Month: May 2016

Campbell Newman: the gift that keeps on taking

John Quiggin7 Comments

A little while ago, it was revealed that the Queensland taxpayers were picking up the bill for Campbell Newman’s indefensible defence in a defamation action brought against him and Jarrod Bleijie (aka Boy Wonder) for accusing two Gold Coast lawyers of being bikie criminals, apparently on the sole basis that they were fulfilling the professional obligation of providing some bikies with a defence. The bill amounted to $0.5 million, and was greatly increased because Newman and Bleijie refused to mitigate the damages by apologising.

Now, thanks to the Oz, we learn how we are paying for the new State Executive Building, which Newman and then-Treasurer Tim Nicholls assured us we would get for nothing as part of a complex land deal. In reality, it turns out Newman left us on the hook for a 15-year lease at above market prices. Of course, the Oz being the Oz, this is presented as the fault of the current Labor government, which denounced the deal at the time and has continued to do so.

Trump and Tribalism (crosspost from Crooked Timber)

John Quiggin62 Comments

Watching the rapid consolidation of the Republican Party around the candidacy of Donald Trump, I’ve tried to make sense of this in terms of the “three party system” analysis I presented a few months ago. I saw the Republicans as the “hard neoliberal” party relying on the votes of (white Christian) tribalists and making symbolic gestures in their direction, but largely ignoring them, particularly if their interests came into conflict with those of big business.

What’s become clear since then, I think, is that the Republican Party apparatus (politicians and party officials) is more tribalist than this analysis suggested. Faced with the prospect of electing their hated tribal enemy, Hillary Clinton, as President, the vast majority look like backing Trump (some, but not all of them, holding their nose as they do so).

From a hard neoliberal viewpoint, this makes no sense. Clinton’s Democratic Leadership Council background is that of the stereotypical soft neoliberal. Her candidacy is the best chance of maintaining the long-running alternation in office between the hard and soft variants of neoliberalism. Admittedly, she will be pulled to the left by the general shift exemplified by the Sanders insurgency, but she is unlikely to do anything that would fundamentally undermine capitalism. By contrast, a Trump takeover of the Republican Party would be a disaster for neoliberalism (which does *not* mean it would be good for the left). That would be the inevitable result of a Trump victory. Even a creditable defeat, which would be blamed on the old establishment, could leave the tribalists in control of the organization.

The only groups where the #NeverTrump analysis seems to hold sway are the business donor class and the remnants of the rightwing intelligentsia (hard to believe they were carrying all before them only 20 years ago). The donors obviously have no interest in throwing money at someone like Trump. As for the intelligentsia, even if they were willing to embrace Trump, it’s obvious he has no use for any but the most total hacks, and not even many of those.

The two-party preferred fallacy

John Quiggin17 Comments

Back in the 1970s, when the idea of analyzing voting and poll results in terms of the “two-party preferred vote, it was a major advance. Even though Australia has had preferential voting since (I think) 1921, it was poorly understood, to the point that when a candidate or party with plurality of votes lost on preferences, it was seen as a source of justified grievance (not helped by the fact that both the DLP and the Australian Democrats were splitoffs from a major party that aligned mostly with the other major party).

But that was in the days when Parliaments (or at least Lower Houses) were almost invariably made up solely of members of the major parties. Just as in the 1970s, the facts have changed but concepts haven’t caught up with it. Even though it’s now very common for the government to have a minority of seats, and such governments have worked very well, pundits still treat this outcome as an aberration, a “hung Parliament”. This is reflected in the continued use of the two-party preferred measure, which presumes that the last two candidates in any electorate, after preferences are distributed, will be those of the major parties. So, for example, Green votes for Adam Bandt are allocated between Labor and Liberal parties and used to forecast the election outcome, even though Bandt’s preferences will never be distributed.

There are various ways this could be fixed. The ideal one, in my view, would be to replaced “two-party preferred” with a seat-by-seat allocation of votes to “two most preferred”. That would need big samples to be reliable, but there are a variety of techniques that could be used to mitigate the problem.

The big benefit of this is that we could then see whether or not the poll was predicting an outright majority for one party. Assuming equal luck in marginal seats, a poll giving more than 50 per cent of the “two most preferred” vote to one party would imply a majority of seats for that party.

