Category: Global Policy

The Trump Triumph demonstrates why inflation in the US and in much of the developed world is persistently low. Inflation is unpopular- it can cost you the next election – especially when the growth in incomes of the workers, wage and salaries, lag  the increase in prices. Which they have done in the US until recently, despite the high levels of employment.

The recipe for controlling inflation is well known and usually well practiced. Simply put it requires that the increase in the demand for goods and services be closely matched to the increase in the real supply of goods and services that are the source of all incomes. If demand appears to be growing too rapidly in ways that add to the ability of firms to easily raise their prices, the remedy is to raise the cost of credit – raise interest rates to discourage borrowing to spend more. Actions not beyond the with of a modern, data dependent and politically independent central bank.

A temptation not generally avoided in the persistently high inflation economies, Africa provides many examples, of a central bank and its cohort of retail banks, to fund a large proportion of additional government spending. Then consistent increases in the supply of money ( of bank deposits) and bank lending, stimulate demand for goods services and assets and continuously higher prices, inflation persistently in the high teens, are the inevitable rationing mechanism.

Yet this was the classic way inflation ran out of control in the US post the Covid lock down shocks to supply and incomes. The spending of the US government rose dramatically and generously to compensate workers for their enforced idleness. With the strong backing of the Fed and its willingness to buy the extra government bonds being issued, on a huge extra scale. It was classic money creation and a burst of inflation – more demand and less supplied-  followed.  

Seemingly, unforgivingly, to the surprise of the Fed who then had to play catch up with much higher interest rates that naturally were very unpopular with potential house and car buyers. The flow of money into financial assets raised their prices and were much welcomed by the minority of wealthy Americans who have enjoyed a massive improvement in their balance sheets. US household wealth is up by over 50 trillion since Covid. US household incomes have barely increased since then- and are barely highr when adjusted for inflation.

But there is now every reason to expect US inflation to stay down around the 2% p.a level it is falling towards. Even should Fed  Chairman Powell be replaced. The political case for low inflation has been reinforced. Ironically what the responses to Covid took away from the second Trump campaign- gave it all back in the third.

The South African authorities, especially its independent central bank would like to aim at lower, developed world type inflation rates. South Africans would welcome such outcomes. But is it a realistic objective? The inflation outcomes will depend critically and unavoidably on the path of the exchange rate. If for example, the ZAR more or less retains its exchange value with the Aussie dollar- as it has been doing lately – SA could enjoy similarly low Australian type inflation and interest rates. It would then be a very smooth ride to lower inflation.

But the ZAR is clearly not under the control of the Reserve Bank. It is determined by SA politics and the outlook for SA growth. It is the political risks to the growth outlook for the SA economy and the ability to fund government spending without money creation that drives exchange rate weakness and generally higher prices. Too much spending has not been the reason for SA inflation. The exchange rate shocks for our very open economy have driven prices higher and inflation expectations higher. Limiting demand to counter these forcers acting on prices has meant less growth and not much less inflation.

We must hope that the new political dispensation gives SA more growth and more exchange rate stability. If it does persistently low inflation will follow painlessly. If not chasing the inflation tail will just add to economic misery.

Abundant summer rain in SA has taken the weather forecasters and climatologists by surprise. They did not expect La Nina to persist for a third successive year- which was thought highly unlikely. La Nina describes an upswelling of cooler water in the Pacific Ocean that brings more precipitation with it – in Southern Africa – and less in other parts of South America.  Its opposite is the little boy- La Nino – associated with warmer seas – and a drier South Africa. The quality of the weather forecasts has apparently been improving but the predictions of the climate models more than 10 days ahead are surely not to be described as confidently made with little margin for error.

Therefore, what confidence should we attach to forecasts of climate over the next fifty or more years? Yet society is being called upon very vociferously to believe in the climate models and their predictions of very harmful global warming. We are therefore being called upon – perhaps better described as being forcefully instructed so by our betters – to eliminate emissions of carbon dioxide – at enormous expense – to limit global warming. Costs of the astronomical order of 200 trillion dollars are bandied about. Which incidentally makes it extremely unlikely that resources of that order of magnitude will be willingly supplied by still highly constrained economies – and their dependents. Many billions of whom still lack clean and affordable energy to heat their shelters and cook their food.

