Why the neo-Thatcherites’ gamble is doomed…

“Trickle down economics never existed in the first place, just in the minds of those who don’t like tax cuts” said a friend of a friend, citing a 2015 Spectator article by Thomas Sowell on the same subject.  He proceeded to describe the “basic premise of conservative economics [as being] that the most effective way to help people out of poverty is to grow the market, [which] creates opportunity for people on the lowest rungs to earn wages”, which sounds suspiciously like trickle-down economics to me.

I studied ‘A’ Level Economics from 1989 to 1991, from Thatcher’s heights through her downfall, and proceeded to study Economics at Queen’s.  I say study, but the truth is that at the age of 49, I have still not learned how to study.  However, we studied 1980s economic policy in considerable detail in class, and I have held this knowledge ever since.

The conventional thinking of the time was reducing tax burdens on the rich would have two effects:

  • The rich would choose to use spare cash thus released to invest in job creation
  • The rich would be less likely to use tax avoidance schemes and therefore tax revenues would be maintained or increased – the so-called Laffer Curve.

Inconveniently, both were shown in the 1980s to be true.  Spare cash released was pushed into new jobs, and tax revenues were maintained or increased.  In addition, the evidence points towards this “supply side economics” leading to lower inflation than that which results from putting money in the pockets of those who are short.

In addition, inflation was largely controlled by the expedient of interest rates to encourage saving and discourage borrowing as required, a measure which broadly worked from 1990 until the 2008 crash.

Surely something that worked in the 1980s and which was seen to be true then must still be true today?  If not, why not?

Everything has its limitations

If you cut taxes too much in the first place, then those with spare cash are going to run out of things they would like to spend money on.

There are people who consider tax to be something to be avoided at all costs, and to pay a penny more than absolutely essential is anathema, and no amount of tax cuts will change their behaviour.

I can’t remember if we got that far when I was still at school, but certainly within a few years, it became clear that a 40% income tax rate did not have the benefits proclaimed.  The law of diminishing returns – the reality that life is not compound interest, and for many things, the more you do something, the less will be the response.  If you cut taxes too much, tax revenues will fall; if business owners are content for the time being with the extent of their business interests and that it offers enough profit to them, they will simply not bother to invest.

And then there are the markets

As we have seen, one of the options when you have spare cash is to play the stock market and generate wealth in that way.  Always risky, but if you are trying to increase your wealth, it can be more effective than investing in jobs with lower returns. [Shorting the pound?-Ed] Indeed…

2020s context

There are several issues in 2022, and COVID, Ukraine and the cost of living crisis are only three of the issues at hand.

Interest rates

Interest rates have been historically low for years, not having been above 0.5% since March 2009, and to be honest, they have been artificially low.  The shock of what in a historical context is a modest increase in interest rates is massive, because a change in interest rates from 2% to 4% will double the interest payable, and a change from 10% to 12% will only increase the interest payable by a fifth.

Inequalities

I class this as 2020s context because this has got worse.  The rich have got richer; the poor have been left with increasing numbers of minimum wage jobs where there is no reward for hard work because you get paid the same amount as the worker beside you who does the bare minimum.  There is too little incentive to excel, and too much incentive for mediocrity.

Social responsibility

Ah, social responsibility.  What held society together: the responsibility to look after the have-nots and to ensure that others could be the best, the recognition that when all have the real ability to excel, the country will be best.  Gone in favour of a libertarianism that puts others last and self first [maybe first, last and everything?-Ed], and which disgraces what still occasionally purports to be “Christian” Britain which ignores the bits of the Bible it doesn’t like just so it can dutifully be seen in church for elections and state occasions.

How efficient can you be?

An essential element of Thatcher’s scheme was tight fiscal policy, whereby current spending was largely met by current taxation.  A recurring theme has been unending “efficiency savings” which is one of the worst pieces of doublespeak I can imagine.  Yes, there were efficiency savings to be made, and they were made without impacting on service, but you cannot expect to keep making “efficiency savings” indefinitely.  I am struggling to think of an “efficiency saving” in the last 30 years which has not resulted in a reduction of service – indeed, I wonder how many budget cuts have resulted in proportionately larger service cuts because the overhead has already been pared to the bone and the resilience to cope with shocks is gone.