My reading is that most of the current polling yields a deliberative (or, as our pundits persist in describing it, “hung”) parliament as the central estimate, with enough error to allow either side the chance of majority. Given the likely alignment of independents and Greens a deliberative parliament would probably allow the formation of a Labor minority government. That raises the thorny question of the relationship between Labor and the Greens, which I will deal with in another post if I get time.

Minimum wages and predistribution: Extract from Economics in Two Lessons

John Quiggin44 Comments

A bit out of order, this is another draft extract from my book-in-progress, Economics in Two Lessons. It’s part of the chapter on income distribution, meant to follow the section on unions, and precede the Australia-US data point and the discussion of corporate profits [links to CT, but all published here also]. After this, I plan to conclude the “predistribution” part of the chapter with a discussion of intellectual “property”, then move on to “redistribution” through taxation and public expenditure.

As always, encouragement is welcome, constructive criticism even more so.

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Predistribution and profits: extract from Economics in Two Lessons

John Quiggin14 Comments

Over the fold, another extract from my book-in-progress, Economics in Two Lessons. Encouraging comments appreciated, constructive criticism even more so.

Predistribution and profits

As we’ve seen in previous sections, the social constructions of property rights and institutions surrounding employment makes a big difference to the determination of wages and working conditions. These social constructions affect ‘predistribution’, the distribution of income and wealth that arises before the effects of taxes and public expenditure are taken into account.

Predistribution is equally relevant to the other big source of personal income: profit derived from private businesses and corporations. Without legal structures designed specifically to protect businesses from the risks of failure, profits would be far less secure, and the difficulty of establishing and running a business much greater. Corporate profits are not a natural outcome of a market society, but the product of specific structures of property rights introduced to promote corporate enterprise.

The risks of running a business in the 18th century, and well into the 19th, were substantial and personal. There was no such thing as bankruptcy: a business failure meant debtors prison, where debtors could be held until they had worked off their debt via labor or secured outside funds to pay the balance.

After a brief and disastrous experiment in the early years of the 18th century (the South Sea Bubble), joint stock companies were also viewed with grave suspicion.

The prevailing view was Quoted in John Poynder, Literary Extracts (1844), vol. 1, p. 268. [1]

Corporations have neither bodies to be punished, nor souls to be condemned; they therefore do as they like.

This is often misquoted as

“Did you ever expect a corporation to have a conscience, when it has no soul to be damned, and no body to be kicked?

Adam Smith was similarly scathing, though with more of a focus on the principal-agent problem

The directors of such [joint-stock] companies, however, being the managers rather of other people’s money than of their own, it cannot well be expected, that they should watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over their own…. Negligence and profusion, therefore, must always prevail, more or less, in the management of the affairs of such a company.

Exceptions were made only for specially authorised quasi-governmental ventures like the East India Company, focused on foreign trade. In general, limited liability companies were not permitted in Britain or most other countries. The partners in a business were jointly liable for all its debts.

These same rules applied in Britain’s American colonies and continued to prevail in the United States until the middle of the 19th century. The introduction of personal bankruptcy laws put an end to debtors prison, greatly reducing the risks of running a business. The creation of the limited liability company was an even more radical change.

These changes faced vigorous resistance from advocates of the free market. David Moss, in When All Else Fails, his brilliant history of government as the ultimate risk manager, describes how the advocates of unlimited personal responsibility for debt were overwhelmed by the needs of business in an industrial economy. The introduction of bankruptcy and limited liability laws took much of the risk out of starting and operating a business.

By contrast, in Economics in One Lesson, Hazlitt doesn’t mention limited liability or personal bankruptcy and seems to assume (like most defenders of the market) that these are a natural feature of market societies. More theoretically inclined propertarians have continued to debate the legitimacy of bankruptcy and limited liability laws, without reaching a conclusion.

This debate over whether bankruptcy and corporation laws are consistent with freedom of contract is really beside the point. The distribution of income and wealth is radically changed both by the existence of these institutions and by the details of their design. In particular, the massive accumulations of personal wealth made possible by capital gains from share ownership would simply not exist. Perhaps there would be comparable accumulations of wealth derived in some other way, but the owners of that wealth would be different people.

