do the work for anything over £10 per hour. That being the case I should have success in finding someone to do the job.

But once the government imposes 20% income tax, things change, because now the most the workmen can earn from me is £9.60 per hour, which means they'd be unwilling to do the job for me. The minimum wage law, therefore, stops otherwise mutually beneficial transactions happening.

The same is true of VAT. If I can produce a bicycle for £100 and John is willing to pay no more than £250 for it, then a bicycle will be produced. However, once tax is introduced onto a good, things change, because the retailer takes responsibility for the tax, but passes it onto the consumer in the form of higher prices. If the cost of a bike is £100, and the selling price is £250, the retailer is only responsible for paying VAT on the extra £150, which means the price of the bike is now £280, and John no longer buys it.

The more the government interferes with taxes, the more sales they stop from happening by impeding the supply and demand equilibrium point between what will be mutually valuable to buyers and sellers. In short, government taxes cost the nation in terms of transactions that never take place and opportunities that never materialise. When politicians tell us how they will invest in our economy, what never gets acknowledged are all the intangible costs – the value that never gets created because of those deadweight losses.

It’s not easy to measure the deadweight costs of taxation, but I’ve done a bit of research on what expert economists think, and it is thought to be something like a rate of 30%. In other words, for every £1 raised in taxation you have to add on about 30% to the cost of doing something.

So a social care bill, a child’s education and medical expenses that cost, say, £200,000 over a 15 year period would have cost around £125,000 in the private sector. Not only does that mean the additional state-layered bureaucracy costs another £75,000 for the same level of services – it also means there was £75,000 worth of GDP not created in our economy as a result.

Given that the cost to the consumer in having money taken out of their wages and getting it back in the form of state-supplied services is approximately an additional third of the whole transaction value, we should not be too enamoured by politicians’ promises that they want to do more for us.

Finally, I'll leave you with this rather telling thought. In business, a lot of firms try to sell us extras we don't really need in the form of hidden fees - admin charges, extra consumables, additional packages and insurance add-ons, etc - which is a dead giveaway that these aren't things we'd often choose to buy if they were offered in a clear and transparent way. 

You might like to consider that taxes follow a pretty similar template in both their complexity and stealthiness, and that that probably tells you a lot of what you need to know about the kind of things politicians are trying to sell us, and the appetite we'd have for them if they were offered in a clear and transparent way.

A Popular Idea, But A Bad One

We all know really why Jeremy Corbyn is a Brexiter in a Remainer's clothing - it's because he wants our nation to undergo a prodigious re-nationalisation program, and he sees the Brussels Eurocrats as being an impediment to this (one of the few good things about the EU is they prohibit European nations from nationalising, subsidising and bailing out their own interests, as it is, rightly, seen as being inimical to competition from outside industries).

Apparently some of Corbyn's nationalisation plans (like the nationalisation of the railways) are proving hugely popular. Now, while I've written before about the imprudence of nationalised industry in the specific sense (see here and here), and while I have numerous blogs on the benefits of the private sector over the public sector (if you were ever inclined, all of them can be seen by clicking on this Private Sector vs. Public sector tab), I probably haven't written a blog post that swiftly points out why generally speaking nationalised firms are worse for us than non-nationalised ones.

A good place to start here is to remind you of Milton Friedman's famous dictum regarding the four ways to spend money:

“There are four ways in which you can spend money. You can spend your own money on yourself. When you do that, why then you really watch out what you’re doing, and you try to get the most for your money. Then you can spend your own money on somebody else. For example, I buy a birthday present for someone. Well, then I’m not so careful about the content of the present, but I’m very careful about the cost. Then, I can spend somebody else’s money on myself. And if I spend somebody else’s money on myself, then I’m sure going to have a good lunch! Finally, I can spend somebody else’s money on somebody else. And if I spend somebody else’s money on somebody else, I’m not concerned about how much it is, and I’m not concerned about what I get. And that’s government. And that’s close to 40% of our national income.”

