The other two Ts at the G8
Tax and transparency are the other two subjects about which G8 ministers will waffle meaninglessly next week. It’s a pity, because progress in these areas would be among the best ways of helping the developing world.
Tax havens are wrong for three reasons: they drain the tax base of developed countries, making it harder for them to maintain aid and social spending; they suck ill-gotten spoils from developing countries; and they destabilise the global economy.
Tax avoidance in rich countries is currently in the headlines. Using techniques with names almost too exotic to mention — anyone for a “Dutch Sandwich”? How about a “Double Irish”? — Google funneled payments to tax havens via low-tax countries like Holland and Ireland to minimise tax on its £11.5 billion in UK revenues between 2006 and 2011, paying only £10 million to the UK Treasury. Some have worked out that Google’s overseas tax rate is 2.4%, compared with the 28% it should be paying in Britain.
Apple, Marks and Spencer, Boots, Tesco, HSBC, Lloyds Halifax, Amazon, Starbucks, Vodafone — of course they’re going to minimise their costs. They’re profit-making enterprises. It’s no good berating them about their naughtiness; the only way to tackle these companies is to close down the havens where they hide their earnings. But no single rich country can address the problem alone because if Bermuda closes for business a company will just send its money to the Cayman islands. Action has to be taken in concert, which is why a multi-country group like the G8 is one of the only hopes for progress.
Developing country governments have had it even worse — having been denied billions of dollars in sorely-needed revenues as money is syphoned overseas. Liberia is an example of a poor nation that’s been ravaged by the iniquities of global tax-dodging, as a succession of kleptocrats stashed diamond wealth in hidden Swiss accounts. Switzerland’s at fault, not Liberians, who have a fragile democracy and a history of nasty dictators.
Nicholas Shaxson in his brilliant book Treasure Islands suggests that Transparency International‘s corruption perceptions index has things the wrong way round: we should rank countries on banking secrecy, not graft. The real economic issue is that nations harbour the spoils of corruption, not that Charles Taylor foists himself on Liberia.
Shaxson points out that tax havens, or what he calls secrecy jurisdictions, have played a starring and hitherto misunderstood role in the untrammelled economic liberalisation of the last few decades, in effect allowing cash to skitter freely around the planet. The market in shares, currencies and bonds is international and therefore difficult to tax — but the profits must eventually end up somewhere. Secrecy juridictions were purposefully set up as places for traders to hide their loot.
Most people ignored the euromarket for years after its birth in the mid-1950s, partly in the hope that it’d go away and partly because the UK and American authorities didn’t want to draw attention to the vast acreages of cash being made by their financial elites.
By the time we’d noticed, it was too late. Banks were among the prime users of tax havens, which played a key role in the credit boom of the 1990s and 2000s. Michael Lewis in The Big Short even argues that the creation of the financial weapons of mass destruction that caused the crisis wouldn’t have been possible without the likes of Cayman and Bermuda.
Some have argued that some of the low-income secrecy jurisdictions benefit so much from their offshore status that it’d be wrong to dismantle them. I worked for two years in Vanuatu, one of Britain’s former colonial havens in the South Pacific. London’s intention when the country gained independence in 1979 was to establish a tax haven which opened for business toward the end of the working day in Hong Kong, four hours west.
All kinds of nefarious activity found its way to Vanuatu. An Indian businessman convinced the government to accept a fake diamond ruby as security for a loan (the last time I saw it, the ‘diamond’ ruby, actually a lump of rock, was acting as a toilet-paper holder in the Department of Customs bathroom). The director of a local bank was jailed in the US for his involvement in an international lottery scam. A tax cheat was arrested on Vanuatu soil by the Australian Federal Police and last year jailed for eight years over a A$5 million fraud. I remember him telling me he was a big fan of free trade. Little did I realise at the time quite what he meant.
The damage to Vanuatu’s reputation is huge. Foreigners often think of the country as a bit mickey-mouse, and as a result serious investment is severely curtailed. The absence of income tax creates appalling inequalities. Vanuatu has a Gini coefficient of 58, placing it among the 10 most unequal countries in the world. None of this is worth the 10% that the financial industry is estimated to contribute to GDP.
Not only are tax havens harmful to their own people, but allowing companies the freedom to shift their cash offshore makes no sense for the global economy. During an economic downturn governments can’t easily spend more to stimulate demand if they are being held to ransom by the financial industry. Central banks can’t easily cut interest rates if commercial banks immediately just shift their cash elsewhere in search of higher returns. Today’s angst about the cost of financing government debt, as seen in the financial travails of Portugal, Ireland, Italy, Greece and Spain, is exactly what the economist Keynes feared; it’s why he recommended controls on the movement of capital where necessary, and it’s why they were so prevalent until the 1970s. It’s also why he wanted a much stronger role for the International Monetary Fund and World Bank, which he hoped would help prohibit hot money flows and prevent a global race to the bottom in which countries tried to out-compete each other on tax.