The climate models will not only have to accurately estimate the volume of Co2 and other gas emissions to come and estimate within narrow limits their impact on average temperatures, and also predict how different parts of the planet will respond differently. They will also have to estimate the influence of the other powerful natural forces that will simultaneously and powerfully act on climate. Forces prominent in any climate model will have to include estimates of the variable influence of our lucky old Sun on climate.  I am told by an expert that there is significant disagreement on whether we are about to enter a relatively quiet sunspot cycle, which normally leads to a period of cooling.

Another persistently powerful forces on climate will be ocean flux of which the Ninas and Ninos are an example. To quote the same authority “- the Atlantic Multi-decadal Oscillation (AMO) is a cyclic phenomenon of sea surface temperature anomalies in the North Atlantic Ocean. They switch between positive and negative temperature phases over ~80-year periods. The consensus view is that the AMO is about to shift to a cool phase”.

Climate models are necessarily highly complex and hence prone to error. The climatologists carry grave responsibility for the accuracy of their models. And the politicians will be held responsible for the expected trade-offs of present costs (higher taxes and energy prices) for future- always less than certain – benefits. I am no climate expert. However, I am well-aware of the fallibility of long-term forecasts of the state of any economy. And of the weakness of scenario building that inevitably attaches too much weight to recently observed phenomena. I am conscious that the planning horizon of any firm that commits to capital expenditure is seldom beyond 20 years for very good reasons. Relying on benefits beyond twenty years are too uncertain to influence current outcomes- it is also true of governments and its plans.

It makes good sense to wait and see what dangers and the opportunities that climate change may bring over the long run. A stronger better endowed economy will have the capacity to better manage adversity. The potential danger of global warming adds to the case for faster not slower growth- for more, rather than less resilience. Humans are well practiced in adapting to natural challenges. We can rely on them to cope with continuous climate change.

Relying on ambitious plans imposed top down has not yet proved a useful strategy for humanity.   The plan to control climate through intervening severely in the global market for energy is highly ambitious and top down in a manner not ever embraced before. Yet the search for cheaper, less noxious, less dangerous, and more reliable energy is one of the positive steps for mankind that are still worth taking. What South Africa could be doing with great urgency would be to bring the oil and gas recently discovered off our shores onshore

Nobody knows with any degree of confidence how long the economic disruption caused by the responses to the Corona virus will last. And just how much output and income and wealth (savings) will have been sacrificed.

The survival of any business that services crowds of people is gravely threatened as the Chinese lock-down approach to limit infections is widely adopted.  Collateral damage to those enterprises and the large number of self-employed who depend upon opportunities to earn income generated by airlines and airports, cruise ships, hotels, shops, restaurants, theatres, conference, sporting events and their like, even retailers, will be considerable. Including damage to the banks and others who provide them with credit. The margin of safety for many businesses and the self-employed is always very narrow. They will need financial reserves as well as assistance from governments to survive the turmoil.

Perhaps as much of 10% of one year’s global incomes and output will be sacrificed to contain the virus. This is an enormous sacrifice that is being made to overcome a virus that we are informed is not that morbid and comes with limited mortality risk. Currently 180,000 people around the world have been infected. Many have now recovered. The number of victims will surely rise – perhaps treble – before the tide turns if the Chinese evidence is relevant.

What we will never know with any certainty is how many infections and deaths will have been avoided as a result of the shutdowns. Some heartless economist will no doubt attempt to calculate the cost in GDP sacrificed for each death avoided- as well as the present value of the lives saved in the form of future earnings -the narrow economic benefit of saving – mostly old lives. It will be a very large number.

It is obvious that any such cost-benefit analysis has not informed policy in any way. Admirably only potential benefits, numbers of lives saved, have driven the responses made. And taking the pressure off health systems that would otherwise have been overwhelmed by the number of supplicants has been the means to the end of saving more lives. Perhaps when the dust is settled the issue of how to develop a health system capable of responding to an emergency of this kind will be addressed – as a more effective solution than putting people off work.