Now, given that politicians have certain popularity-gathering incentives to spend taxpayers' money well, you'd think they might have constant mindfulness of appearing to the public to be prudent spenders. In a small sense this is true, yes - but what you have to remember is that due to asymmetry of information, short memories and copious amounts of spin, the relationship between a government's achievements/mistakes and the public's perception of them is pretty opaque and obfuscated - which is precisely what politicians and civil servants love.

If you’re spending someone else's’ money on someone else, as the government does with its various 'investment' schemes (which are rarely investments actually, they mostly mean 'costs') then the motives are likely to be less prudent than if you’re spending someone else's’ money on yourself. But both pale in comparison to if you spend your own money on yourself, which is what private businesses do, and because of which they have a better nose for efficiency, targets and outcomes.

The private sector is astronomically more competitive, because it has to forecast future demand and attract funds competitively. That's why public sector projects are far more notorious for cost overruns, being overstaffed, and for costly time delays.

That is why, apart from government spending that helps the needy and most vulnerable in society, low levels of state spending make society better off. Private investors are generally more prudent because it is their own money at risk, whereas the public sector corresponds to the fourth quarter of Friedman’s quadrant: they spend other people’s money on others far more recklessly.

And while we're at it, the national beef with big business is a strange one too. Quite often goods and services are produced more efficiently when they are produced large-scale. A firm might be able to make 50,000 burger meals in less than twice the time it takes a smaller firm to make 25,000. Trading small-scale often reduces the extent to which comparative advantage takes effect. Bob's metal firm can spend 3 days making 10,000 hooks, and Jim's carpentry firm can spend 3 days making 2,000 varnished boards, whereas one firm making both may take 8 days to produce that quantity.

A firm is said to be a more effective trader if it can produce a good or service at the same quality but at a lower cost than its competitors. And the benefits to society occur when as many firms as possible specialise in their field of comparative advantage and use it to trade. Therefore, it's usually the case that the country's biggest firms are the ones providing the most value for consumers, as well as being the biggest job creators.

To end, here's a thought experiment. Imagine if you pulled 30 people off the street in a random fashion, took them to an airfield, showed them all the parts of a Boeing 747 and asked them to work out how to build the plane from scratch. These non-experts would be clueless regarding how to assemble those proprietary parts - and the take home lesson would be: don't leave big and important jobs in the hands of amateurs, which is exactly how we should feel about our politicians and our economy.

 

Hostages Falling In Love With Their Abductors

Libertarians are always going on about making the state smaller and the economy larger. A regular reader (and personal friend) asked a while back whether this was a realistic desire, given that, in his view, the state and the economy are inevitably yoked together. What the question really points to is another question: are the state and the economy inextricably conjoined because they have to be, or is it merely the case that the majority think this has to be the case?

Economist Adolph Wagner certainly thought so – he came up with a law that went on to be known as "The Law of Increasing State Activity" - or Wagner's Law as it was also more popularly called. Wagner's Law states that as the economy develops over time, the activities and functions of the government increase. As progressive nations expand their economic growth, the proportion of money that goes into the public sector grows too, and this is largely due to the electorate's perceived need for increased state activity, increased administrative costs and an expanding welfare sector.

I have a hunch that Wagner's Law will continue to play out in the short term, but longer term the morbidly obese state will get swallowed up by its own gluttony and then begin to decay. And just like when a parent pulls a splinter out of their child's finger, I think the people will have to wise-up and help the state go through its initial pain in order to help with the necessary decline. The main reason for this is to help promote the understanding of what a rough deal we get from the state overall.

In the market of trade, I am going to give you money and you are going to plaster my walls - that is a mutually beneficial exchange of money for services, and it involves free choices. The relationship we have with the state is not of this kind - we are compelled to consent to the state's laws and regulations, or else we have to leave its geographical jurisdiction. Unlike the plastering job, it isn't a contract we signed because we agree to all its costs and benefits - it was one we had to sign to carry on living in the place of our birth. There is no analogous relationship in the free market. No plasterer or newsagent or car salesman ever assumes on your behalf that you want these things and that you will pay for them or else go to prison.