The current financial system is constructed. It isn’t, as most theorists of globalisation suggest, the result of an inevitable and faceless century-long trend toward liberalisation. Britain built its network of secrecy jurisdictions on purpose, with the idea of putting London at the centre of global financial industry after the decline of the British empire. The United States leapt on to the wagon, and today a number of US states are in effect tax havens, notably Delaware, Nevada and Wyoming. These havens came into existence as part of a conscious strategy, not through an inexorable or uncontrollable process. The United States and Britain opposed a co-operative, controlled, post-war economic system because they stood to gain from financial deregulation.
Because the system was constructed in the first place, it can also be dismantled. The chances of this happening next week — or in the next few years — are limited because the world’s corporations and financial industries, literally, have so much invested in it. But it shouldn’t stop campaigners from bringing the issue to attention or enlightened politicians from discussing it at international talking shops. Tax havens make no economic sense, they helped cause the crash and they perpetuate inequality. They should be shut down.
The G8, trade and development
Next week’s G8 summit in Northern Ireland will probably be dominated by discussions over a transpacific trade agreement and a proposed US-Europe deal. Both aim at boosting flagging growth in the world’s biggest economies. That would be good news for the whole world.
But don’t forget about the impact of trade deals on developing countries, argues Yurendra Basnett in a preview of the summit. Without careful design these two mega-treaties risk doing little for the developing world and could even make matters worse.
Trade taxes are already low, so the focus is likely to be on standards and trade facilitation. If the G8 agrees anything in these areas, Basnett argues, it should sign up to a principle of ‘do no harm’.
Take car production lines: common standards on both sides of the Atlantic would mean manufacturers no longer have to operate two separate production lines. A good idea in theory, but what about other countries? If EU–US trade standards damage Japan’s car industry, supplier countries like the Philippines and Samoa will suffer.
The UK has made a welcome proposal to help African countries reduce border crossing times and increase intra-regional trade. No-one can argue against making borders more efficient, but potentially unforeseen consequences may emerge: workers who earn their livelihood from delays at the borders must be ensured employment elsewhere.
Smoother borders will only lead to more trade when countries have the capacity to produce more and governments can effectively manage any improvements. It’s no use breaking down trade barriers if economies haven’t got anything to sell.
Efficient borders will provide value for money when they are facilitating more trade; efficient borders with no trade will be merely white elephants.
Basnett further argues that developing countries should have a role to play in new production networks and that countries should be helped to export better quality products.
A ‘do no harm’ principle aimed specifically at developing countries would be a major step forward.
G8 get-togethers are normally just talk-fests resulting in little more than a watered-down press release. Any progress on the two other ‘Ts’ to be discussed at the conference — tax and transparency — would do more for the developing world.
But with the World Trade Organisation Ministerial conference approaching in Bali next December, the group could at least show a statement of intent about trade that would be difficult for the WTO to ignore.
International development — what works and what doesn’t
Here’s a video from the Overseas Development Institute highlighting the progress that’s been made in international development in recent years. To sum up: some worrying trends, but lots of good stuff.
On leeches and bleeding
Noah Smith, a very bright professor who blogs a lot about economics and who is unusually open to challenges from the economic wilderness, has an article in the Atlantic Monthly asking whether we should trust economists. Comparing them to 14th-century physicians who thought that either leeches or bleeding were the cause of illness, Smith concludes that mainstream economists are difficult to trust because their assumptions are wrong, they haven’t built a proper model of the economy and their data is bad. On top of all this, their models are dodgy because they’re just stories about how the world might work, not genuine explanations of hard data like in the natural sciences.
But we should probably make do with medieval quackery, Smith asserts, because economists are a humble bunch who are aware of their shortcomings. He quotes a couple of famous economists — Greg Mankiw (author of the textbook I used as an undergrad) and US Federal Reserve chairman Ben Bernanke — as saying that they don’t know everything about the future. Moreover, Smith continues, the quacks are better than the loonies outside the mainstream who peddle snake-oil and wizardry.
Smith cites as example of this unpalatable wizardry the Austrian economists, “who believe that we only need logic to understand how the economy works, and that data and evidence are useless.”
Smith is mostly right about the problems with economists. But as an example of wilful mischaracterisation this last statement is difficult to surpass. As Peter Klein (dismissed by Smith on Twitter as a troll) points out:
Certainly no Austrian economist has ever maintained that one can provide a detailed analysis of actual business cycles, or monetary policy, or any aspect of applied economics without careful, detailed, empirical study. It might surprise Smith to know that Mises wrote detailed empirical studies of prewar business cycles and European monetary policy, that Rothbard produced a 368-page treatise on the Great Depression, and that contemporary Austrians have written about the credit collapse, quantitative easing, and just about anything else in recent economic policy.
It’s not that i’m particularly keen on the Austrian school of economics. I am keen, however, on trying to understand different schools of thought. Dismissing them as “absurd”, as Smith does, is totally unhelpful, and typical of the mainstream of economics, which tends to ignore, misrepresent and drag opposing sets of ideas through the mud rather than accepting the possibility that they might have something to contribute, however small.