Privatisation has not helped with this, and with this comes a hint of what’s to come.  It is of course true that privatisation leads to lower costs, because that’s an essential element of profit.  However, it does not lead to lower prices, because businesses will always maximise price subject to what the market will pay.

A note on supply and demandSupply and demand curves diagram showing equilibrium point

In Economics, we talk about equilibrium – the point where businesses produce an amount of a good at a price that suits them and suits the public to the extent that the public will clear them out.   Businesses can price above equilibrium, but if they want to make their desired profit, they will sooner or later have to cut prices to a level the market will pay.

The higher the price, the more profitable, and the more you’re willing to put in to produce it rather than something less profitable.  The lower the price, the more people who will buy it.

So far so good, but we also talk about elasticity of supply or demand.  For businesses, price elasticity of supply means how a change in price affects how many they are willing to sell, but the main one that interests us here is price elasticity of demand.

Price elasticity of demand basically means whether, if the price goes up, you will keep buying something anyway, especially essentials such as food, heat and light [what about beer?-Ed] maybe not essential as such, but yes, people will fork out for their preferred beer even if the price goes up.  The rise of 30-60% in the price of milk in the early part of this year was a perfect example, and would have been reasonable if the farmers were going to have the historic problem of the inadequate price they receive addressed – but is symptomatic of price inelasticity of an essential [like petrol and diesel-Ed] Exactly.

Won’t the market provide?

Yes, the market will provide anything you want, but it will not necessarily be at a price that you can afford.  I’ve talked about bus privatisation in the past, and one of its effects was that a lot of loss-making services in GB were withdrawn because the local council could not afford to cover the cost of fuel, staff and maintenance for the bus companies to operate them.  Profit can become one of the most serious inefficiencies in the market because it adds to the customer’s costs.

However there is a far bigger problem than even the diminishing returns of cutting taxes and expecting economic growth to result, and it is simple rationality.

The business of a company

“It’s obvious.  If we cut taxes for the rich, they will make lots of jobs to sell lots of things to make lots of money.”

“Who to?”

“The market of course.  There’s a whole market out there to be sold to.”

“Out where?”

“Out in the streets of the United Kingdom, out in the streets of France, Germany, the US… you name it.”

Except… the streets of the United Kingdom are lived in by people struggling with the cost of living.  There is no market for extras once you’re in debt in a vain attempt to cover food, heat and light [and the cost of travelling to work-Ed] Indeed…

Except… Brexit, particularly the failure to agree consumer, veterinary and phytosanitary standards, has had a deleterious effect on the ability of British businesses outside Northern Ireland to sell their goods competitively in the EU.

Except… this trading bloc is small.  That trading bloc is far away [Yes, Ted-Ed]

It is a fallacy to think that supply-side economics – putting more money in the hands of the rich – will lead to more jobs if you are simultaneously allowing demand to be constrained by the cost of living and international red tape.  Businesses and their owners need to see a path to profitability, they need to know that what they put on the market at a loss in year one will recoup their outlay reasonably quickly or they will go out of business.

To expect jobs to be created when the market for goods and services is compromised is irrational.

Speaking of red tape…

The Government’s big bonfire

Kwasi Kwarteng promised that environmental protections would not be slashed in the proposed 38 investment zones, only “red tape”.  One wonders which bit of red tape doesn’t involve environmental protections, given that planning rules are proposed to be “swept aside“.

Environmental, social, consumer and worker protection measures – the usual meaning of “red tape” – save money in the long term.  You don’t have to replace or compensate workers injured at work, and you don’t have to compensate injured consumers after selling dangerous goods. Especially with regard to plans to change farm subsidies back to acreage rather than use of land, environmental protections lead to wiser use of resources rather than exhausting land – remember set aside?  Yes, the Brexit bonus of rewarding environmental care of land torn up to be replaced with an acreage scheme like the one we escaped from.

Increasing tax avoidance

The use of shell companies to collect income that should have been paid personally was the subject of the IR35 off-payroll worker rules, which have not been without problems, but their intention was to force people who had been avoding tax to pay a similar amount to those paid in the normal way.  Abolishing the plug in this loophole, however imperfect the plug, instead of fixing it, obviously reduces tax revenues.

