12 May 2015

The case for freer markets and a less powerful state


When posed with the question, ‘economic liberalism: damned, discredited or indispensable?, my own view is that all three are true.  Economic liberalism has been unfairly damned, wrongly discredited and remains emphatically indispensable, especially in areas where it has barely been tried. I’ll come on to the lessons from and aftermath of the financial crash shortly.

A myth seems to have arisen that we in the UK – and in the West more generally – live in a neo-liberal age. That there is, indeed, a neo-liberal hegemony. Were this to be true, it might be fair to associate systemic policy failures with this neo-liberal hegemony and look for a very different model of organising society. But it isn’t true. We live in a social democratic age. There is a social democratic hegemony.

Over the course of my lifetime (I’m in my early forties) state spending in Britain has increased by a factor of about three and half in real terms. The state now spends about £700bn a year (in 2010 terms) compared to around £200bn a year when I was born in 1972. The rise in government spending has been seemingly inexorable – going up under governments of all stripes and political complexions. With the exception of this government of course, which might just succeed in cutting expenditure by about 3% or so over 5 years, but will still add around £600bn to the headline national debt figures – the biggest deficit-financed Keynesian fiscal stimulus in our peacetime history.

Spending on all welfare provision in the UK – including state pension provision – amounts to around £8,000 per household. Twice what it was in nominal terms a decade or so ago. If this is severe, savage neo-liberal austerity, I dread to think what social democratic largesse would look like.

I don’t believe that liberals can agree or should even seek to agree on the proportion of GDP that should be spent by the state. But there has been a tendency amongst those who self-identify as liberals in Britain to take the view that whatever the present prevailing level of public spending, it would be preferable if the total amount was just that little bit higher. That’s not liberalism, really. It’s pork barrel politics.

So, I take the contrary view – that in almost all cases – whatever the prevailing level of public spending, it would be probably be preferable if it was rather lower. This, in addition to the fact that I’d like to swiftly restore real terms public spending to the sort of level it was at in Tony Blair’s first administration, I am often considered to be some sort of wild extremist. I think it makes me a liberal.

But there are good liberal grounds for wanting a smaller state than at present. Not merely because there is a pressing practical need to cure the deficit, but because a state that is spending not far off 50% of national income is a state that is simply too big.

There are practical grounds too, however.  Pretty consistently, in recent decades, governments – again of all political persuasions – have only found it possible to collect around 37% of national income in tax receipts. In a very good year for the state, it might be 38% or so. In a very bad year for the state, perhaps it’s 36%. But the numbers are very consistent within this band. Given this 37% rule seems to be close to being an iron rule, spending above this on any consistent basis is a road to ruin. Sure, you can go a bit above these numbers for a year or three. But not consistently, Parliament after Parliament. And especially not with our significant debt legacy issues, which – including unfunded liabilities – probably amount to around £5trn or £6trn.

If the state spending large amounts of money it doesn’t have was the route to economic success, Greece would be bailing out Germany, not the other way round.

Let’s take the financial crash, where again, a myth has arisen. The myth being that financial services in the UK were some kind of wholly unregulated, Wild West, anarcho-capitalist sector of our economy. This picture is wildly inaccurate and has unfairly, wrongly and dangerously led to diminished faith in economic liberalism. The last time I looked at the FSA regulatory handbook, it contained 10 sections.

  • The section titled ‘Prudential Standards’ is divided into 11 sub sections.
  • The sub section ‘Prudential Source Book’ for banks, building societies and investment firms is made up of 14 sub sub sections.
  • The sub sub section ‘Market Risk’ is divided into 11 sub sub sub sections.
  • The sub sub sub section of ‘Interest Rates’ has 66 paragraphs.

There are over a million paragraphs of regulations in the rule book.

Until the late-1970s, bank supervision was performed by the Bank of England with a team of around 30 employees. When the Bank of England was given statutory responsibility over bank supervision in 1979, fewer than 80 people were engaged in the supervision of financial firms. Since, then the number of UK financial supervisors has increased dramatically, rising almost forty-fold to around 1,200.

In 1980, there was one UK regulator for every 11,000 people employed in the UK financial sector. By 2011, there was one regulator for every 300 people employed in finance.

If the number of financial regulators and the number of private sector financial services industry jobs both continue to expand at the rate they have for the past 30 years, the number of regulators will overtake the number of financiers by 2070. Everyone working in financial services will be able to have their own personal regulator, on tap, standing over their shoulder. What makes this statistic even more shocking is that the numbers don’t even include compliance roles in the private sector, the number of which have exploded since the crisis.

Regulatory reporting requirements have risen too. In 1974 returns could have around 150 entries. Today, UK banks are required to fill in more than 7,500 separate cells of data – a fifty-fold rise. And forthcoming legislation could see that rise to between 30-50,000 data cells spread across 60 different regulatory forms.

I don’t know how you’d describe such a legal framework, but it certainly can’t be described as market liberalism.

At the Institute of Economic Affairs, I tried to order the sectors of our economy from most to least regulated. It’s a fool’s errand, of course – as it requires all sorts of contestable factors to be considered, how many regulations, how burdensome are they, how many regulators and enforcement agencies are there, how strict is enforcement etc.

But my approximate guess was that financial services are the second most regulated sector of our economy. I was disappointed it didn’t come top – I think handling weapons grade plutonium comes top.

What economic liberals need to do is to reassert the case for freer markets and individuals and a less powerful and affluent state.

There is a significant negative relationship between the government expenditure ratio (level of tax/GDP ratio) and the growth rate of GDP per capita. For every 1 percentage point increase in government spending relative to GDP,  there is a decrease in investment-to-GDP ratio of 0.15 percentage points and a cumulative fall of 0.74 percentage points after five years (Alesina et al., American Economic Review, 2002). In its own study, the OECD reports that a 10 percentage point cut in the tax-to-GDP ratio could increase economic growth by 0.5-1.0 percentage points. In response to conditions of the late 20th century, they acknowledge that ‘…up to one third of the growth deceleration in the OECD (over the 1965-95 period) would be explained by higher taxes.

Economic liberalism – and much more of it – is vital to our economic future. It is, indeed, indispensable. We need to make more of an effort to ensure that those who seeks to damn economic liberalism or discredit it are confronted head-on.

Mark Littlewood is the Director General of the Institute of Economic Affairs and the IEA’s Ralph Harris Fellow.