Mainstream economists are in fact far from humble. The implicit view of Bernanke and Mankiw is that they’re on the right track and that their brand of economics will, eventually, establish the truth. The 1994 textbook of Mankiw’s that I used says at the beginning: “Macroeconomists are the scientists who try to explain the workings of the economy as a whole… To be sure, macroeconomics is a young and imperfect science… we do know quite a lot about how the economy works.” He seems to think that the type of models used by mainstream economists aren’t quite up to the job yet, but eventually they should yield better answers.
The mainstream approach is so dominant that its practitioners are able to laugh about their own minor shortcomings. Haha, they exclaim. Look at our funny little foibles, but don’t bother taking any of the alternatives seriously.
Macroeconomists act from a position of power. It’s OK for Bernanke to affect modesty by saying that he doesn’t know much about the future. He sets monetary policy for the world. He knows that what he says goes, and that his sort of economics will anyway be force-fed to Americans and the rest of us because he influences how much money the Fed prints and how long it keeps interest rates at zero. For him to joke that economists don’t know much about the future is like a teacher joking to a pupil how boring his lesson is. They’re in charge, regardless.
Mainstream economists are part of a school of thought which posits some very specific things about human behaviour — many of which, in my view are complete rubbish — and which is backed by immense corporate power, as documented in the film Inside Job. Ideas about methodological individualism, rationality and equilibrium support the status quo. Neoclassical economists dominate the universities and in some cases even close down departments which think differently. From the 1980s economic methods infiltrated other social sciences in what came to be known — even by its proponents, led by Gary Becker — as the “imperialism of economics”. Far from being humble, this was a prolonged episode of extreme arrogance in which one individual had the temerity to write a decade ago that “economics is the premier social science.”
It is ludicrous naivety for Smith to suggest that “when you listen to economists, the key is to try to understand why they think what they think”. Most of the public don’t have a clue and never will have any idea about why economists think what they do. Economists, because of their close relation to power and because of the necessarily complex nature of what they do, are in a position of privilege, and it’s up to them to be realistic, to make it quite clear why they think what they think, and to be much more modest about their predictions.
Either that, or we prise their fingers off their privileged perch, one by one. Smith’s, and Mankiw’s and Bernanke’s method of economic science is mistaken. Most economists aren’t honing techniques to be able gradually to achieve better knowledge about the future. They’re never going to get better at predicting the future. The whole notion that we should spend our time building mathematical models using ridiculous assumptions like perfect foresight and rationality is flawed, and we ought to do away with it. One of Smith’s commentators rightly points out that these are “ghost” models, which produce results that are precisely wrong. Better to be somewhat right using intuition than precisely wrong using a formal model. If mainstream economics were any good as a school of thought, how come almost no mainstream economist was anywhere near predicting the 2008 crisis, after more than a century of economic ‘science’?
The leeching and bloodletting analogy is a good one, because it took a revolution in medical science to overcome these practices. When they were proved false, they were mostly consigned to the dustbin of history along with the physicians who practiced them. It was eventually discovered that bloodletting actually helped kill the patient. Leeching is now a rare technique used to reduce swelling on certain wounds during surgery. The 14th-century physicians were using the wrong methods, and would never arrive at the truth. I dislike that bastardised phrase ‘paradigm shift’, but a scientific revolution may be the only way of moving beyond the kind of 14th-century quackery that currently infects economics.
The future of aid
Future international development agencies will be cross-ministerial platforms for the coordination of aid rather than behemoths with their own projects, programmes and spending. These agencies will be staffed by politically astute people with good negotiation skills. So says says Andy Sumner in the Economist:
One might imagine smaller, cross-governmental administrative units with mandates to pursue ‘policy coherence’ on trade and other matters and with the technical capacity needed to build, say, tax systems in developing countries. Such new units would need to be staffed by people with ‘soft skills’, meaning with strong political sensitivity, rather than, as in the old days, people whose skill lay in evaluating and managing big projects.
What’s striking is the optimism of Sumner’s piece. Sumner accepts the possibility that extreme poverty — those who live on $1.25 a day or less — could be slashed to about 300 million by 2030. This is based on the idea that big countries like China, Brazil, Indonesia and India are developing so rapidly that they’re on the brink of becoming middle-income. Contrast this optimism with the negativity of a book like Dead Aid by Dambisa Moyo, which Bill Gates recently called “evil” (h/t Andrew Parker). Moyo presents a picture where vast oceans of aid are being squandered and stolen. In reality global aid is much smaller than she states (ridiculously, she counts only gross aid to Africa, not net — lenders receive large sums in interest payments on development loans) and it’s had a tremendous effect. Gates, for example, points out that it’s just immoral to deny children live-saving medicines and vaccines, and that health-related aid has saved countless lives — not to mention supported economic growth — over past decades.
Sumner is clear that this positive trajectory isn’t guaranteed. But it’s likely that in a few decades most poor people will live in middle-income countries, with the result that global poverty is increasingly found either in countries which don’t really need aid or in countries that can’t absorb aid easily and quickly.
This relatively small number of fragile states where a relatively high number of poor people live will still benefit from direct aid funding in the form of grants, budgetary support and so on. But overall, traditional aid will become less important, and donors will start thinking of more innovative ways of supporting the big, rapidly-growing countries using tools like better trade and migration policies and additional concessional lending. Handouts just might not cut it anymore. Attention will turn to questions like inequality, the environment and the inclusiveness of economic growth — and this will require a softly-softly approach from donors.