The principal retort to this line of thinking is that the state doesn't just take our hard earned money - it gives us services in return. True, it does - but I don't get much of a say about which services the state provides - for I can conceive of numerous services the state provides that the private sector could provide more cheaply, more efficiently and only to those who want them. I expect to pay for a plasterer if I need one, or give money to a car salesman when I need a new car. But I wouldn't choose to live in a system whereby I have money taken from me to pay for trains other people use or rent subsidies because the government has artificially inflated housing prices.

In this system I have to fund my own preferred mode of transport to work (not to mention all the other concomitant taxes associated with car ownership) plus subsidise other people's rail journeys. A market system would see costs of travel more closely linked to types of travel for the consumer - and ditto numerous other services that are currently funded for across the wider population.

What you have to remember is that while all these public services may be proximally funded by the state, they are distally funded for by the market transactions throughout society. Some services may be better off with some state involvement for the time being (though not necessarily indefinitely), but the idea that there are not plenty of services that could be more efficiently funded and performed by letting us keep more of our money and spending it on more freely made consumer choice-driven decisions is remiss.  

You only have to think that the historically unprecedented progression-explosion in well-being, living standards, reductions in poverty and economic growth had virtually everything to do with trade and competition and very little to do with state-spending programmes (a truth that's compounded by the fact that any successful state interjections during that time were themselves paid for by the fruits of trade and competition in the first place).

Not only does the state force us to obey all its strictures by threatening to incarcerate or deport us if we don't obey, it also runs on an engine of economic oppression whereby it protects its existence and fattens up its own stomach by the self-serving rules it creates to achieve this. The misdemeanours for which the state punishes its citizens most readily are the misdemeanours that subvert its own authority and compromise its own bounty.

Consequently, then, we shouldn't be surprised that Wagner's law continues to be hold its water - nor that our authorities have gradually been shaping its citizens and its media to embrace the narrative that it exists for our own good and that we need to do our bit to perpetuate its gluttony.

The plasterers, the newsagents and the car salesmen justify their existence for our own good only by the continued provision of goods and services that bring value to our society. Except for the important services it provides, particularly for the elderly and the vulnerable, the state does not. In fact, given that the market is the state's biggest rival in competition for efficiency and value, it is no surprise that it looks to create a narrative that undermines its rival. The state tries to engender a nationwide Stockholm Syndrome through fear, distortions and parent-like manipulations, until the majority of its population blithely accedes to the theory of its own legitimacy.

IEA Paper: How Governments Harm Trade

The following paper, published here with the Institute of Economic Affairs, and entitled How Governments Harm Trade (for the full version, see link at the bottom), is a paper in which I explain the principle behind why in most cases the free market works best when governments do not interfere in the prices society engenders by the laws of supply and demand. Those prices, I will argue, reflect human choices played out on a day to day basis, and are the soundest bottom-up basis on which economies are organised, not the top-down organisations that politicians impose on us.

I will show how value is created in every societal transaction for both agents by the combination of consumer surplus and producer surplus. As this paper will also show, the main regulations one ought to be opposed to are ones that artificially interfere with prices and the information-carrying signals they exhibit.

On the issue of when it is good or bad for the state to be involved in the free market, I use quite a simple and obvious formula. It is this: the state should only involve itself in our transactions when there is a net benefit to society from this involvement. That is, when the benefits of doing so outweigh the costs.

When stated like that, I would think it is hard to find a sane person who disagrees with that proposition. The odd thing about society, however, is that it is full of people who would find little trouble agreeing with the idea in its above propositional form, but who quite comfortably hold numerous beliefs that depart from the above logic. It is this societal anomaly that will be unpacked.

To read the full paper click here

NHS Shocks & Stocks

This week we saw confirmation in the media of something that those of us with market-friendly sexual charisma have been envisioning for ages - that the NHS has been hugely criticised for the bad health of its finances (including, for local readers, our own N + N hospital which has been placed in financial special measures).

