Making the Invisible Hand Visible:Reflections on the Political Economy of Freedom

Professor Hannes H. GissurarsonPorto Alegre 9 April 2013

Role of Political Economy

• To make the invisible hand visible, in other words to explain:

1. How one man’s gain needn’t be another man’s loss

2. How order can emerge without anyone issuing orders; spontaneous coordination

• Also to explain the state, especially unintended consequences of government actions

Parable of Good Samaritan

• Four overlooked lessons from the parable:• We need government to protect us from

highwaymen• We cannot trust the intellectuals, the priest and

the Levite• The Samaritan was a man of means; he could

afford to help• He did good at his own expense, not that of his

neighbours

Nature of the State

• Hegel: State is “March of God through History”• Totalitarian 20th Century: “March of the Devil

through History”• The fantasy of the benevolent despot• Process, not end-of-state: power tends to

corrupt, and absolute power corrupts absolutely• Process: people react to costs, produce less or

more, depending on system

Invisible Victims of Totalitarian State

Russian communists

Chinese communists

Other Asian communists

Other communists

German Nazis

0 10 20 30 40 50 60 70

Number of Victims

37 Million Soldiers Killed in Wars

The Big News: 21st Century Capitalism

• Not the financial crisis since 2008• The big news: BRIC countries, comprising almost

half the earth’s population, joined the world economy, participating in international capitalism

• With economic growth, hundreds of millions migrating into middle class

• Economic freedom has on average not decreased, after a rapid earlier increase

News of Capitalism’s Death Exaggerated

1980 1985 1990 2000 2005 20105.2

5.4

5.6

5.8

6

6.2

6.4

6.6

6.8

7

Index of Economic Freedom: World Aver-age

Economic Freedom in the BRICs

1970 1975 1980 1985 1990 1995 2000 2005 20093.5

4

4.5

5

5.5

6

6.5

7

BrazilRussiaIndiaChina

The Four Chinese Economies 2011

Singapore

Hong Kong

US

Taiwan

EU

China

0 10000 20000 30000 40000 50000 60000 70000

GDP/capita $

Seven Nordic economies 2010

Minnesota

South Dakota

Manitoba

Sweden

Iceland

Denmark

Finland

0 10000 20000 30000 40000 50000 60000

GDP/capita $

Swedes in Different Economies

Swedes in Sweden

Average US

Swedish-Americans

0 10000 20000 30000 40000 50000 60000

GDP/capita 2008 $

Capitalism still alive and kicking!

• International financial crisis reminded us that capitalism is subject to fluctuations, such as credit bubbles which inevitably burst

• But so is government: Lenin, Stalin, Hitler, Mao turned lives upside down

• Government made matter worse: subprime loans in US; low interest rates in US; Basel rules underestimating risks from mortgages and government bonds

• New financial techniques obscuring risks instead of spreading them

Moral Hazard of Banking

What is Unseen about Tax Revenue

• Tax revenue does not necessarily increase with the tax rate (Laffer Curve)

• With higher tax rates, people work less, switch over to untaxed activities, flee into the underground economy, invest less

• By over-taxing, government loses revenue• Switzerland and Sweden: almost same tax

revenue per capita, but different tax rates

Laffer Curve: Useful Simplification

0 6 12 18 24 30 36 42 48 54 60 66 72 78 84 90 96

Tax Revenue in $ by Tax Rate in %

Tax Revenue in $

Switzerland, Sweden: Laffer Curve

0 10 20 30 40 50 60 70 80 90 1000

5000

10000

15000

20000

25000

30000

Tax Revenue per capita in $

Tax Rate % of GDP

SwitzerlandSweden

Will to Work Depends on Tax Rates

0.4 0.45 0.5 0.55 0.6 0.6518192021222324252627

France

ItalyGermany

UK

CanadaIceland

AustraliaPortugal

JapanUS

Weekly average work hours 2005

Average Marginal Tax Rate

More Revenue with Lower Rate

1990 1995 2000 200315

20

25

30

35

40

45

50

55

0.7

0.8

0.9

1.0

1.1

1.2

1.3

Corporate Tax Rate Corporate Tax Revenue % of GDP

Corporate Tax Rate

Corporate Tax Revenue % of

GDP

What is Unseen in Progressive Tax

• Sound philosophical and economic arguments against progressive incomes tax

• Not a tax on being rich, but on becoming rich• With flat tax, the rich contribute more $: 36% of

high income more than on low income• Net tax = Gross tax – Public services and transfers• Since public transfers and services more or less

equal for all, net flat incomes tax indeed progressive (higher proportion paid by rich)

Flat Incomes Tax: Net and Gross

0100

200300

400500

600700

-50

0

50

100

150

200

250

Net Tax Payment by Different Monthly Income

Tax Payment from In-dividualPublic services and Trans-fers to Individual

Monthly Income $

Net Flat Incomes Tax Is Progressive

300 325 350 375 400 425 450 475 500 525 550 575 600 625 650 675 700 725 750 775-5

0

5

10

15

20

25

Net Tax Burden %

Monthly Income $

Tax Rates, the Rich, and Revenue

1980• In 1980, there were 116,800

rich people in the US• Those rich people reported

$36.2 billion of income to the IRS

• They paid $19.0 billion of income tax to the federal government

1988• By 1988, there were

723,700 rich people• Those rich people reported

$353.0 billion of income to the IRS

• They paid $99.7 billion of income tax to the federal government

More Rich People, Higher Revenue

1980 19880

100000

200000

300000

400000

500000

600000

700000

800000

0

20

40

60

80

100

120

Number of Rich (Left Axis)Tax Revenue from Rich in Billions of $ (Right Axis)

Distribution of Tax Burden, US 2000

Lowest Quintile

Next-lowest Quintile

Mid-Quintile

Next-highest Quintile

Highest Quintile

0.0

10.0

20.0

30.0

40.0

50.0

60.0

70.0

Proportion of Total Tax Payments

The Unseen Challenge

19921994

19961998

20002002

20042006

20082010

20122014

20160

5

10

15

20

25

30

Proportion of Gross International Product

EUUSChina and IndiaBrazil

Parting Ways: Australia and Argentina

19291934

19391944

19491954

19591964

19691974

19791984

19891994

19992004

0

5000

10000

15000

20000

25000

30000

AustraliaArgentina

GDP/capita $

Slow Growth, Low Income

1%

2%

3%

4%

5%

0 20 40 60 80

70

35

23

18

14

How many years needed for income to double, by different rates of eco-nomic growth

Years

Econ

omic

Gro

wth

Maximize Growth, not Revenue

0 6 12 18 24 30 36 42 48 54 60 66 72 78 84 90 96

Tax Revenues in $ by Tax Rates in %

Tax Revenue in $

Maximum Tax Revenue

Most EfficientTax Rate

Final comments

• Was the revival of economic freedom a return to the pre-1914 world?

• Two causes for optimism: new technology repeatedly proves pessimists wrong; more world trade, with the BRICs, creates wealth

• Two causes for pessimism: the pre-1914 world did’nt have extensive welfare obligations (to those who do not create or contribute), and it had sound money, based on the gold standard