“It’s as though campus physics departments have been taken over by teams of frightfully useful engineers.”
Randomised controlled trials are increasingly trendy in social science and development economics. Based on clinical drug trials in medicine, RCTs randomly assign people to treatment and control groups. The treatment group might, for example, have access to savings accounts, while the control group doesn’t. The technique avoids selection bias: the economist might distort results by picking a group that really wants to take part or where he knows the chances of success are high.
Popular science writers like Ben Goldacre have promoted their use in public policy.
I’m sceptical, as I wrote here. RCTs ignore the role of power in policy, imagining that researchers and policymakers are engaged in an objective and noble hunt for the truth rather than being swayed by convention and corporate interests. It’s no surprise that the State Bank of India, Standard Chartered and Citi all support microfinance. Microfinance gets so much attention — for good or ill — because it’s so prevalent in development policy.
RCTs are unambitious, tinkering only with what can be experimented with and tending to overlook bigger issues. Giving some of the 2.4 billion people who live on US$2 a day savings accounts just isn’t alone going to propel them toward acceptable living conditions.
Testing discrete policy ideas tends to focus on what’s been already done, shifting focus away from the search for radical or sweeping new ideas. Economists now seen as mainstream — like Smith and Hume — were at first considered heretics because they espoused off-the-wall theories would have been untestable.
I’m also wary when natural scientists start doing social science. People aren’t atoms, and because human society is changeable and unpredictable the results of experiments may work in one place for a short time but can’t really be taken as hard fact for ever in the same way as findings in natural science can. So most social-science findings are only provisional and context-dependent. Most natural scientists are aware of these differences, but some aren’t.
A great article in the Boston Review by Pranab Bardhan sums up the criticisms:
First, it is very hard to ensure true randomness in setting up treatment and control groups. So even within the domain of an RCT, impurities emanate from design, participation, and implementation problems.
Second, RCTs face serious challenges to their generalizability or “external validity.” Because an intervention is examined in a microcosm of a purposively selected population, and not usually in a randomly sampled population for any region, the results do not generalize beyond the boundaries of the study.
Third, for many important policy issues, RCTs are not very useful. You cannot run experiments in order to decide where to put power plants or ports. You cannot do a controlled test on the advisability of tight money, fiscal austerity, or deregulation. Moreover, even if you can show convincingly that a policy intervention works in a small-scale trial, policymakers still have to worry about the economic and political spillover effects of a policy when it is implemented regionally or nationally. What will be its impact on other markets and the macro economy? And what happens when a policy once handled experimentally by a local NGO is taken up for large-scale implementation by a national bureaucracy, even a well-functioning one?
Fourth, RCTs show only the average impact: a policy intervention may be very helpful for some people and not at all for others, just as a clinical drug trial may show that a particular drug works well for the average person, but it may not work at all for you. One of the standard questions of political economy, however, concerns who gains and who loses from a given policy. RCTs cannot answer that distributional question.
Finally, even when an RCT shows quite cleanly that A causes B, we do not quite know the mechanism through which it works. In interpreting many experimental results, [authors] give plausible accounts of the processes that may be at work, but these are at best their informed guesses. They are usually not rigorous derivations from the experiments themselves. In understanding alternative mechanisms through which A may have caused B, theory has to play a more important role in empirical economics than the experimentalists have assigned to it.
“It’s as though campus physics departments have been taken over by teams of frightfully useful engineers,” writes Bardhan.
None of this means that social scientists shouldn’t do controlled trials or that policymakers shouldn’t pay any attention to RCTs, but it does mean their findings should be taken with a hefty pinch of salt and that they shouldn’t sideline other techniques.
Economist magazine bashes Argentina!
Despite the breadth and quality of the Economist magazine’s international coverage, I often don’t bother reading stories on certain subjects because I already know what they’re going to say. Argentina is one topic which tends to bring out a particular strand of swivel-eyed lunacy.
“A Decade of Division” shouts the latest headline, above an article about ten years of rule by Nestor and Christina Fernández de Kirchner. The piece criticises the husband and wife pair for allegedly agreeing to take turns at the presidency, a plan which Nestor spoiled by inconveniently dying of a heart attack in 2010.
But before that he “pulled a subtler, counterintuitive power play: he stepped aside.” Stalinist! Clearly he must have thought that no Argentine voting in the 2007 election would have the gumption to vote for anyone other than his wife, who again won hands-down in 2011.
The article makes much of “rumours” “swirling” that Fernández might amend the constitution to seek a third term. “But she seemed to suggest otherwise when she spoke to supporters at her anniversary party on May 25th, stating: “I’m not eternal, nor do I want to be.” Ah. So she probably won’t seek a third term, then.
We just spent four months in the country travelling from north to south. We didn’t experience a country worthy of the mouth-frothing and negativity so prevalent in the English-language international media. Since Kirchner’s election in 2003 the economy has boomed, with a faster and more sustainable growth path than under the right-wing era of the 1990s. Domestic industry has flourished and the economy has avoided the dependence on the financial sector that artificially propped up many developed countries then sent them into slump. Poverty has fallen dramatically. As many as half of all families were poor at the height of the crisis, compared with around a tenth now. Unemployment is much lower now than in Europe. Until recently inflation has been manageable. Many Argentines actually still like Fernández, particularly because she has done something to tackle poverty.