By now everyone knows that the future of the NHS is very precarious - thanks to a number of factors (which I blogged about here). But what I didn't know until reading some stats by one of the Adam Smith Institute think tank members is just how much clinical negligence there is, and how shockingly costly it is proving to be. Apparently just in the 2011-2012 financial year alone, the total cost for the NHS in clinical negligence claims exceeded £1 billion, with a further £50+ million in non-medical compensation claims. However much does this add up to if we factored in every year, even for just the past decade? Several billion pounds I'd suggest.

There is clearly a whole scope of work to be done in terms of accountability - whether it is incentivising the public to be in charge of finances that match actions to consequences, or improving the internal spending structure (like the case of Hitchingbrooke hospital where significant savings were made by spending more wisely on things like stationery in a competitive market).

These Paroxysms Of Lust Over The Public Sector Are Truly Baffling

It constantly amazes me that there are still so many people in the UK who live under the long-refuted misapprehension that public services are better than the more competitive, efficiency-inducing private sector. Currently making the headlines at the minute is the news that if he got the chance Jeremy Corbyn will commit to bringing all rail franchises back into public ownership. I saw two articles out yesterday that give well-argued reasons why railway nationalisation is a bad idea – one from the Adam Smith Institute’s Eamonn Butler (see here), and one from the IEA’s Philip Booth (see here). I’ve also written a couple myself a while back, which you can see if you access my ‘Transport’ link on the side.

Despite many compelling arguments, one area that neither Mr Butler nor Mr Booth considered is the area of opportunity cost, which is what we consider when we factor in what isn’t done as well as what is. I'll explain. There's a well known comment by economist Milton Friedman who wanted to rebut the idea that if soldiers enlisted in the army for money rather than duty they would be mercenaries, because to join the forces for money casts an aspersion over their commitment and patriotism. Friedman refuted the idea that a paid volunteer in the army would be worse than a conscripted member by pointing out that compulsory conscription isn't impassioned patriotism either, as forced servitude also does not contain the volitional incentives for serving one's country with impassioned patriotism. Friedman said the following:

“In the course of his [General Westmoreland’s] testimony, he made the statement that he did not want to command an army of mercenaries. I [Milton Friedman] stopped him and said, ‘General, would you rather command an army of slaves?’ He drew himself up and said, ‘I don’t like to hear our patriotic draftees referred to as slaves.’ I replied, ‘I don’t like to hear our patriotic volunteers referred to as mercenaries.’ But I went on to say, ‘If they are mercenaries, then I, sir, am a mercenary professor, and you, sir, are a mercenary general; we are served by mercenary physicians, we use a mercenary lawyer, and we get our meat from a mercenary butcher.’ That was the last that we heard from the general about mercenaries.”

This kind of wisdom is the kind needed to show why proponents of government-run services overestimate the benefits and underestimate the costs. To show where they've gone wrong we need to see why the question of whether voluntarily paid soldiers or conscripted soldiers cost the nation more. Friedman showed that conscripted soldiers cost more by showing that costs are not the same as expenditure.

The expenditure of an army soldier is what he is paid in salary, whereas the cost of an army soldier is how much his being in the army robs society of the skills and abilities he could otherwise put in. Those who've chosen the armed forces are those who are getting paid for their chosen vocation; those who are conscripted are those who are now not free to do what they'd otherwise be doing.

When Elvis Presley was conscripted in the army, the cost of that conscription was whatever he didn't record or film whilst in there. If he'd been denied the reported $200,000 he was paid for shooting the film GI Blues then his conscription cost would have been $200,000, and the expenditure would have been whatever his military salary was (Muhammad Ali on the other hand refused to be conscripted on grounds of religious beliefs, which cost him personally his boxing title).

Alas, the politicians like Corbyn who are calling for re-nationalisation of the railways would do well to become mindful of the difference between costs and expenditure regarding government-run services. Not only do we see greater inefficiency and waste in government-run services due to the credit-guarantee that comes in the form of taxpayers, we see that government expenditure can't be considered without also considering cost too. The expenditure for nationalised railways is evident - although the extra costs, like pension contributions, sick pay, holiday pay, human resources costs, and so forth are usually overlooked, as are labour costs by being treated as beneficial jobs rather than expenditure (which is what they actually are). It's the costs that really bring about the inefficiency.