It is a however a generous response that only a relatively well-endowed society with a large reserve of spending power could possibly make. Without such a reserve to provide relief to those unable to earn any income would suffer terribly for want of life’s essentials. And using the reserve to keep businesses and banks afloat so that they can fight another day also makes good economic sense.

The government spending and financial taps are therefore being opened wide- wider than ever. Central banks are not only creating money to buy government bonds they are also buying shares in businesses and securities issued by them. And are offering loans on generous terms not only to banks but directly to businesses. Taxes are being relieved and postponed and access to unemployment benefits widened. Aid to businesses, for example airlines, will be provided on a large scale. The extra spending so facilitated will reduce the loss of output. It will help pay for itself.

South Africa and too many South Africans have little by way of reserves against economic disasters. Our fiscal space is highly constrained as our Budget proposals have made clear. And raising debt to fund extra spending has become even more expensive for SA after the crisis. Yet monetary policy in SA has lots of room to help our economy. There is room for the Reserve Bank to cut interest rates significantly and to offer financial support for banks and businesses. Our frail economy will need all the help it can get. Let us hope that the Reserve Bank can think – must think and act- beyond the narrow inflation fighting box it has hitherto confined itself.

A new book by Harvard economists Daron Acemoglu and James A Robinson sheds light on what success looks like for nations. An empowered and critical civil society is crucial.

The achievements of a few highly successful economies are admirable and conspicuous. Consistent growth in incomes and output over many decades has eliminated poverty. The growth has been accompanied by rising tax revenues that are easily collected, without much disturbing the engines of growth.

In all the many cases of national failure there is an elite who have a powerful interest in the stagnant status quo – and who resist the obvious reforms that would stimulate and sustain faster growth. Zimbabwe comes to mind as an example.

The authors also examine the potentially suffocating role of the “cage of norms” – well-entrenched customs that stultify access to markets and inhibit competitive forces. The caste system in India is still such an inhibitor of economic progress. Traditional land rights are a serious obstruction to producing more in South Africa.

Acemoglu and Robinson regard BEE as helpful to economic success because it broadened the political interest in established enterprises and business practice, enough to help protect them and the economy against destructive expropriation. Cultivating a new elite into business success was necessary for stability and growth.

One wonders how Acemoglu and Robinson might now react to the revelations about state capture and corruption; and to the failures of the South African state to deliver satisfactory outcomes for the resources made available to it.

The next question is: will the highly transformed South African elite act in the general interest and encourage the invigorating forces of meritocratic competition for resources and customers? Or will they act to protect their gains and privileges?

The new elite should be aware that a failing economy will not be politically acceptable and any elite dependent on it will be highly vulnerable. They should be encouraged by our open and critical society to take the steps to get South Africa back into the narrow corridor that leads to economic success.

A successful city is pro- rich and pro-poor. It budgets for growth to serve all who live there.

Cities bring people together in what becomes very crowded space. They come together to make better connections: helping employees connect with employers and helping customers and clients to connect with the suppliers of important services. The physicians are helped to connect with their essential patients. Lawyers, accountants, consultants of great variety, can connect with their clients who rely on their skills and experience for which they willingly pay and make practice possible. Restaurateurs, with their chefs and waitrons, connect the many who they feed and amuse. And artists of all kinds connect with the audiences they may only find in the large city, to mutual delight.

Cities offer valuable choices to all their citizens, rich and poor and those in between, that are not available outside. We complement each other and we combine together to make as sure as we can that our crowded space can serve our purpose to connect. And so we establish and maintain a grid of one kind or another to deliver essential services – water, energy, roads and other forms of transport – more cost effectively than if we somehow had to do it for ourselves, off grid so to speak.

The essential purpose of local government is to maintain and improve the quality of the vital connections by providing the grid efficiently. Elected civic leaders should compete on this basis for the votes that elect them to office. Successful cities will attract migrants from outside to join in and share in the success. They manage the growth well enough to preserve the advantages of city life for all who choose to live there, including the poor who cannot or will not pay enough to be connected to the grid. Yet it is essential to keep them well connected, for the sake of the city and all including the well-off who live nearby. Making these connections possible is not charity – it is good sense.