Some Argentineans, smiling.
This isn’t to suggest that everything is smiles — and nothing would excuse further concentration of power or the amendment of the constitution so as to support a third term for Fernández. Inflation is also clearly a big problem, as is the massaging of statistics. The black market dollar rate has diverged significantly from the official rate in the last few months, suggesting a worrying downturn in confidence. Calle Florida in Buenos Aires heaves with money changers. The middle class apparently take regular trips to Uruguay to get dollars.
But it does seem that publications like the Economist, and its readers, dislike Argentina’s alternative economic policy so much and want to punish it for its 2001 sovereign default, that they will concoct a negative story whatever the reality. Reading the comments under the Economist piece you’d think that the country’s economic performance in the 2000s didn’t outstrip either of the previous two decades or that the country has somehow been less politically stable. One poster says that the country used to be as wealthy as Australia and that somehow it’s the Kirchners’ fault. Er, maybe it was rich 100 years ago. The long-term decline in the country’s relative world economic standing might have something to do with the intervening century, during which it was ruled by dictators and quasi-fascists.
While in the country I began to wonder whether the Argentina that the Economist referred to was some other land, some fictional anti-Xanadu where journalists project their dystopias. The reality’s not that bad.
Diane Coyle at the Enlightened Economist blog has an interesting post about James Scott’s book Seeing Like a State: How Certain Schemes to Improve the Human Condition Have Failed. I haven’t read the book but will add it to my reading list. It’s about the consequences of several 20th-century authoritarian schemes such as Tanzanian viligisation, China’s Great Leap Forward and Le Corbusier’s urban planning in Brasilia. Coyle describes Scott’s main rules of thumb as to:
1. Take small steps – and stand back and observe in between each.
2. Favour reversibility. “Irreversible interventions have irreversible consequences.”
3. Expect surprises.
4. Plan on human inventiveness. “What is perhaps most striking about all the high modernist schemes is how little confidence they repose in the skills, intelligence and experience of ordinary people.” The less is ‘left to chance’, the less room for local experience and knowledge.
Coyle sees the conclusions for social science as to: “be far, far humbler about what we know than is typical. A lot of economic analysis suffers from the same high modernist blinkers as the disastrous social engineering described in the book.”
She’s right. And the parallels with my own book are striking (which uses social theory to inform development economics and isn’t about politics or the “human condition”, although I probably should have read Scott’s book). I reference some of the post-modernist literature which criticises modernists for amongst other things their arrogance, unwarranted certainty, universalism and top-down approach. My main target is the Washington Consensus, which dominated development policy from the 1980s well into the 2000s.
My own four-point taxonomy involves:
- An examination of the influence of values and norms. “Partly, the idea of being reflexive simply means having an open mind and looking at your own project… Being socially reflexive at an institutional level would require that the agents of a development process ask to what extent ‘grand theory’ is useful, distinguishing between objective advice and what is simply a reflection of interests or a projection of a different worldview.”
- An implicit assessment of the extent to which local context is important. Context matters because people in different societies behave in different ways; values vary; and institutions are different.
- A recognition that economic tools, concepts and policies can undermine themselves, even though they were designed for greater control. Economic systems are open-ended and events are often completely incapable of prediction, even as a stochastic process, a perspective implied by the Keynesian methodological approach.
- An allowance for theory to be revised if it proves inadequate or as circumstances change. Economists should be open to fallibility and to the possibility that theory may be proven wrong by events (again, this is pretty much Keynesian). Mainstream economists rarely revise theory in a fundamental way.
I also argue strongly for the use of the skills, intelligence and experience of ordinary people. Local experience and knowledge is in my view critical for successful development policy.
Scott’s book is clearly anti-state, and leftists should take note. The government can’t solve all of our problems. The best-intentioned schemes backfire; taxes aren’t socialist; debt isn’t good. It should be remembered that a strong strand of leftist thinking places emphasis on human agency: the ability of people to shape the world, to think and act for themselves. Parts of the left have always been suspicious of state power, the state, it is argued, having become synonymous with corporate control (banks and multinationals now run government). A lot of leftists argue for the devolution of power on democratic grounds so that people can better control the environment in which they live. The left wing of the Scottish National Party is among its loudest. The Scottish Socialist Party campaigns hard for independence.
But it would be wrong to argue that only statists wear high modernist blinkers (not that I know whether Coyle or Scott think this). Thatcherism was modernist. It reduced individuals to atoms in a mechanical system which left little room for agency. If there’s no such thing as society then social behaviour can’t produce unpredictable consequences. The zeal for competition and deregulation of the 1980s and 1990s was as arrogant, teleological and, ultimately counterproductive as any leftist modernism. I’m not sure that water and council-house privatisation, the poll tax and the destruction of the unions were all that far from social engineering.