This is despite decades of diversion of tax take from higher rate income tax payers to low paid VAT payers.  Yes, poor people pay proportionately less VAT than richer people, but this brings in affordability.  I remember a past Tory Chancellor stating that an increased tax take would be evenly spread among taxpayers, ignoring one simple fact.

If you ask someone earning £1000 a month to pay an additional £50 each month in tax, and you ask someone earning £10,000 a month to pay an additional £500 in tax, who you think will notice more?  Is it the richer person who has to pay £500 extra each month to the exchequer instead of investing in the stock market, or is it the part time worker struggling to make ends meet and is asked for £50 which they had set aside to spend on school uniforms?

Same percentage, vastly different impact.

Plus one slight problem.

If you cut taxes, that becomes the new normal.

In the 1980s, taxes were cut but revenues increased and investment increased until those who benefited from the tax cuts ran out of jobs they wanted to invest in.

If taxes increase, instead of reducing the amount invested in what economists call savings – such as the Stock Market – it’s job investment which loses out.

The markets have their say again

If you have five maxed out credit cards and go to the bank to ask for a loan not to consolidate but to borrow even more, the bank manager won’t need to carry out a credit reference check to refuse you a loan.  It isn’t quite the same for the country, but the Government’s plans rely on the markets’ willingness to buy bonds at an affordable price. The less faith the markets have, the less they will be prepared to pay for a bond to support the Government’s unfunded tax cuts.

This was also behind the run on the pound on Friday, where it lost 5 cents against the dollar and 2 cents against the Euro which continued to climb against the dollar.  These are marks of lack of confidence in the UK Government, compounded by reported short selling – betting on a fall in the value of sterling.

In addition, every country in the world has a credit rating issued by agencies such as Standard and Poor, Fitch and Moody – the UK lost its top AAA rating the day after the Brexit referendum.  If the big three rating agencies do not have faith in the UK’s ability to meet its obligations, all the pleadings of Liz Truss and Kwasi Kwarteng won’t help.

Competition?  What competition?

Another thing to be pointed out is that the tax measures conflict with competition and innovation.  If the cost of living crisis means that the only people who actually benefit from a tax cut are very rich, then people with new ideas but less income will continue to be stuck in the quagmire of not being able to save money to start their own business.  The effect of that is to maintain barriers to entry to the market by people who have devised better ways to do things, thus protecting the existing oligopolies.

So what of Sowell?

Sowell’s consideration was that what we call trickle-down economics is not the transfer of wealth, but the creation of additional wealth.  The benefit is the additional jobs created, and the workers must be paid before the profits flow upward at a later date – if at all.

Yet, this is faulty.  When the profits come, who benefits?  Is it the people who created the profits who are rewarded?  Is it even the operational managers who can get the best from their staff?  No – it is the shareholders who become richer, not the people whose effort created the wealth.

Of course shareholders should expect dividends, but it is one of the inefficiencies of the private sector, and I have read stories recently of companies who have paid dividends despite substantial losses.  Another is the preference to eliminate competition, which protects inefficient but profitable ways of doing things against people who can do better.

Conclusions

Some might argue that it is chicken and egg – that if you supply the right goods and services, people will buy them, but this is not the 1980s.

There is not a core of employed people to constitute a market of people who will buy what you put before them, because of the reach of the cost of living crisis.  There isn’t spare cash to buy things now, and we might even see more groceries and less non-grocery in our supermarkets.

To the extent that supply-side economics ever worked, it has always required demand.  Without that demand, there is no incentive to invest; without investment there are no new jobs; without new jobs, there will continue to be no demand.

And demand facilitation, together with fiscal responsibility, is entirely absent from the mini-Budget.  For all that I despised Thatcher’s policies, this was a mistake that the Iron Lady, the hero of Truss and Kwarteng, would never have made.

Author’s note: I have not miraculously become a Thatcherite, but this article outlines some of the key reasons why Thatcherism did what it said on the tin, and why what I think we should call neo-Thatcherism will not.

I continue to advocate social justice, whereby, amongst other things, innovators and others aren’t prevented from entering the market and making all our lives better by bringing their ideas to reality; where those who go the extra mile can expect to be duly rewarded; where those who cannot work are safeguarded and looked after; and where everyone who has paid their taxes properly, charged their customers fair prices and paid their suppliers and staff fairly, can go and enjoy their wealth as they please without the rest of us getting in the way.

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