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Category: Economics

Was Adam Smith a socialist? #3 – Are high profits a sign that a country is going to ruin?

The proponent of the view that Adam Smith’s system did not permit inequality in the first place cited the following comment from Smith to “prove” his point: that profits are “always highest in the countries which are going fastest to ruin.”

Apparently, this indicates he was against high profits. And hence a socialist. This idea is also related to Keynes’s view about the declining marginal efficiency of capital.

There is some merit in this view.

We know that poor societies will tend to have a lower rate of financial savings (instead, animals, and particularly children, are used as a means of saving) and will tend to consume all output.

In such a society, only those investments become profitable that allow higher rates of profit to be generated and hence enable the payment of higher rates of interest which are necessary to borrow money for investment.

Further, in such developing societies, with highly underdeveloped and incomplete markets, there are many more opportunities for profit than the opportunities available in well developed countries. However, these profitable opportunities are associated with greater risk, so not many people are willing to invest in developing societies.

This is where Schumpeter comes in. Innovation and competition are the main long term drivers of profit. With every commercial innovative breakthrough, there are immediate profit opportunities but unless the government institutionalises monopolistic power, the market will always wear down the profit margin.

Two forces are at work in relation to innovation:

(a) the technical frontier gets harder to breach and the “bang” for each new innovation potentially gets relatively smaller than the bang from the previous big innovation. For instance, the internet is a much smaller innovation (relatively speaking) than the discovery of electricity; and

(b) more research takes place and knowledge is generated at an exponential pace, as a society becomes more developed.

The empirical question is – which of these two forces “wins” at a particular point in time.

Thus, it is simply untrue to assert that profits are “always highest in the countries which are going fastest to ruin”. The question is – what’s the level of associated risk, the level of innovation, the depth of markets.

It is unclear whether Adam Smith fully understood the concept of profit. 

Once again, I would like to reminder readers that Smith was a founder of economics. He has been superceded on numerous things by other analysis.

Everyone who reads Smith should use his BROADER understandings as a starting point, and thereafter read more – much more (i.e. many other authors); in order to understand the market.

I think I’ll now move on to other issues. The idea that Smith was somehow against inequality – even if true – is related (at best) to some of his erroneous understandings. We must look at the TRUTH that lies in his work and not focus on things on which he has been superceded.

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Was Adam Smith a socialist? #2 – the issue of inheritance tax

Following on from my post here, let’s examine the claim that according to Adam Smith, “inheritance laws SHOULD partition fortunes”.

Before saying anything else, let me note that it is good that at least some people think that Adam Smith’s writings are useful. The fact that socialists cite Adam Smith in THEIR favour is a sign that they are at least somewhat willing to learn something new.

For these same people should know by now that the liberals do NOT have a Bible (unlike the socialists with their Communist Manifesto). Adam Smith is NOT considered the final word in economics (else why would there be a need for thousands of books on economics after Smith?). Smith is considered one of the early thinkers.

And as with all early thinkers in any aspect of human knowledge, the early thinkers made a LOT of mistakes. Adam Smith’s work is replete with mistakes. The bigger mistakes of Adam Smith (labour theory of value, for instance) were used by “economists” like Marx to create a mammoth edifice of mistakes.

But Adam Smith is important to the liberal because he was right on MOST things. That’s saying a lot for someone who lived 250 years ago. Now, if only these socialists would actually read and understand Smith, they would be well on their way to understanding FURTHER advances in economics and finally they might actually become educated. Which would be a wonderful thing.

Now back to this claim about Smith and the inheritance tax.

ADAM SMITH DID NOT SAY THAT A SOCIETY **SHOULD** HAVE INHERITANCE TAX

This is what he actually wrote:

The death of a father, to such of his children as live in the same house with him, is seldom attended with any increase, and frequently with a considerable diminution of revenue, by the loss of his industry, of his office, or of some life-rent estate of which he may have been in possession.

That tax would be cruel and oppressive which aggravated their loss by taking from them any part of his succession. It may, however, sometimes be otherwise with those children who, in the language of the Roman law, are said to be emancipated; in that of the Scotch law, to be forisfamiliated; that is, who have received their portion, have got families of their own, and are supported by funds separate and independent of those of their father. Whatever part of his succession might come to such children would be a real addition to their fortune, and might therefore, perhaps, without more inconveniency than what attends all duties of this kind, be liable to some tax.

Now, Smith was a very primitive thinker on matters of public finance. Liberalism is, in any event, not so much about public finance as it is about productivity.

Smith has been challenged on a number of issues with regard to his views on taxation. I broadly support his insights even into public finance, but clearly he missed out a critical consideration while discussing the inheritance tax, above.

