Sunday, 21 February 2010

Agreements and disputes: Tim H and Chris D

Tim Harford's on a couple of rants this weekend: a light-hearted bitch about non-mathematical economists alongside a more serious argument against the "Robin Hood tax" (a much catchier, or perhaps I should say Orwellian, name for the Tobin tax).

I'm with Tim on this one. There's a typically Curtisian video on the front page of the campaign's website (about as blatantly manipulative as the director's better-known work, Love Actually, and with about the same amount of factual content). It attempts to put across the idea that the tax is simultaneously tiny and huge - small enough to have no impact on financial efficiency while being large enough to solve all the world's problems at home and abroad.

Tim makes the case against it pretty well - here's a key example:
For instance, I might buy car insurance which could – if I knocked somebody down and permanently disabled them – trigger a payment of £1m. My insurance company might want to reinsure that million-pound risk, a perfectly sensible, socially useful and non-speculative transaction. But at a “tiny” tax rate of 0.05 per cent, that’s a £500 tax on a face value of £1m. It’s hard to imagine such a tax wouldn’t somehow affect my premium.
The basic point here is that a transaction with a value of £1 million doesn't necessarily mean anyone makes a £1 million profit. It doesn't necessarily mean that some plutocrat is trading £1 million of platinum futures in order to buy themselves a new yacht; the economic value of the transaction may only be a few pounds. You might ask why the markets are so leveraged that a nominal instrument priced at £1 million is only worth £10, but this is to misunderstand the nature of financial markets.

Finance aggregates the risks, liabilities, assets and profits of hundreds of millions of people, each of whom has only a tiny stake in the whole. This is the only reason we can even get an insurance policy to protect us against such risks. It's the reason that small shareholders can finance huge infrastructure projects; and it's the reason that specialised companies can exist which serve just a few hundred customers out of a worldwide market of billions.

Now you could always make an exception in the tax for transactions like the one Tim described. But then, the insurance company could also restructure its transactions to have a lower face value. One possibility - instead of trading a security with a £1m face value, simply sign a letter saying that if certain conditions are met, then you'll trade that security. Another option - insurance companies are priced out of the market and only huge reinsurance companies can afford to provide car insurance. Even though the same transaction is happening, because it's done internally within the company, with no money changing hands, they don't have to pay the tax.

The nominal value of a transaction is arbitrary - it depends entirely on how the deal is structured and there is no doubt that people would immediately find ways to reduce nominal deal size without affecting the reality of what's going on. Any of these routes would make the market less efficient, but would avoid or reduce the tax take.

The essential principle is that taxes should only be levied on the economic profit from a transaction and not its nominal value. If the Robin Hood campaigners want to simply argue for a tax on banks' profits to support poverty reduction, I'll sign their petition. But if they continue to pretend that this magic tax will somehow come for free, without harming our economy or the growth that saves jobs and increases incomes, they won't get any support from me or most of the economics discipline.

And I was quite amused by this little effect - Google obviously hasn't quite caught up with Bill Nighy yet:



Someone else with whom I normally agree has surprised me this weekend with two postings that I don't get at all. Chris Dillow says first that:
The only way the taxpayer can gain by selling bank shares is if they are sold at an over-inflated price, such that subsequent returns on them are lower than the returns to gilts.
So, let’s be clear. What Osborne is proposing here is nothing other than a Russian-style privatisation* - the plundering of public assets for the benefit of friends of the government.
This is a rather simplistic view of the capital markets. Like any form of ownership, owning shares is not a neutral portfolio matter, but can change people's behaviour. The reason that governments subsidised home ownership in the old days was not some foolish fallacy of composition - some people choose to own a home, therefore it's good for everyone to own homes - but because ownership gives people a stake in their community, encourages investment and increases social cohesion.

Of course home ownership is not an unalloyed good, and the subsidy in that case was probably overdone. But you can hardly argue that it made no difference to anybody's behaviour.

The same with share ownership. Rightly or wrongly, the intention - just as with the big privatisations in the 1980s - is to change culture and behaviour by altering how people relate to their savings and to public companies. The attempt might not be successful, but it isn't by any means a pure money transfer.

More bizarrely, he extrapolates from his personal claim never to have met anyone interesting in a cafe, to an assertion that cities are no good for innovation, knowledge spillovers or growth. I am astonished by this. I spend about a third of my work time in meetings, workshops, conferences and other conversations that would never happen if I were based outside of London; and perhaps the same proportion of my leisure time meeting and talking to people that I'd similarly never have met. The knowledge and ideas that are exchanged and created in these interactions are manifold.

Of course it's no more valid for me to base this argument on my own personal experience than it is for Chris; but it isn't controversial to claim that these kind of conversations are happening all over London and other big cities, all the time. There is a reason people come to the cities to work, and there's a reason GDP per head is far higher in central London than anywhere else in the UK. This seems to be one case in which the conventional wisdom is exactly right, and the contrarian view is just contrary.

1 comment:

PunditusMaximus said...

Interesting variant on "if the market does it, that means it's good." Isn't one of the fundamental causes of our current crisis that financial markets are currently essentially gambling outlets, rather than vehicles for allocating capital?