And the South African city would surely do better if it were given fuller responsibility for policing, schooling and securing the bulk supplies of water and energy for their grids – that has proved not nearly secure or capable enough when provided by the central government or by proxy provincial governments.

City success will be revealed in the value attached to the buildings of the city, the houses, offices, factories and warehouses that make up the city. More accurately it is revealed in the value of the land under the buildings and the vacant land that can be put to more valuable uses over time. Development and re-development increase the supply of buildings, helping hold down land values and the rentals attached to them. They help keep more people flowing in rather than out of the city.

There is a virtuous civic circle to be sustained. The better the city delivers, the more its land will be worth and the more revenue it can collect to maintain and improve its connections and grid. And failure to deliver soon shows up in deteriorating property values and increasing financial strain, harming all, perhaps especially the poor.

Cape Town has been the success story of SA cities, judged by the flow of migrants to it (rich and poor) and by the growing value of real estate that is so supportive of its balance sheet and income. The city borrows very little and its net interest bill, after investment income, is very small compared to its revenue and expenditure.

Yet the city budget proposes to fund the significant capital expenditure needed to guarantee sufficient water with permanently higher tariffs. Lower tariffs would serve the city much better by helping to preserve on-grid demands. It would also generate enough extra revenue to pay the extra interest and repay the loans. This would be possible with more borrowing that in no way would threaten financial stability. Rather it will help by improving the growth potential of the city that depends upon its grid – especially so when competitively priced.

Taxes: Appearance and reality in the US and everywhere else

Reducing the US corporate tax rate and the taxes applied to offshore profits earned by US corporations and the repatriation of cash generated offshore, has had perhaps unintended consequences that are proving very helpful to the tax reformers. Some leading companies have immediately converted lower taxes to come into bonuses for their employees.

These reactions help raise the issue of who actually pays an income tax or a payroll tax. Those employees soon to notice a lower tax charge on their salary slips will have no doubts about who pays the income tax – and how they benefit from any reduction in tax rates. Shareholders receiving extra dividends, because the company has more after tax cash to distribute, will draw similar conclusions about the immediate benefits of lower tax rates.

But these immediate reactions to lower tax rates in the US will not be the last or the most important consequences of lower income tax rates. Lower tax rates will have improved the prospective returns on capital invested by US companies. More than pay dividends or buy back shares, the company may therefore wish to invest more in plant and equipment.

If so, and this seems very likely judged by the reactions of CEOs, the additional capacity will give these firms the capacity to produce more. To sell more they may well have to reduce prices or improve the other terms on which they supply their customers. The benefits of lower tax rates will thus also go to their customers in the form of lower prices or better quality or better service, depending on the competition to attract more custom. And workers may benefit as the firm hires more of them, perhaps on more favourable terms, again depending on the competition in the labour market for new hires.

In the long run the benefits of a higher return on shareholders capital, higher because less is paid away in taxes, will tend to be competed away. Actual returns after taxes may then fall away to a new equilibrium of lower required returns on a larger stock of equipment and a larger, better paid labour force in which more intellectual capital has been embedded. The effects of higher tax rates would similarly be reversed into higher prices as investment and hiring activity responds negatively to higher required returns before taxes.

These long run effects will be hard to identify, precisely because nothing much of what else will affect the economy will remain unchanged after a tax regime is changed and economic actors respond. Exchange rates may change, while tax rates in other countries may change to make imports more competitive. Trade across borders may be become more or less open. Yet it would be hard to argue that changes in taxes will not have wider consequences than is revealed on a payslip or dividend payment.

It is also surely true that the benefits, medical or pension etc. that employers provide for their workers will influence the supply of workers, skilled and unskilled, to the firm. The better the benefits, the greater will be the potential supply of job applicants and the lower the quit rates. Increased supplies of actual and potential workers in response to improved other benefits of employment will mean the firm has to offer less take home pay to attract the workers it wishes to hire.

Employees may well be paying for the benefits in the form of a cash salary sacrifice, which is to the advantage of the hiring firm. And taxpayers will be contributing, should the benefits in kind rather than cash enjoy much lower tax rates, in other forms of tax. Such tax favours for employees may help make the firm more competitive, in the form of a lower wage bill. This in turn may enable it to offer lower prices or better terms to their customers – as in the case of lower income taxes.
In these and many other ways, hard to identify, taxes tend to find their way into the prices consumers pay for the goods and services they buy. And this applies to all taxes and not only the VAT or sales taxes imposed on final expenditures.