He missed out the fundamental issue of double taxation – that this inheritance has ALREADY been taxed for provision of public goods. He also missed out the even more fundamental principle of the continuity of human families and the power of DNA.

Regardless, even if we assume that his analysis was ill-informed, we can see that nowhere is he REQUIRING the imposition of inheritance tax. All he is saying is that in the case where children are grown up adults in their own right, the state might, PERHAPS, impose SOME inheritance tax.

A very tentative exploration of the matter.

I deduce that it would be inappropriate to take this error of Smith’s analysis to lump him along with socialist fanatics like Marx and Piketty.

But once again – to the socialists reading this post – do ACTUALLY try to read Smith. Once you’ve done that you’ll be ready for much more, and finally, one day, you might even be ready to understand the economy.

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Was Adam Smith a socialist? #1

Comment received on Whatsapp. I’ll analyse and comment later. (There’s a somewhat similar comment here; also this; and this.

===THE COMMENT===

Smith’s capitalism demystified……

“People in a free market economy are to trade with, not rob, one another.”
– Smith didn’t preach / prescribe inequality as a precondition of wealth creation.

Smith is assumed to have accepted inequality as the necessary trade-off for a more prosperous economy. This is, in fact, the default assumption, which is wrong. The building blocks of Smith’s economic system do not allow concentration of wealth; the important point about Smith’s system is that it precluded steep inequalities not out of a normative concern with equality but by virtue of the design that aimed to maximize wealth. Once we put the building blocks of his system together, concentration of wealth simply cannot emerge.

In Smith, profits should be low and labour wages high, legislation in favor of the worker is “always just and equitable,” land should be distributed widely and evenly, inheritance laws should partition fortunes, taxation can be high if it is equitable, and the science of the legislator is necessary to thwart rentiers and manipulators. Political theorists and economists have highlighted some of these points, but the counterfactual “what would the distribution of wealth be if all the building blocks were ever in place?” has not been posed. Doing so encourages us to question why steep inequality is accepted as a fact, instead of a pathology that the market economy was not supposed to generate in the first place.

The key principles of Smith’s system work against the concentration of wealth-they also speak about the top issues in economic policy today: profits, taxes, and the minimum wage.

First, Smith thought high profits denoted economic pathology. The rate of profit, he said, was “always highest in the countries which are going fastest to ruin.” This pathology was not simply a symptom of mercantilism, but resulted from the incentives on the economic groups living by profit alone.

Unlike Ricardo, Smith believed that the interests of profit-seekers were structurally and thus “directly opposite to that of the great body of the people,” because “the rate of profit does not, like rent and wages, rise with the prosperity, and fall with the declension of the society. On the contrary, it is naturally low in rich, and high in poor countries” (with a few exceptions, especially new economies). Accordingly, when the economy is sound, wealth concentration should not occur. Only when profit-seekers have rigged the system through legislation do concentrations occur. Smith states that fortunes would, indeed, not be high and that in any case they were prone to dissipation. Such a system cannot generate steep inequality.

Wages, at the same time, should rise with increased wealth. On this basis, Smith defends adequate labor wages, which had to be at least sufficient to provide the “necessaries,” covering lodging, food and clothes, the latter tailored to middle-class comforts. This baseline appears minimal, yet it provides for more than is covered by the contemporary minimum wage. Moreover, high wage levels should occur naturally. Wages are only lowered artificially, through state intervention, because of the sophistry of merchants and manufacturers who are much more adroit in manipulating legislatures to pass laws in their favor. Moreover, employers enjoy a bargaining advantage over workers and can coerce them to accept worse terms, because they need individual workers less than individual workers need employment. Wages are not the simple product of supply and demand in Smith; bargaining asymmetries are key.

Taxation is perhaps the most contentious topic today, with prescriptions of punitive levels as the main instrument applied to reverse inequality. As such, it is seen as a distorting intervention in the market and a departure from “free market” principles. Smith did not prescribe punitive taxation, but what is missed is that he praised the British tax system though it imposed double per capita taxes than the French. Yet, “The people of France…are much more oppressed by taxes than the people of Great Britain.” Why? Because taxes were less equitably distributed, falling disproportionately on the poor.

A fair distribution of taxation was key to the soundness of the English economy in Smith. The rich, he claimed, should be taxed “something more than in proportion” to their wealth. “The inequality of the worst kind” was when taxes must “fall much heavier upon the poor than upon the rich.” The reasons were not moral. Bad taxes were simply bad economics.