The cost of having 'conscripted' private sector employees in the railway is the cost of what they would be doing if they weren't being paid by the taxpayers. It's true some might be working in the rail industry, but they would be being paid by private company expenditure not taxpayers expenditure. So to put the analogy to effect in a more general sense, the cost of being nationalised is the cost borne by what those workers would otherwise be doing were they not funded by the taxpayer.

The other reality check pro-nationalisers need is over the issue of why the railways system is as it is. Train tickets are not priced as they are because there are private operators - they are priced as they are because the subsidies that used to keep the prices lower have been reduced. Whether the subsidy is increased or not, it is not an argument for re-nationalisation, which means running at a loss for the taxpayer, and more inefficiency too.

It's true that rail fares have crept up, and it's true that trains are delayed, they break down, tracks get damaged, and carriages get overcrowded, but to think that these problems are caused by not having the government in charge of the railways is really quite ludicrous. Consider prices – everyone’s favourite complaint. The complaint the rail fares are hugely overpriced, and that a government-run service would bring this back in check is overinflated, because the current profit margin for train operating companies is only between 3% and 5%. Ignore the fact that if the government makes no margin it becomes a very precariously run (and costly) enterprise – at 5% profit margins, a reduction of up to 4% on your train ticket is hardly going to amount to the kind of huge saving many imagine.

As for the issue of over-crowding (another favourite from people who think the trains run inefficiently), they may have missed the fact that the railway network is, actually, nationalised, it is only the train services operations that are tendered out privately. Given the limit on how many trains can viably enter a station at any one time, it is foolish to blame the private franchises for over-crowding. If anything, the sensible pricing that offers cheaper off-peak fares for people who are less price-sensitive or able to travel more leisurely under fewer time constrictions is exactly the kind of competition customers ought to value.

Consider that the government runs a comprehensive school monopoly and there is a shortage of teachers, but that shortage hasn't hiked up teachers' pay. Doctors, surgeons, lawyers and accountants all work in a prolonged qualification-based arena in which it is hard for competing forces to challenge, and that is not due to privatisation, it is due to scarcity. Also, scarcity power (which is what makes prices high) is not absent in government monopolies any more than private monopolies.

The paradox of competitive private industry is that it often starts as a nationalised company (as all the providers in the UK did - electricity, gas, telephones, water, etc), because otherwise there are few providers able to build the initial infrastructure to get their business off the ground. Generally, without governments' anti-monopoly policies one firm would rule because it costs so much to start a business that competition ends up costing too much to compete. For example, suppose no one was providing any large-scale water supplies around the UK. Thinking of economies of scale - to produce tap water, an aspiring water company had to invest in a huge network of water pipes stretching throughout the country. The fixed cost of this investment is very high. However, once in place any company that can distribute water to tens of millions of households brings the average cost down. Yet it often would not be worth another water company building another network of water pipes to compete with the existing company, because if they only got a small share of the market, the average cost would be very high and they would go out of business This is an example of a natural monopoly – but these largely occur when the goods or services provided are not fungible (see below).

That's why it's not always bad when the government first owns the means of production and then gets to the stage where it can sell off the rights of provision to competing companies, whilst stipulating a rule that they must compete for shares in the existing infrastructure.

What conditions this process is whether or not the good or service is a fungible one – by which we mean whether or not that good or service is easily replaceable in competition. The trouble with rail is that it is not a fungible good in the same way that food, clothes or cars are. If you need to take the train to London to Norwich you can't suddenly decide to purchase a vacuum cleaner instead and still get to Norwich, whereas if you're hungry and on arrival you find that sausage rolls at the station are too expensive you can buy some fruit from the nearby supermarket. Similarly, if the price of BMWs or leather jackets become undesirable, there are plenty of other alternatives you can seek, like Fords, Vauxhalls, wool or denim.