Higher taxes mean higher prices and vice versa. And as important for the supply side effects of taxes of all kinds is how well the tax revenues are utilised. A good ratio between taxes collected and benefits provided, for obvious example in the quality of education supplied by governments, will tend to increase the supply of skills and lower costs of production and prices to the benefit of consumers ultimately.

The conclusion to come to when recognising the full ramifications of a tax system on the supply of and demand for goods and services, is to keep the tax system as simple as possible. That is to avoid trying to redistribute income through taxes of one kind or another (that find their way into prices) and hence may not redistribute income at all. All taxes may become a tax on expenditure rather than on income. Appearances of redistribution of income through can be very deceptive and damaging to an economy.

It would be more helpful to recognise reality and simply tax expenditure of all kinds at the same rate, thus avoiding income taxes, including taxes on income of companies and taxing one form of income in cash or kind at very different rates. Redistribution is best done by targeting government expenditure – not taxes. As is raising the taxes to pay for benefits as least disruptively as possible. 9 February 2018

The leaked “Paradise Papers” reveal how global companies minimize their tax payments by (legally) routing revenue and taxable earnings through low tax or no tax jurisdictions. Such revelations should not be a surprise given the significant differences in company tax rates and tax systems across tax regimes that influence corporate actions.

The obvious solution to this reality is not to tax companies at all. Rather to tax all the income generated by business operations for their many dependents, where they reside at the personal income rate. Though the very highly income taxed may still decide to live in Monaco, the Bahamas or Mauritius – a freedom they should not be denied and where they may well be subject to high expenditure and property taxes.

The owners of businesses can be taxed on the dividends received and the wealth (capital) gains, realized and unrealized gains generated for them. Their lenders can all be taxed on the interest received from business borrowers. All landlords including institutional owners can be taxed on their rental income.

And those employees receiving benefits in cash or kind, including contributions the firms make on their behalf to pension plans and social security funds, can as usual have taxes withheld from them by their employers and passed on to the government. Indeed fuller use of businesses  as tax collectors. Forcing them to withhold income of all kinds, for which the individual income tax payer is only later credited. Collection rates are likely to be as good as they are with PAYE and could fully make up for any loss of taxes from companies.

The costs incurred by companies collecting taxes for the government are (understandably) allowed as a deduction from their taxable income. Usually also allowed as a deduction from taxable company income are the interest, rental and employment costs incurred by the firm – though not all interest incurred may be treated the same way. Also allowed as a deductible expense will be a rate of depreciation of the purchase price of plant and equipment, though with different rates applied to similar asset classes in different jurisdictions.  These allowances may or may not approximate the actual loss of market value incurred by the company. And if not will add to or deduct from the economic income being generated.

All companies and individuals have every incentive to manage their tax liabilities as best they can and not only where they best report revenue and income. They may well structure their balance sheets with more risky debt to take advantage of the taxes saved. Debts that may (wrongly) appear cheaper than equity, the opportunity cost of which, is not allowed as a tax expense.

With the elimination of taxes on the income of businesses, all this tax structuring and gaming will disappear. Companies and their auditors would have to determine the measure of income as well as assets and liabilities to report. And so owners and managers would more rationally incur expenses, including interest and depreciation and location costs, regardless of their tax implications.

The US Congress is currently proposing a dramatic reduction in its federal corporate tax rate to 20% to make its companies more competitive. A reduction intended to keep more of them and their taxable income and investment and employment activity at home. There are also tax reforms on the agenda. Among them is to allow firms to fully deduct all capital expenditure (whatever its life) from taxable income- a very important way to increase economic income after taxes. A further proposal is to disallow all interest incurred as a business expense.

This would take the US company tax system close to a very low company tax rate – much lower than 20% in economic effect, given how income is to be defined. It is a new competitive challenge that all other economies will have to confront. The ideal way to compete with the US and all the tax havens is to eliminate the company tax system.