Smith’s overarching point was this: taxes were bad only when they undermined the productive use of capital. But taxation should be used to discourage unproductive economic activities. Landlords, for instance, charged tenants large fines for lease renewals, rather than raise the monthly rent. This is usually “the expedient of a spend-thrift, who for a sum of ready money sells a future revenue of much greater value.” It is “hurtful to the landlord,” frequently to the tenant, but always to the community. So it should be taxed at a higher rate. A tax upon house–rents would also “in general fall heaviest upon the rich,” a welcome outcome, since rent was an unproductive expense; when high, it was simply a luxury. And when Smith advocated against a tax, it was for pragmatic reasons, as with taxing capital: capital holdings could never be verified and could always flee the country, so taxing them was counter-productive. But ground-rents should be taxable, as “Nothing can be more reasonable than that a fund which owes its existence to the good government of the state” should be taxed more than in proportion to its benefit.

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Inheritance tax as a litmus test to distinguish socialists from liberals

I’ve written on inheritance tax earlier, but the topic came up again. My comments:

====

The only justification for any inheritance tax is based on the concept of equality. Only socialists worry about equality. Liberals worry only about poverty. It doesn’t matter how unequal a society is so long as there is absence of poverty and there is equal opportunity.

I won’t go into too much details regarding this ultra-socialist idea of appropriation, but note:

a) Inheritance tax is a tax on already taxed income. Except in the rarest of cases, such a tax is fundamentally untenable.

b) We live through our children, and while we may not work only for their sake, we have in mind the continuity of life that our children represent. Our children are us. Why would anyone labour if they can’t pass on the fruits of their labour to their children? This amounts to the destruction of the entire system of nature, and imposing values that are totally inconsistent with the way nature has progressed to date. If parents can’t look after their children and therefore ensure that their genes are passed on successfully into the future, then we are essentially saying that we disagree with life itself.

c) This idea is inequitous, because different people consume/save differently, and the incidence of this tax will fall on those the more prudent; and families that tend to die at an average age of 50 would be taxed more heavily than those that die at age 90.

Inheritance tax is a very good test of liberalism. I’d now classify your worldview as social liberal, willing to let people produce through the market but thereafter keen to confiscate their wealth at the earliest opportunity. This is actually a form of socialism, not liberalism.The liberal doesn’t ever talk about equality for that is none of his business. He also talks about tax only to the extent that it is required to fund government; not as a means to “equalise”/ “redistribute”. Any redistribution is anathema to the liberal.

I guess the general principle of the liberal is that he works with human nature, not against it (for that’s guaranteed to fail – and cause some severely perverse consequences). What is the most prominent thing we observe throughout history? That republics have repeatedly degenerated into kingdoms (based on the principle of inheritance), that a non-heritable varna system degenerated into a heritable caste system (with rationalisations of the sort given in the Upanishads), that there is vast and disproportionate effect of family on the prospects of someone in politics (one such family has continued unbroken since independence – 70 years! in an alleged “democracy”).

Any attempt to violate the laws of nature will be met with failure. This raw truth is something socialists dislike and will often (like Piketty) cook up bogus “facts” to excite us to support their continued attempts to violate our biology. As a species, we are very easy to excite, and particularly susceptible to envy. But envy can’t be the driving force for any mature public policy.

And once again I remind people about this short video in which Milton Friedman raises some serious issues with inheritance tax. It will, as Friedman says, destroy society itself.

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Open borders – some notes

I never get time to write properly on most issues of interest. This is one of them. I wrote something here on this blog in 2013. Then there was a debate in 2014. Since then I never got time to sit down and review – so I could further elaborate. I’m now going to start these ‘half-baked’ blog posts which contain preliminary thoughts – so I can keep moving.

My FB post of 20 March 2014

HAYEK DID NOT PROMOTE OPEN BORDERS.

I totally oppose open borders since the people who pay taxes for running a particular nation are entitled to decide how these should be used, not those who haven’t paid for them. For a theory of freedom kindly read DOF (http://discovery.sabhlokcity.com/). There is NO freedom without a strong state.

Economic migration always moves from a place of lower public infrastructure to higher. There are no rights to millions of people who have chosen to create unfree and poor societies to get access to higher quality public infrastructure, justice system or security. The more free societies can, however, CHOOSE whom they want. At a minimum the entrants should be both personally capable and committed to liberty.

I was informed that Hayek supported open borders. I wasn’t aware of this. I have found, now, that he OPPOSED open borders, as well:

“in a letter to the London Times on February 11, 1978, Professor Friedrich A. Hayek—himself an immigrant several times in his life—praised the British Conservative leader Margaret Thatcher for her call for stringent immigration controls. “While I look forward, as an ultimate ideal, to a state of affairs in which national boundaries have ceased to be obstacles to the free movement of men,” Hayek declared, “I believe that within any period with which we can now be concerned, any attempt to realize it would lead to a revival of strong nationalist sentiments.” [Source: http://www.amatecon.com/etext/cftoi/cftoi-ch17.html].

