[I should mention before I start that all of the figures in this afterword were chosen for ease of calculation. Any resemblance to reality is purely coincidental (and unlikely).]
Politicians rarely understand economics.
That isn't too surprising. Economics is one of those fields that is actually quite hard to define, let alone follow and control. Time after time, people make economic decisions, based on something that sounds like logical thinking, and discover that the real world simply doesn't work like that. On paper, the grand economic plans the Soviet Union produced were perfect – it was reality, the planners concluded, that was wrong. Of course, there's only so far you can go before reality knocks you down.
The problem with intellectuals, as a general rule, is not that they’re stupid. There are plenty of very smart intellectuals. The problem is that intellectuals can fall into the very simple trap of mistaking theory for reality. To borrow a line from Sherlock Holmes, when you make theories before you have facts, you start twisting the facts to fit the theories – as opposed to the other way round. Communism, for example, was the brainchild of Karl Marx, one of the world’s intellectuals. In practice, communism fails spectacularly every time it is tried. And yet the intellectuals will asset that communism hasn’t failed, it just wasn't done right.
It’s quite easy to be seduced by a good-sounding theory. Witness, for example, the colossal market for management trends. Or military theories such as ‘the bomber will always get through,’ ‘battleships rule the seas’ or even ‘shock and awe saves us from mass troop deployments.’ The problem, of course, is that such theories can be misleading and often cause major problems for anyone who believes them uncritically.
When it comes to economics, there are millions of theories. How many of them have really been tested? And how many of them are understood by the governments?
Let me start with a simple statement and go on from there. People respond to incentives and disincentives. If someone sees an offer for 50% off dinner, that’s an incentive to go to that particular place to eat. On the other hand, if the restaurant is hugely expensive instead, that’s a disincentive to anyone with one eye on their pocketbook.
This applies almost everywhere – and not just in economics. If one provides support for unwed mothers, expect a rise in the number of unwed mothers. Why not? The incentives they are offered make the best choice for them personally not to wed. People are governed, largely, by rational self-interest. They will do what is in their own best interests, as they see them, and not what might be in society’s best interests.
Politicians tend not to understand that, simply because politicians (like aristocrats or the very wealthy) are largely insulated from reality. The money they distribute in the form of tax-funded endeavours doesn't come from their pocket, it comes directly from the taxpayer. This has two dangerous effects; it convinces many of them that the government can pay for everything and it blinds them to the dangers of taking too much money.
I shall start with a simple (and partly silly) example to illustrate my point.
Let us assume, for the sake of argument, that Fred wishes to open a business selling homemade cakes. He can just do it, right?
Well, no – he needs to do some planning.
First, he needs the tools of his trade. He needs bowls, spoons, mixers, a cooker and whatever else is needed to actually make cakes. Let us assume, for the sake of argument, that all of this costs £1000. Second, he needs a shop, where he can both sell cakes and produce more. The deposit is another £1000 and the monthly rent is £100. Third, he needs working materials. We will stipulate that a month’s supply of everything he needs, from flour to baking powder, is £1000.
His first investment, therefore, looks a little like this:
Tools - £1000
Shop - £1100
Materials - £1000
What that means, in essence, is that he must be prepared to pay £3100 before he actually starts producing cakes. Fred cannot start from nothing. He must spend money before actually making money.
However, we’re still not done. Next month, he will have to pay:
Shop - £100
Materials - £1000
On the face of it, it seems that once he has met the first investment, he can get away with paying £1100 every month. This is not, of course, entirely accurate. What happens if he breaks a tool, something that will happen sooner or later. Let us assume that he needs to have at least £200 ready to replace lost or damaged tools. Failure to have this ready may well mean that he can no longer cook, therefore destroying the business when he runs out of cakes.
So his monthly requirement ranges from £1100 to - £1300.
It is a basic law of small business economics that you cannot spend more than you earn. If Fred, each month, earns a gross (before tax, running costs, etc) profit of precisely £1300, he won’t be making any profit because all of his earnings are going directly to replace what he spent to start the business in the first place. If Fred earns £1500 each month, he will have a net profit of £200 per month and a yearly profit of £2400 (assuming that there are no unanticipated costs.)
This is important because Fred isn't making cakes out of the goodness of his heart. Oh no, he wants to run a business. His incentive to produce cakes is the lust for profit, for money he’s earned with his sweat and blood.
From all this, we can draw another economic law. Businesses that can’t pay their own way will go bust, eventually.
What, you might reasonably ask, does this have to do with governments?
The fundamental problem is that governments cannot, as a general rule, create economic growth. If that was possible, the communist nations would have worked splendidly. In reality, politicians can do a handful of things to encourage economic growth, but the key to making it work is to do as little direct interference as possible.
What a government can do is discourage economic growth.
You might think that sounds insane – and you would be right. Why should a government wish to discourage economic growth? The bigger the economy, the more money can be skimmed off in tax and plunged back into working for the population. What sort of idiot would interfere with that? Absurd, right?
Politicians do interfere – and quite often, the results of their interference is to cause economic depression and, more dangerously, a lack of faith in the government.