Neoclassical economics, which tends to be methodologically individualist, underpins much neoliberal thinking. It has been criticised for having a mechanistic approach; for imagining that its policy solutions apply everywhere; for believing that people are motivated solely by material ends; and for failing to show introspection. Neoclassical development economists, I would argue, often fail to root their analysis in the actual lived conditions of real people and should use genuine empirical techniques rather than crunch numbers in Western universities.
So both political poles have tended to resort to modernism. Economics, as Coyle points out, should be much more humble (OK, I know it’s not very humble of me to hang an entire blog post on a book I haven’t read). As it happens I think it’s possible to go a lot further than humility, which is quite a vague term — one person’s doubtful is another’s cocky — and to build in to economics syllabuses and analysis methodological foundations that preclude the kind of over-confidence we’ve suffered over the past century or so. Ingredients would include at least inter-disciplinarity, pluralism, awareness of the history of economics and of economic history, care about the use of maths and stats, greater use of case-studies and self-reflexivity. But that’s for another blog post.
The economic case for Scottish independence
I’ve just ploughed through the report from the Scottish government released this week on the economic arguments for independence. I’m quite impressed.
The case is split into four parts:
1. Scotland can afford independence. There’s loads of oil still left and government finances have been in much stronger shape over the last five years than England’s.
2. Scotland has lots of potential based on its high levels of education, natural resource wealth, international reputation and desire to stay inside the EU. Key industries are the life sciences, tourism, creative industries, digital and ICT, energy, renewable energy, low carbon technologies, food and drink, financial and business services.
3. The union is damaging Scotland via income inequality and the concentration of economic activity in London. Economic policy can’t currently be tuned to Scottish circumstances.
4. Independence would help Scotland fulfil its promise. Small countries are more nimble and better able to adapt to changing global conditions.
One of the best things about the report is that it sees the economy as controllable. As I argue in my book Reflexivity and Development Economics, economic relations are socially created and should be moulded to suit human ends. “The economy” isn’t an autonomous, independent object which acts on us and which should be left to its own devices; it evolves and mutates. Seeing economic relations as part of human society means actively nurturing and developing the levers of policy, something which has become unfashionable over the past few decades under neoliberalism.
But beyond such sweeping statements many economists fail to go. The Scottish government’s dismal scientists are unusual in identifying 10 specific fiscal levers which they says the government will use in the event of independence:
- Oil and Gas Taxation
- Excise Duty
- Value Added Tax (VAT)
- Air Passenger Duty
- Capital Borrowing
- Welfare and Social Security
- Corporation Tax (base and rate)
- Public Sector Pay/Pensions
- Capital Gains Tax
- Rural and Environmental Taxation
The document also identifies eight non-tax policy levers:
- Consumer Protection
- Industry Regulation
- Energy Markets and Regulation
- Implementation of EU Legislation
- Competition Law
- International Trade
- Immigration
- Public Provision and Procurement
As someone who spends a lot of time in the world’s poorest countries, it’s interesting to see Scotland try something of a strategic, developmental approach. Current UK economic policy doesn’t view these tax and non-tax levers as having anything to do with strategic economic goals (and nor does most mainstream economic development policy). They’re seen as necessary evils or about revenue collection. An ingrained laissez-faire attitude means that these tools aren’t used to tailor policy to the regions or toward equality, poverty reduction or even economic growth. Leave the economy alone, the free-marketeers say, and it will look after itself. Tinkering will only mess with the supposedly efficient outcomes of markets. But the events of the last half-decade have proved that the economy isn’t very good at self-care and that governments need to intervene to produce desirable outcomes and to mitigate the worst impacts of markets.
Presenting specific policy controls, as the Scottish government does, takes chutzpah, as does the naming of specific economic sectors for development. A senior Scottish civil servant tells me that the government is forthright about naming sectors and suggesting methods for their support, and they aren’t the high-employment, low-value-adding industries of the past: there’ll be no return to ship-building or mass manufacture. The future is in the life-sciences, whisky, tourism, the creative industries, digital and information communication technology and renewable energy.
This week the government formed a fund for the support of the wave-power industry, something which it sees as important for meeting carbon-reduction targets and as a possible source of exports. This isn’t the discredited import-substitution or ‘picking winners’ policy so derided in the past; it’s smart, targeted investment in sectors with obvious potential (Scotland is very windy and wavy, for example, and has lots of good scientists and engineers), in conjunction with the private sector. Of course there will be a few failures, but it also looks likely that the success stories will outweigh the balls-ups. Most governments and economists lack the imagination to go beyond the same old low-tax, hands-off, light-touch policy that has dogged economics for the past few decades. Alex Salmond’s government should be congratulated on its courage and foresight.
Another admirable thing about the report is its stance on London and the southeast. Over-dependency on Britain’s capital isn’t just an issue of geography but of inequality. As the report points out (the panel which oversaw the report includes Joseph Stiglitz), rich people (read financiers) spend a lower proportion of their income than the poor. And cutting welfare payments further sucks demand out of the economy. If there’s one thing that Britain’s economy needs at the moment, it’s an increase in demand in the marginalised regions. Inequality is also demotivating: people don’t work as hard beneath a glass ceiling. In general, unequal societies tend to under-perform economically.