With trains things are not quite the same. The only competition for your train fare is other transport alternatives – driving, getting the bus, or occasionally cycling. But the competition in the railway services is not fungible: if you’re at Norwich station looking to get the 7:20am to London, you will not have a choice of trains like you will a choice of snacks and drinks in the nearby shops. A private monopoly or cartel that provides a service (like trains to 25 million people) is very hard to break, as competition for such a service is hard to generate. It's very costly to start up a rival firm to provide 25 million rail customers, and any small firm can be swallowed by being bought out by offering shareholders bigger shares in the larger company, as SKY TV did. Moreover, the fact that profit margins are under 5% shows that rail travellers are not getting ripped off - it is just simply the case that railway services are very expensive to run, they require lots of investment, and are large scale operations - and as such, they need to be run with the kind of efficiency that only the private sector is going to deliver.

Let's Finally End This Myth About Thatcher

When myths are widespread, it's good and necessary to prick the balloon of illusion. Perfect cases in point are these anti-Thatcher memes that used to pervade through the jungle of left wing social commentary. Given that all of the world's most successful economies got the way they did by adopting the things Thatcher espoused*, one would think it should be rare to meet people who are still aboard the anti-Thatcher bandwagon. However, to my surprise I met someone last week who believes Thatcher ruined our economy and made people generally worse off through her industrial policies. When I shared this on Facebook it emerged from the resulting thread that this anti-Thatcher rhetoric is still alive and kicking.

Alas, anyone with even the sketchiest understanding of economics would know why this myth should have long been put to bed. The reality is, the reason Thatcher's economy was a terrific success was largely down to her government’s understanding of the relevance of the works of the likes of Smith, Ricardo, Bastiat, Hayak and Friedman - which, to put in a nutshell, state that global trade, competition, private industry, low taxes, a small State and hard work are the key tenets to a successful economy. It was because of the Conservatives' embracing of these qualities that, despite popular myths to the contrary, Britain actually manufactured more under the Thatcher years than in the decades that bookended her time in office, and increased its public spending in that time period too.

Since the Second World War, and the foundations laid down by the Clement Atlee socialist government, Britain had been awash with economic hardship and putrid nationalisation projects that were being choked by overly-powerful unions. This went on until the 1979 Thatcher years, when she and her party upset a lot of people by transforming an economically impotent Britain into one of the world's economic superpowers again**. It's true that a lot of this comes from, and remains in, London and the South East - but power law distributions make this unsurprising - the whole point is that Britain is an economic powerhouse once again, and it's largely thanks to Thatcher's terms in office in allowing the free market to bear the fruits it couldn't under a stultified socialistic system.

What needs to be grasped is that although the industries most constantly talked about (like coal and steel) declined as a proportion of the aggregate economy, other sectors (like service industries) expanded. To capture the point, next time you’re in London – the country’s economic epicentre – have a walk around and see how many sectors are providing steel, coal and timber compared with service-based goods.

You might also like to note that this isn't a pro-Thatcher bias - the exact same thing happened in all the other prosperous economies too - it's just the way the world was changing. When steel and coal industries declined across Europe and America, that declension was offset by huge expansion in service industries, in every case making the countries in which this was happening richer. The Thatcher government had a strategy to discontinue unprofitable industries - as all governments should with their responsibility to its taxpayers - because despite emotional attachments up north, this unprofitability couldn't carry on under the pretext of it being British unprofitability (replace 'British' with 'white men' and see how it sounds a lot like racism)

The reality is that due to the changing landscape, Britain's coal industry had been declining long before Thatcher. In fact, it's quite famously known that more coal pits were closed under Wilson's Labour governments than under the Tory Thatcher's ones. The reason is obvious - but also widespread across other advanced economies - we saw not only the rise of cheaper coal abroad, but also the rise of first oil and then gas and later nuclear as less ecologically unfriendly sources of power. With that comes a decline in industries that relied on coal, in favour of industries that relied on oil and gas.

A few crazy trade unionists would have preferred to have kept subsidising inefficient and less profitable coal mines (and have the taxpayer pay to prop them up), all in name of Britishness, but as well as sounding a lot like racism to me, it is certainly illogical and economically short-sighted.