A crucial policy question, therefore, is whether current laws and policies relating to corporate bankruptcy and limited liability have promoted the growth of inequality and contributed to the weak and crisis-ridden economy that has characterised the 20th 21st century. The combination of these factors has produced absolute stagnation or decline in living standards for much of the US population and relative decline for all but the top few per cent.

There can be little doubt that this is the case. As recently as the 1970s, a corporate bankruptcy was the last resort for insolvent companies, typically leading to the liquidation of the company in question. As well as being a financial disaster, and a source of shame for all those involved. For this reason, nearly all major companies sought to maintain an investment-grade credit rating, indicating a judgement by ratings agencies that bankruptcy was, at most, a fairly remote possibility.

Since that time, bankruptcy has become a routine financial operation, used to avoid inconvenient liabilities like pension obligations to workers and the costs of cleaning up mine sites, among many others. The crucial innovation was “Chapter 11”, introduced in the Bankruptcy Reform Act of 1978.

The intended effect of Chapter 11 was that companies could reorganise themselves while going through bankruptcy, and re-emerge as going concerns. The (presumably) unintended effect was that corporate managers ceased to be scared of bankruptcy. This was reflected in the spectacular growth of the market for ‘junk bonds’, that is, securities with a high rate of interest reflecting a substantial probability of default. Once the preserve of fly-by-night operations, junk bonds (more politely called ‘high-yield’) became a standard source of finance even for companies in the S&P 500.

At the same time, legislative changes and the growth of global capital markets greatly enhanced the benefits of corporate structures, while eliminating many of the associated costs and limitations. At the bottom end of the scale, the ‘close corporation’ with only a handful of shareholders, became the standard method of organising a small business. This process was aided by a long-series of pro-corporate legislative changes and court decisions (notably in Delaware, which has long led the way in this process, and where vast numbers of US companies are incorporated). At the top end, the rise of global financial markets from the 1970s onwards allowed the creation of corporate structures of vast complexity, headquartered in tax havens and organised to resist scrutiny of any kind.

At the behest of these corporations, governments have negotiated agreements supposedly designed to ensure that corporate profits are not taxed twice in different jurisdictions. In reality, using a combination of complex corporate structures and governments (notably including those of Ireland and Luxembourg) eager to facilitate tax avoidance in return for a small slice of the proceeds, the effect has been to ensure that most global corporate profits are not taxed even once in the countries where they are earned.

What can be done to redress the balance that has been tipped so blatantly in favor of corporations. The obvious starting point is transparency. Havens of corporate secrecy, from Caribbean islands to US states like Delaware must be made to reveal he true ownership of corporations, in the same way that tax havens like Switzerland, used mostly by wealthy individuals, have been forced to disclose the ownership of previously secret accounts.

The use of complex corporate structures to avoid tax is a much more difficult problem to tackle. Some measures are being taken to attack what is called “Base Erosion and Profit Shifting’, but past experience suggests that slow-moving processes of this kind will at best keep pace with the development of new forms of avoidance and evasion. It’s necessary to re-examine the whole structure of global taxation agreements. Instead of focusing on the need to avoid taxing corporate profits twice, the central objective should be to ensure that they are taxed at least once, in the place where they are actually generated.

More generally, though, the idea that corporations are a natural part of the economic order, with all the human rights of individuals, and none of the obligations needs to be challenged. Limited liability corporations are creations of public policy, useful to the extent that they promote the efficient use of capital but dangerous to the extent that they facilitate gross inequalities of income and opportunity.

Identity crisis (repost from 2014)

John Quiggin17 Comments

When I posted the following piece two years ago, I didn’t suppose it would be enough to kill the absurd idea that “most Australians pay no net tax”. But, given its obvious kinship with Mitt Romney’s disastrous “47 per cent” catchphrase, I felt sure that hardheads on the political right would kill it off before it lined them up on the losing side of a class war.[1] Not for the first time, I was wrong. So, here’s a reprint.

In the latest issue of Gerard Henderson’s Sydney Institute Quarterly, Adam Creighton, economics correspondent at the Oz, “explains why most Australians pay no net tax”. That’s a striking conclusion, so I checked it out. Creighton has discovered that most Australians get about as much back in transfer payments and public services as they pay in taxation. The poor get a bit more, and the rich a bit less.