The document rightly points out the need for economic policy to move away from the kind of one-size-fits all measures that characterise current British economic policymaking and move toward a decentred, context-sensitive approach. It’s probable that only further ceding of powers to various parts of the UK can achieve this.
I’d have liked to see measures aimed at reining in finance. London’s boom emanates from the City. Any new Scottish government should enact measures to restrain the financial sector and stop Scotland itself becoming Edinburgh-centric. The report’s a bit vague here, talking of a “thriving financial service sector” (p. 24) and making “the right services available to all of Scotland’s people. This will go beyond big high street banks, and include credit unions and, potentially, new forms of finance, and pensions.” This vagueness is politically understandable given that Salmond probably doesn’t want to scare off the financiers (and that he used to work for the Royal Bank of Scotland), but Scotland should avoid reliance on the bankers who caused the crash, building sustainable and responsible industries which have positive social spin-offs.
The argument seems to rest on a couple of dubious counterfactuals:
Firstly, that the proposed oil fund would have been bigger if Scotland had been in charge. But who’s to say that Scotland wouldn’t have squandered the funds, like many other countries have, and like Westminster did? Why can we be so sure that it won’t do so in future? There’s no guarantee that the SNP will stay in power.
Secondly, that the UK economy engaged in a “massive boom in credit and debt expansion”. Why wouldn’t Scotland have done the same? Lots of other small countries overspent and deregulated finance too much, like Iceland. The report points out that Scots save slightly more than the English, but its now increasingly understood that debt can be created irrespective of the stock of savings. This recognition should place even more emphasis on regulation of the finance industry in order to stop it creating too many loans and dodgy financial instruments.
On page 9 the document falls for the notion that austerity will help reduce debt: “Even with an unprecedented eight years of austerity planned by the UK government…net debt is forecast to reach over 85% of GDP”. The phrase “even with” is misplaced. Lower government spending in a downturn tends to increase unemployment, lower tax revenues and raise benefit payments. Austerity will prevent a reduction of the debt pile.
The discussion on capital spending on page 27 somewhat contradicts this austerian view, suggesting that capital spending under a Scottish government would have been £7 billion higher over five years, and that this would have helped prevent recession by creating 19,000 jobs. Probably true, but it would have been better to put this kind of analysis at the centre of the document rather than hiding it halfway through.
Finally i’d have liked to see some mention of measures of economic growth other than Gross Domestic Product. I know that the independence campaign is currently facing allegations of fudging the numbers and that this sort of document has to put forward a very precise view at a critical time in the independence campaign, but Salmond has in the past talked of a new approach which places emphasis on happiness and wellbeing rather than competition and money-grabbing. Stiglitz himself has written extensively about new measures of economic development which move away from the old GDP model toward life satisfaction and fulfilment. An independent Scotland would have the chance to pioneer these approaches as national policy.
Overall, I don’t know whether that the report convinces me about independence. More devolution looks likely, and devo-max could probably deliver most of the goals of the report. The SNP think that Scotland is going to escape all the failings of Westminster, and that stupidity and greed won’t exist in the new nation. So far the government’s proven quite enlightened but there’s no guarantee that the nationalists would stay in power after independence or that they’d stay sensible when they got their hands on the chocolate box. Too many newly-independent nations predicted a sparkling future but encountered a disappointing reality.
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Update: Robin McAlpine of the Jimmy Reid Foundation has an article in today’s Scotsman criticising the report for being too conventional. The analysis is correct, argues McAlpine, but the prescriptions unambitious.
McAlpine’s comments on the creation of a new currency are vague. As I wrote in the same newspaper last year, beginning independence with a new currency would be risky and difficult and would probably limit Scotland’s fiscal and monetary options still further by making Scotland vulnerable to the confidence of international debt markets. Launching a Scots pound sounds radical, but if rushed, the outcomes wouldn’t be. Better to become independent using the pound then launch a Scottish currency after a few years of hopefully sound economic performance.
McAlpine coruscates Salmond for considering a three percentage point cut in corporation tax, suggesting that it might attract low wage employers. I’m in no way in favour of a race to the bottom whereby we try to outdo England and others, but fiscal policy has formed part of the development strategies of lots of successful countries, and the SNP would be silly to rule it out. A few percentage points off the normal corporation tax rate wouldn’t be disastrous and it would still leave the rate well above Ireland’s disastrous 12.5%. On the contrary, tax breaks can sometimes attract good employers and encourage domestic industry.
McAlpine accuses Salmond of trying to “recover the very economic structure that caused the crisis in the first place”. But nowhere does the report imply that we should return to the bad old days. The argument is actually rather forward-looking, placing huge emphasis on low-carbon, environmentally-sound industries with genuine value addition. It’s far more progressive than Westminster ever would be — for example talking about the need for equality. Yes, the report fails to say how an independent Scottish government would control the financial industry, but in no way is its general thrust a continuation of the policies of the Labour and Con-Dem administrations.
