PsyFi Search

Wednesday 21 July 2010

Weightless Economies

Dangerous Economists

Although economists are generally a fairly harmless group there’s the ever present danger that they’ll get someone or other with some real power to actually listen to their beliefs. Once that happens we’re all potentially in trouble as the subtlety of the real-world gets lost in an economic miasma. A case in point was Selective Employment Tax (SET).

Introduced into the UK in the 1960’s it was a levy so self-evidently stupid even most of Britain’s notoriously supine representatives recognised its imbecility. Yet, backed with the imprimatur of one of the foremost economists of the day, the government went ahead and implemented it anyway in the quaint, old-fashioned belief that money earned through manufacturing is somehow “good” and that through services “bad” – just in time to miss the growth of the knowledge economy. Thus proving that the only thing worse than a politician with an idea is an economist with a Big Idea.

Balance of Payments Blindness

The idea behind SET was twofold – to fix Britain’s balance of payments deficit and to encourage manufacturing industry. Oddly, though, neither of these conditions is obviously an issue in need of resolution: essentially SET was a solution to a problem that didn’t really exist anywhere other than in people’s minds.

A balance of payments deficit isn’t necessarily a problem as long as you can pay the interest on the debt. Government debt isn’t like personal debt – countries, in theory, last forever and so, in theory, can their debt. The idea that countries should export more than they import was given the lie by Adam Smith in The Wealth of Nations:
“Nothing, however, can be more absurd than this whole doctrine of the balance of trade, upon which, not only these restraints, but almost all the other regulations of commerce are founded. When two places trade with one another, this doctrine supposes that, if the balance be even, neither of them either loses or gains; but if it leans in any degree to one side, that one of them loses and the other gains in proportion to its declension from the exact equilibrium. Both suppositions are false.”
Mercantilists and Protectionists

Smith was railing against the view of trade known as mercantilism, which believes that there are winners and losers from free trade and requires protectionist measures to protect a country’s interests. Of course free trade begets winners and losers at the corporate level, but not at the national one: therefore, it’s usually the corporate losers who demand trade barriers.

Yet two hundred years after Smith we find the British government was still in thrall to it. Not just did it seek a positive balance of payments as an “obviously” right thing but it also sought to boost manufacturing industry over services. These two issues are partially linked – manufacturers build goods which can be exported for hard currency, much more obviously than the export of services which tend to be invisible.


The solution proposed in sixties Britain was Selective Employment Tax: a tax on the employees of services companies with an offsetting bonus for those employed in manufacturing. In all honesty it’s hard to know where to start the criticism, so perhaps a few facts are in order. The government taxed all employees at source, so everyone had this deducted from their salaries. Manufacturing companies had to apply to the government for their refunds and bonuses, which meant a whole new bureaucracy had to be created to administer the tax and to make subjective decisions about which industries were involved in “manufacturing” and which in “services”.

The madness continued. A further group of employers were classified as neither manufacturing or services – agricultural groups, transportation companies and so on. These had to pay the tax anyway but then had to reclaim it. Most service companies promptly put their prices up, or laid off employees. And all of this was in order to encourage workers to move from service industries to manufacturing when the service industry had been employing people at a rate seven times in excess of manufacturing over the decade.

Kaldor's Virtue

The architect of SET was Nicholas Kaldor, a Hungarian economist who became advisor to a sequence of British financial ministers. Kaldor believed that:
“Those nations that developed their manufacturing sector embark on a virtuous cycle of productivity and income growth; in contrast, those nations specializing in agriculture or services will experience stagnating productivity and incomes, and a vicious cycle of decline.”
Kaldor's beliefs were based on empirical data, but with limited historical scope, and his academic theories about how economies really work. Unfortunately the love of hard manufacturing over soft services seems to be as much an emotional and psychological issue as one governed by hard, rational economics. There’s something about making real, physical things that somehow seems more valuable than the provision of what economists call “weightlessness”: services, not goods.

Weightlessness and Dematerialisation

Along with weightlessness comes the concept of dematerialisation: information is power, or at least money. Dematerialised objects are, in the jargon, infinitely expandable – if you read this article and find it useful (or not) then that makes no difference to whether it can be used by the next person or not. A bottle of wine, on the other hand, can be consumed once and only once, however pleasant the experience.

Dematerialisation brings its own problems – ideas are relatively easy and costless to generate but may be harder to protect, for instance. However, the weightless knowledge economy is the present and future of business as studies of the relative importance of services conclude:
“…that for growth, the services sector is the most important in all advanced economies. In economies with per capita GDP of at least US $5,000, the services sector accounted for more than 40% of that economy’s growth performance. In 80% of economies having per capita GDP of at least US $10,000, the manufacturing sector contributes less than 20% of that economy’s growth performance."
This, of course, is a world away from Kaldor’s dream of a British manufacturing resurgence yet you’ll still find leaders of countries pining for a way of re-establishing lost manufacturing glories. Probably this is because it’s harder to move manufacturing jobs – and votes – than services, but in the end it’s now ideas and knowledge that rule our world, not welding and riveting.

Away from the Ivory Towers

Kaldor was unquestionably an economist of genius but some ideas, no matter how good, simply can’t be made to work in the real-world. As Carole Nakhle records of him in Petroleum Taxation:
“… when other governments called on his advice and tried to introduce his ideas the results were catastrophic, leading in several cases to governmental overthrow, revolution and violence. For example there were riots in India when his tax advice was applied. In Sri Lanka there were also violent protests. In Mexico the government fell, also in British Guiana. In Ghana there was a coup, in Turkey, riots, in Venezuela a change of government – quite a record.”
Like so many of his ilk Kaldor seems to have been unable to translate theory into practical actions when faced with the nasty complexities of the real world. He also seems to have been fooled by his own knowledge of past glories, as he translated these into the basis for future success through a set of ideas that were outdated before they were even introduced.

Trust in Markets, Not Economists

SET was successful on its own terms: it helped push the British balance of payments into surplus and was a useful mechanism for government mercantilist policies. Sadly neither of these was really in the UK’s national interest because even as SET was pushing employees into manufacturing the rest of the world was dematerialising and setting the scene for an eventual British economic collapse.

The only certain judge of what people want are the free markets. Just because someone proclaims they’re a prominent economist gives them no more insight into the future than the rest of us. As so often, true insight comes from clear thinkers, not straitjacketed economists:
“He who receives an idea from me, receives instruction himself without lessening mine; as he who lights his taper at mine, receives light without darkening me.”
Take a bow, Thomas Jefferson.

Related articles: From the Railroad to the Internet ... and Back Again, Pulling up the Intellectual Property Ladder, You Can't Trust the Experts with Your Investments

1 comment:

  1. The only certain judge of what people want are the free markets. Just because someone proclaims they’re a prominent economist gives them no more insight into the future than the rest of us.

    I entirely agree with the second sentence.

    I kinda, sorta agree with the first sentence. The one problem I have is that it is sometimes necessary to interpret what the market is saying; the message is not always self-evident. In those cases, we end up using principles developed by our favorite economists to do so. The market might be trying to tell us something real, but we might not be hearing what we need to hear.