One of the primary products of a government is bureaucratic paperwork. This is understandable; pretty much anyone, employed anywhere, will work hard to make it seem that they are indispensible. Given time, the bureaucrats, sometimes encouraged by their elected masters, will start sticking their noses into just about everything. And the cost of meeting their demands increases exponentially.
Go back to Fred’s baking shop for a moment. Let’s add another cost, the cost of complying with government regulations. Fred, being a baker, will know, better than any civil servant, that the regulations are largely nonsense. But he will not be free to simply ignore them. No, if he is caught ignoring regulations written by the ignorant for the fools, he will be fined, arrested and/or forced out of business. Let us assume that the total monthly cost for complying with regulations is £500:
Anyone seeing a problem here?
Monthly costs: £1600
Gross profit: £1500
Net profit: -£100
Put bluntly, Fred is in the red. He needs another £100 to meet his operating costs.
So ... what does he do? What can he do?
You cannot run a business at a loss indefinitely. Yes, if you have savings or a convincing reason to think that profits will improve in the future, you can endure for some time before it catches up with you. Fred’s business is doomed for two reasons; he cannot meet his costs and he isn’t making any profit. Why should he be putting forward the effort when he gets nothing out of it?
Regulations and taxes aren’t the only way the government forces business costs upwards and puts those who can’t meet them out of business. One example is the minimum wage, which is largely spun as being good for people just entering employment, who might well be paid peanuts if there wasn't a minimum wage. BUT ... if the cost of paying your workers gets too high, small businesses will have no choice, but to fire the workers. Or ... what if they’re expected to provide medical coverage for the workers? This is a tiny cost for a massive corporation, but lethal for a small business like Fred’s bakery.
This isn't the worst idea to come out of whatever politicians use for brains. One idea, from Hawaii, insists that anyone who buys a struggling business has to keep the old workforce. That doesn't sound like a bad idea, until you realise that the business might well have been struggling because it had too many workers and the new owners are stuck with them. In practice, business owners will probably end up letting their business collapse rather than trying to sell them to someone who might make them into a success.
The path to economic hell is paved with good intentions. In order to avert unemployment, one idea seriously proposed in France was to order business to take employees they didn’t want, let alone need. The costs would have been staggering. Or, to comply with new European Regulations, hundreds of British farms had to either make vast payments or collapse (most collapsed). Or, if that wasn't bad enough, liability became such a problem that the merest whiff of a lawsuit could ruin a small business, while large corporations had armies of lawyers to defend themselves.
Political interference is partly to blame for the problems confronting Europe right now. The blunt truth is that Greece, Spain, Portugal and – to some extent – Italy were ill-prepared to meet their EU requirements. Their financial sectors were effectively black holes; giving them access to lines of credit from the EU was foolish in the extreme. And yet that is exactly what the EU – after having managed to avoid doing due diligence – did. The results should not have been a surprise.
But, some critics will say, how can you trust the corporate lackeys to actually do the right thing without government regulation? Won’t an absence of regulation lead to outright chaos and mass exploitation?
To some extent, the critics have a point. There is a need for supervision of the economy. However, it needs to be strongly limited, based around ensuring fair play rather than trying to control and direct every last aspect of the economy. Furthermore, it needs to be watched to ensure that it doesn't inadvertently provide disincentives that prevent people from engaging in economic activity. Finally, it needs to be supervised to ensure that it doesn't create an army of assholes in suits who, like gangsters of old, walk around brandishing their credentials and demanding the equivalent of protection money from helpless businessmen.
Is there any way, therefore, that we can bring this monster under control?
Yes, there is – but I rather doubt that the politicians will implement them without being pushed.
First, remove the arbitrary power of civil servant bureaucrats. Little details like the precise details of a weapon (which can move it from legal to illegal) should not matter. Instead, the bureaucrats should make recommendations to a jury of citizens, who will decide if the complaint has merit. A small business owner threatened with a fine will have a chance to defend himself in front of his peers, instead of facing a mass of faceless bureaucrats who will hide behind the letter of the law and refuse to discuss specifics. I would go so far as to give that jury the power to order the bureaucrat sacked, if the complaint is silly enough.
As I have lectured before, arbitrary power is a dangerous weapon. It would be better to keep it out of an unaccountable person’s hands.
Second, reform the compensation culture, particularly by banning ‘no win, no fee’ lawsuits (at least against small businesses). Silly complaints (such as suing a company for a problem you yourself caused) not only to be thrown out, but actively punished.
This isn't to suggest that Fred, if he fails to keep his eggs cool overnight, should escape punishment. If he serves tainted fool and people get ill, then you can prosecute him! Make examples out of people too stupid to follow common sense rules like keeping the refrigerator cool and the smart ones will take sane precautions. It will work far better, I assume, than creating a situation where someone can hide behind the letter of the rules and ignore the spirit.
All of this, of course, requires a major infusion of common sense. I wish I could be hopeful.
Christopher G. Nuttall
Kuala Lumpur, 2013
PS. If you enjoyed reading this essay, read ‘The Voodoo Sciences.’ It’s well worth a read.