I don't dispute that much of what happened to the UK under Thatcher was a hard pill for many to swallow, as jobs were lost, families broken up, communities' clubs shattered, and so forth - but equally what holds us together is going to have to be much more than industrial nationalism. In global economies, climates change all the time - and we humans have to adapt to those changes. Coal mines were shut down because coal could be bought cheaper from abroad. Cheaper coal is better than expensive coal for the one buying it, irrespective of the country from which it happens to come. Trade should have no national preferences, and generally coal mining in the UK is expensive compared to open cast mines in countries such as China, Russia, India, Australia, and Indonesia. It’s the old Adam Smith wisdom again - you can try to produce wine in Scotland, but much better to produce it in vineyards in sunnier countries like France and Italy.

What’s usually the case, as is with Thatcher’s critics, is that they have missed most of the costs and mistaken the benefits for costs, by having too narrow a vision in supporting the parts of the economy that are not healthy (which not-coincidentally, often seem to be the particular industries in which they find themselves). It's no use being emotionally affiliated to an industrial factory that's costing us money just because it happens to be one’s own, or because it happens to be based in one's own country

The argument that supports why enhancing the global connectivity is good for all economies is the same argument that supports why market economics on a global scale is more efficient than the Darwinian natural selection model for economics, and why Thatcher's critics have got it wrong - it is the efficiency of the relationship between prices, supply and demand. It is foolish and impractical to favour bailing out and propping up industries in Britain, when Britain (and the rest of the world) can benefit more greatly (and has benefited more greatly) from the efficiency of the relationship between prices, supply and demand on a global scale. Making good use of the efficiency of the relationship between prices, supply and demand on a global scale is the more or less the same as making good use of the efficiency of finding improved technology. Whenever a government departs from this mandate by trying to artificially improve industries on the basis that they happen to be 'our national industries' (as the Labour Government of the 1970's tried to do) it only succeeds in diminishing the extent to which opportunities to improve everyone's welfare exists.

Competitive markets is what brings about the allocation of resources with maximum efficiency.  Adam Smith showed in his seminal Wealth Of Nations that the different ways to allocate resources is only maximised to the best effect when competitive markets function freely (for further reading, this has also been proven mathematically by Debreu and McKenzie). 

There may be plenty of reasons to criticise Mrs Thatcher – but claiming she ruined our industry is not one of them – because, in fact, the opposite is true; she helped enhance our economy in ways that seemed unlikely in 1979.  To criticise her for that is as foolish as criticising all the people driving safely in China and India because you happen to prefer car crashes in Britain.

There is one simple reason why British manufacturing of consumable goods has gone downhill, and if you don't get this point you're not getting the whole picture; manufactured goods acquired from other countries makes Britain richer as well as making the exporting countries richer too. In the vast majority of cases the price system in the competitive marketplace couldn’t have favoured the companies that are no longer manufacturing in Britain – quite simply because consumers started to buy from cheaper manufacturers abroad.

Let me offer a schoolboy example that shows the logic is correct. Pretend that instead of two countries we have two schools – School A and School B, neither of which is permitted to trade with the other. Johnny at School A has a monopoly on pencil cases. Johnny can sell Billy a pencil case for £5. Now because of a new policy which enables School A to trade with School B, Billy can now buy a pencil case from Charlie in School B for £3. Johnny has two choices, he can match Charlie’s £3 selling price or he can find something else to trade in. If he chooses the latter he will ensure he is no worse off than a £2 loss, otherwise he might as well choose to match Charlie’s £3. So the worst case scenario is that Johnny carries on trading, losing £2 per unit. Billy’s £2 gain matches Johnny’s £2 loss, so there is no net gain or loss. But now consider Freddy at School A.  Freddy, who was never willing to pay £5 for a pencil case, buys one for £3 from Charlie in School B, and goes home happy (as does Charlie with another sale). 

Billy’s gain and Johnny’s loss cancel each other out, but Charlie’s gain amounts to a net gain.  The logic is compelling and simple – in net terms both School A and School B benefit from being able to trade with each other. Instead of two schools, relate that model to every country in the world, multiply that simple pencil case model by factors of billions to allow for an open and competitive market, and different countries’ resources, strengths and geographical positions, and it is obvious that each country benefits from unconstrained trade potential. 