To save Creighton some work in future, can I suggest he consider the budget identity constraint “Expenditure = Income”. Since the government spends on services and transfer payments roughly the same amount as it raises in tax revenue[2], it’s obvious that, for the average Australian the same identity must hold, with income renamed as “tax paid” and expenditure as “transfer payments and public services”.

Next up: Why there is no net travel into the CBD

fn1. Romney wasn’t silly enough to push this line in public. He got caught using it at a donors meeting, when someone secretly filmed him.

fn2. Taking account of the seignorage from inflation, returns on assets, intertemporal transfers through debt etc, this rough equality becomes an identity. Please, no arguments about deficits, and especially about MMT. The point of this post is a really simple, and doesn’t need this kind of complication.

Why is global finance so profitable (crosspost from CT)

John Quiggin21 Comments

In a recent post, I asserted that

activities like tax avoidance/evasion and regulatory arbitrage aren’t peripheral flaws in a financial system primarily concerned with the efficient global allocation of capital. They are the core business, without which the profits of the global financial sector would be a tiny fraction of the $1 trillion or so now reaped annually

As I’m working on income distribution issues my long-running book project, this seems like a good time to see if this claim can be backed up by hard numbers.

First up, here’s my source for the $1 trillion number (actually $920 billion). As a plausibility check, I’ve tried to estimate the total size of the global financial sector. Various sources, including Wikipedia estimate that the banking and insurance sector accounts for 7-8 per cent of US gross product. Extrapolating to world gross product of about $80 trillion that would give around $6 trillion for the total size of the sector. The US is almost certainly more financialised than the world as a whole. Still, the profit number looks about right. A trickier question is whether the rents accruing to managers and top professional in the sector should be counted as part of profits. I’d guess that these rents account for at least another $1 trillion, but I have no real idea how to test this – suggestions welcome.

Is tax avoidance/evasion and regulatory arbitrage a big enough activity to account for a substantial share of a trillion dollars a year? Gabriel Zucman estimates that there’s $7.5 trillion stashed in tax havens, of which around $6 trillion is untaxed. He estimates the tax avoided at $200 billion . I’ll estimate that half of that ($100 billion) is creamed off in financial sector, mostly as profits or rents. That implies a profit margin of a bit under 2 per cent, which seems reasonable.

Tax evasion by wealthy individuals is only a small part of the story. Legal tax avoidance is almost certainly more important. Most of that involves companies, but it’s important to distinguish between “close” corporations, which hide the activities of an individual or family and large global corporations. I don’t have any idea how to measure the cost of avoidance through close corporations. As regards global corporations, Zucman estimates that “a third of U.S. corporate profits, or $650 billion, are purportedly earned outside the country, with a cost to the US of $130 billion a year . Extrapolating to the world as a whole, that would be at least $500 billion. Again, assuming the financial sector creams off half of the sum, we get $250 billion (the fact that the finance sector itself accounts for around 40 per cent of all corporate profits means there’s a problem of recursion that I haven’t worked through)

Then there’s manipulation of exchange rate and bond markets. I have no idea how to measure this, but given that the notional volume of trade in some of the markets concerned is measured in the hundreds of trillions, it seems plausible that the profits and rents from market-rigging must be at least in the tens of billions.

These are probably the biggest scams, but there’s also regulatory arbitrage, privatization (a huge source of rent over recent decades), domestic tax avoidance and more.

Adding them up, I’d suggest that $500 billion a year is a low-end estimate for the profits and rents associated with various forms of anti-social financial sector activity.

There’s lots of potential error around these numbers, but the order of magnitude seems reasonable to me. As against the claim that the explosion in financial sector activity and profits over the past 40 years has been driven by the benefits of a more efficient allocation of capital by rational markets, the claim that it’s all about tax-dodging and socially unproductive arbitrage seems pretty plausible.

Obviously, the social cost of a financial system devoted to undermining tax and regulatory systems far exceeds the profits earned from the activity. That’s true of any kind of socially destructive, but privately profitable, activity. But the problem is greater in the case of financial sector activity because of the disastrous effects of financial crises.