McAlpine’s charge that Salmond isn’t considering a “proper industrial policy” is just plain mistaken. The government report talks of the need for new, innovative industries which build on Scotland’s strengths. We can’t turn back to the days of mass manufacture — these things are done far more cheaply in China and other low-cost destinations. When China gets too expensive, manufacturers will find another low-wage country. The government document is in direct opposition to the idea of trying to attract “another thousand supermarket jobs”, suggesting that low-carbon energy, the life sciences, tourism, creative industries, digital and ICT are the future.
I don’t think that McAlpine really disagrees fundamentally with Salmond — he’s just trying to sound critical so as to paint the SNP as more conventional than it really is.
A chapter in the European Report on Development by Yurendra Basnett and Jodie Kean highlights the need to include productive capacity in the Millennium Development Goals (MDGs), the set of development targets originally established in 2000 and due for revision in 2015. The chapter makes clear that developing countries can’t pay for health and education without economic growth. An international framework that better recognised the importance of the economy would help countries build the tax revenues to pay for proper social services. Put bluntly, self-reliance would be better than handouts.
Many of the economic challenges of Low Income Countries and Least Developed Countries (LICs) and (LDCs) have until now conventionally been thought of as lying on the demand side rather than the supply side. If only we could break down overseas barriers to trade, the story goes, the economies of LICs and LDCs would respond with increased production.
In my experience many LICs and LDCs simply don’t have the productive base or flexibility to be able to sell much on international markets, and they are unlikely to do so without considerable attention to local productive capacity. I remember a colleague in the Vanuatu Department of Trade coming back from Japan saying that a single potential buyer wanted 20 tonnes of coffee a month. The entire country produced that much a year. The lack of roads and inter-island shipping, insufficient electrification and phone coverage — not to mention the difficulties of the transition from subsistence work to a cash society — meant that the coffee company was unlikely quickly to increase its capacity. For the economy as a whole, the export of most other products besides a few basic commodities like copra was a pipe-dream despite widespread duty and quota-free access to foreign markets. The economy wasn’t flexible enough to be able to respond to international market conditions, not that such flexibility is ever likely. Tourism has since grown but this has led to over-reliance on a single services export.
In Lesotho, where I worked last year, exports are heavily concentrated in garment production at a single group of Chinese-owned clothing manufacturers in the capital, Maseru. Although the country is Africa’s biggest garment exporter, it forms only a tiny fraction of global textile and garment production. The industry is over-dependent on government subsidies and the African Growth and Opportunities Act (AGOA) under which the continent’s exports get preferential treatment in the United States. Few industries other than clothing have had much success, and considerable effort is needed to develop the infrastructure, finance and human resources for export diversification. This won’t happen automatically. It needs donor and government support.
The focus of much of the international community tends to be on smoothing trade flows — trade facilitation — and trade agreements, when the smallest and youngest countries like Vanuatu and Lesotho simply don’t have the ability to take full advantage of these agreements. This isn’t to discount the importance of trade agreements, but they are only part of the story. The economies of most LDCs and LICs are too tiny to be able to supply in enough quality and quantity. Many of these sort of economies are excluded from global supply chains and their economies lack diversity.
This lack of attention to the supply side and productive capacity is not just about the marginalisation of small countries; it has theoretical and methodological foundations. The global development discourse has tended to promote liberalisation rather than to intervene in the economy to stimulate agricultural growth or industrialisation. The lowering of tariffs, smoothing of trade flows, trade facilitation and reducing barriers to investment were all a product of the post-Washington Consensus era in which it was thought that freer markets would automatically spark economic expansion. In a sense, the exclusion of explicit economic goals in the MDGs was connected with this line of thinking. Economies would sort themselves out — the international community should only attend to social goals.
The experience of East Asia, as should be well known, teaches us otherwise. Governments need to act in specific ways to stimulate production, using tariffs, domestic taxes and subsidies. Health and education are public goods which themselves contribute to economic growth (so they shouldn’t be excluded from the MDGs). The private sector, left to its own devices, often fails to build infrastructure. An officially-recognised international framework would help countries pursue these interventionist goals.
This emphasis on the supposed automatic functioning of markets has been connected with the prevailing economic orthodoxy under which Keynes was banished and the neoclassical model became paramount. Industrialised and non-industrialised economies were said to operate more or less at full capacity all the time. The lessons of Keynes and his disciples were forgotten, and it was forgotten that economies could in fact perform below full demand for long periods, if not indefinitely.
Shoved even further to the sidelines were thinkers like Albert Hirschman and Michal Kalecki, who showed that developing economies didn’t even have enough capital, never mind being unable to use it fully. Specific government measures were required to develop capital and subsequently to deploy it to full effect.
Within the neoclassical framework it’s difficult to accommodate the likes of Hirschman or Kalecki because neoclassical economics is a tightly-specified and prescriptive world which doesn’t allow for differences between developed and developing economies — still less between developing countries — and which tends to promote more or less the same solutions everywhere. In this sense the shortcomings in the kind of development thinking which underlay the old MDGs are deep-seated and methodological rather than simply about refinements of policy. Hopefully, in a post-2008 world, in which neoclassical economics is under question and in which new sorts of economics are emerging, productive capacity and economic development can be included in any new global development agenda.
Emergent Economics 