But that’s not the whole story; I have only said why free international trade is good for economies. There is another important factor in this picture – impeding the process of free international trade actually harms the people the government wants to protect – its own industry (and thus, its own citizens). Here’s how it happens. Let’s use a simple and extreme illustration to explain what is a more complex but no less valid truth about why government interference is bad.

Let’s suppose there is a car factory in Newcastle that isn’t doing as well as the Executives or the Government would like, due to consumers’ preference for cars in Japan. The Government introduces a policy that favours car production in Newcastle over car imports from Japan.  How on Earth could that not be good for the British economy – Britain’s gain is Japan’s loss, right? Wrong. Quite simply, what you put into the pockets of the car factory in Newcastle you take out of someone else’s pockets elsewhere in Britain (as well as having people probably paying more for their cars). Consider Slough’s boiler factory; what you don’t see is an almost invisible chain of events; the boilers made in Slough are shipped off to Japan and sold to a company that makes its money producing nuclear reactors, the buyers of which are companies who trade in mineral oils, and those companies deal with companies who make cars in Japan and ship them to Britain. 

In other words, there is a complex economic process that is going on outside of your peripheral vision, whereby both the car factory in Newcastle and the boiler factory in Slough are both bringing cars into Britain. That is to say, if you protect the car factory in Newcastle from competition you must damage Slough’s boiler factory because somewhere down the line they are the competition. So the next time you hear a politician announcing how much he or she wants to do to protect British producers in one industry from foreign competition, be aware that he or she is unknowingly proposing an action that hurts other industries in Britain, and amounts to a net loss in economic efficiency. 

Finally, I'll leave you with a passage I wrote in this blog about the benefits of global trade and how it is similar to the innovations of new technology:

"Finding someone who will do the job for less is a good thing for the economy in a similar way to how improving technology is good for the economy (and in most cases it’s a good thing for the person doing the work too – because having accepted the lower wage job, one presumes he did so because the terms offered were an improvement on his situation prior to accepting it).  In fact, not only is finding someone who will do the job for less a good thing for the economy in a similar way to how improving technology is a good thing for the economy - they are more or less the same thing.  Here’s why. 

Suppose you have a car factory in Manchester, and on the staff team you have 3 innovative engineers; Tom, who designs a machine that assembles the engine valves 25% quicker than the current machine; Dick, who synthesises two compounds that vastly improves the engine oil’s ability to clean the engine; and Harry, whose newly constructed equipment can make seatbelt holders at £2.60 per item cheaper than the current equipment.  I think you’ll agree that those three advances have improved the car factory in Manchester.  And having agreed, it stands to reason that if you want to be consistent you are compelled to agree that finding cheaper ways to employ people is also good for the economy, because it’s the same thing.

When we outsource the work attached to call centres, medical data analysis, computer software design, electrical engineering, and so forth, we are doing something very similar to Tom, Dick and Harry’s improvements in the car factory in Manchester.  That’s the wisdom that it seems too many people miss; new business and trading links across the world are good for the world as a whole, just as new technological innovations are good for the world as a whole.  Hopefully in our lifetime we will get to live in a world in which we see the end of discrimination against total strangers because they happen to live in another humanly constructed geographical border.  Economics favours it, and so does human kindness and decency."

* This is about the empirical nature of economics and the results seen globally when governments learn how to engender freer trade, less state interference, lower tax thresholds, fewer barriers to trade, removal of cronyism and other vested interests and the encouragement of competition. Off the top of my head the two countries that are not embroiled in major instability or civil war but that have departed furthest from those qualities are countries like Cuba and Venezuela - and one can see clearly how undesirable it would be to live in either of those places (you might add North Korea to that too).

** Then Labour, particularly under the Brown era, tried to repeat the mistakes of the 1970s, with irresponsible spending and unmindful borrowing concealed by stealth taxes and misjudged accounting, injecting copious amounts of credit into the system which gave false signals about the cheapness of money and prudent borrowing.