Once nations have ALL adopted 100 per cent freedom, THEN open borders can make sense, under certain circumstances. Not in the present primitive state where 1/3rd of the world is FANATICALLY opposed to liberty.

Shika Dalmia Sood’s response:

Pardon me, Sanjeev, I admire your positions on many issues, but you are flat out wrong in identifying this as classical liberalism. If the best you could do is pluck out a single quote by Hayek from a piece that is arguing the opposite, then that’s just tendentious. That quote is noteworthy only because it comes from a guy whose full views would lead one to believe otherwise. If Malthus had said it, it would be hardly reportable. I have zero desire to argue with you given your starting point in all of this, but by your logic Bal Thackeray, who advocated even stronger nationalism and restrictionism within his own country in the name of Maharashtran pride, would be an even bigger classical liberal. If Modi used the strong arm of the state to throw Muslims out of India because they are anti-freedom, that would be completely defensible in your version of classical liberalism. Classical liberals also never use the vocabulary of “strong” state. They use limited government which is something vastly different. That you don’t appreciate the difference says something and is at the heart of your misunderstanding. To suggest that Muslims by virtue of living in Muslim countries are not entitled tofreedom of movement and earn a decent livelihood, is both sad and not classical liberal. Also, if the fact that people from less free countries shound’t be allowed to move to more free countries, then I’m not sure how an Indian like yourself is entitled to move to Australia, but not a Pakistani. The government can restrict entry of people if it can prove that they pose a security threat. Not otherwise. But the burden of proof must be on the government. To recommend, as you do, blanket bans on some people is closer to Modi-style fascism. Please reconsider your misguided crusade to label such views as classical liberal. You are not doing anyone any favors. There are plenty of other thinkers you can legitimately enlist on your side. Leave these guys alone. If you are genuinely interested in what they thought on this issue, there is plenty of material on the site I shared and Cato Institute archives. (von Mises’ opus Liberalism had plenty to say on this as did Hayek in places too numerous to mention with the exception of this one. And here too he mentions it as an exception to his full views

MY RESPONSE

Shikha, the classical liberal school of thought is based on strong foundations of the state. It is NOT an anarchist school, as I’ve repeatedly explained. What you are suggesting is a version of anarchy, where people can randomly move from country to country without any check. Labour mobility is important and I’ve written about it. But it is not the same as open borders.

Clearly you’ve not bothered to read the book reference I gave you, for it elaborates how liberty begins and is supported. The territory is the key.

Kindly don’t mix my views randomly with those of bigots and fanatics. If you had cared to read and understand, you’d never even remotely suggest such a thing.

I have already said a LOT on this and may say some more on this. However, the view you are advocating is best described as libertarian. I’m NOT a libertarian. My liberalism is rooted in Hobbes and Locke, and Burke. These are NOT libertarians.

I do write about the ultimate dissolution of the state, as well. But that stage is far, very far away. Till there is 100 per cent equal freedom in all nations, we MUST have borders

Shikha’s response:

I AM NOT SUGGESTING ANARCHY. I am suggesting limited government which a state that is empowered to impose freedom litmus tests is not. Gotta run.

My response:

Open border is a form of anarchy. There is basically no state, for anyone can come and go. MILLIONS of beggars from all over the world will land up and one can’t thrown them out. No preference is given to those who have paid taxes and worked hard to make a state a state.

Israel would be overwhelmed by foreign migrations, and the massive efforts of its citizens to achieve a free prosperous society totally nullified.

I disagree with such anarchy. Your denial of this as anarchy doesn’t mean it is not so. It has all the key signs of anarchy under the present circumstances

My FB comment April 2014

SECOND CLASS CITIZENS? THAT’S THE BEST AN OPEN-BORDER DEBATE PROMOTES? The whole idea is fundamentally flawed, and time permitting I’ll one day write about it.
“We don’t have to give foreigners welfare or let them vote.” – see: Bryan Caplans post here.

ADDENDUM 3 JANUARY 2017

Open borders comment by Cameron K Murray here:

It allows supporters to pretend that the borders of private property within a nation are moral, yet the borders between nations are not. Somehow if I am denied, through accident of birth, to make a living from my share of the land in my own country, this is a radically different thing to Alex Tabarrok’s view,where he asks “How can it be moral that through the mere accident of birth some people are imprisoned in countries where their political or geographic institutions prevent them from making a living?”

As I have said before, even the wildest proponents of open borders agree that

“…open borders could not on its own eliminate poverty and that international migration could only help the relatively better off among the global poor”

Then what is it really for?

ADDENDUM 3 JANUARY 2017

My summary position: The cost of protecting private property precludes having open borders.

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