The perils of nationalisation
More state ownership is not the right answer to economic ills
Finance and economics Jun 17th 2017
WHEN Jeremy Corbyn unveiled his Labour manifesto ahead of the recent British election, opponents gawked at pledges to renationalise the postal and rail systems. Such enthusiasm for state ownership smacks of a philosophy long since abandoned by leaders on both left and right. Despite Labour’s decent electoral performance, nationalisation is not everywhere on the march; on June 5th Donald Trump made public his desire to privatise air-traffic control. But the rise of Mr Corbyn and Bernie Sanders hints at a weakening of the rich-world consensus that the less of the economy owned by government, the better. That is a pity. Expanded state ownership is a poor way to cure economic ailments.
For much of the 20th century, economists were open to a bit of dirigisme. Maurice Allais, an (admittedly French) economist who won the Nobel prize in 1988, recommended that the government run a few firms in each industry, the better to observe the relative merits of public and private ownership. Economists often embrace state control as a solution to market failure. Since there is no way to provide national security only to citizens who sign up to pay for it while denying it to the rest, it requires a government with the power to tax to provide defence. In cases of natural monopoly, in transport and telecommunications, nationalisation is an alternative to allowing a dominant firm to use its market power to overcharge for subpar service. And state control looks attractive when private markets are bad at providing universal access to critical services. Private schools or health insurers have an incentive to skim off the best-prepared students and healthiest patients, and to deny services to harder cases, creating a large pool of people that cannot profitably be served.
But in the 1970s economists came to see state ownership as a costly fix to such problems. Owners of private firms benefit directly when innovation reduces costs and boosts profits; bureaucrats usually lack such a clear financial incentive to improve performance. Firms with the backing of the state are less vulnerable to competition; as they lumber on they hoard resources that could be better used elsewhere. Inattention to cost-cutting is not always a flaw. Oliver Hart, co-winner of last year’s Nobel prize for economics, pointed to private prisons as a case in which profit-focused managers might accept a cost-efficient decline in the welfare of prisoners that society would prefer not to have. Yet economists saw in the productivity slowdown of the 1970s evidence that an overreaching state was throttling economic dynamism. Mr Corbyn first won election to parliament when the Tory government of Margaret Thatcher, inspired by Milton Friedman, was busily selling off bits of state firms like British Leyland (the nationalised carmaker), British Airways and what was then called British Petroleum. Other governments followed suit although public assets in most countries remain large (see right-hand chart).
State-owned firms pose risks beyond that to dynamism. Government-run companies may prioritise swollen payrolls over customer satisfaction. More worryingly, state firms can become vehicles for corruption, used to dole out the largesse of the state to favoured backers or to funnel social wealth into the pockets of the powerful. As state control over the economy grows, political connections become a surer route to business success than entrepreneurialism. Even botched privatisations can improve governance in corruption-plagued emerging economies.
If antipathy to nationalisation is fading, however, that has less to do with newfound confidence in state competence and more with disappointment in private business. Although studies typically find that countries with more of the economy under state control grow more slowly than those with less, much of the rich world—including enthusiastic privatisers like America and Britain—is limping through productivity doldrums. High corporate profits suggest that private markets are not hotbeds of cut-throat competition. Recent economic growth has done more to enrich shareholders and a small set of highly skilled workers than the public as a whole. Tech dynamos like Google and Facebook delight consumers, but these companies increasingly wield unsettling economic and social power. Both the financial crisis and growing suspicion of Silicon Valley fan suspicions that private ownership is not a sure way to advance the public good.
Modern forms of public ownership are designed to look more benign than the old models. The new nationalisation might involve governments sitting quietly in the boardroom, grabbing a share of profits for the public purse and reminding firms not to neglect their social responsibilities, while leaving enough shares in private hands to harness the benefits of red-blooded capitalism.
Hire, not fire
Even this modest version of state capitalism could disappoint. Shared ownership, even at small scales, has the potential to blunt competition in ways that harm consumers. The rise of large asset managers, like BlackRock and Vanguard, means that huge stakes in firms representing much of the stockmarket are controlled by a few passive investors running money for private savers. Recent research suggests that this concentrated ownership may be bad for competition. As a result of common ownership of airlines by asset managers, for instance, fares are estimated to be 3% to 5% higher than if ownership were more dispersed.
Some on the left might see higher prices as an acceptable cost for a reduction in corporate power (and it is hard to imagine service at some airlines getting worse in public hands). Yet there are other risks to consider. China’s state-owned sector is proving difficult to shrink in part because it accounts for so much employment. Governments trying to deliver good jobs may be tempted to lean on state-controlled firms to hire more staff, particularly in countries with powerful public-sector unions. Consumers and taxpayers would bear the costs of such bloating. Corporate power, inequality and underemployment are all real worries. Expanding state ownership is the wrong way to tackle such ills.
Getting the most out of business taxes
Changing rates does not make a lot of difference
Finance and economics Jun 15th 2017
ONE of the hottest debates in economic policy at the moment is how to ensure companies are paying the optimal amount of tax. On the right, politicians think that a lower corporate-tax rate will lead to more business investment and thus faster economic growth. Hence the initial stockmarket enthusiasm after President Donald Trump was elected on a platform that included cuts in business taxes. On the left, the belief is that business is not paying its “fair share” of tax and that it can be further squeezed to pay for spending commitments. Hence the promise of the Labour Party in Britain’s recent election campaign to push the corporate-tax rate up to 26% (from 19%).
How do these theories translate into practice? To find out the effect on business investment, The Economist took the corporate-tax rates in OECD countries and divided them into quartiles from highest (1st) to lowest. Then we calculated the five-year average in each quartile for gross fixed capital formation as a share of GDP.
As the top chart shows, the relationship is not very strong. The countries with the highest tax rates generate less investment than those with the lowest, but there is not much difference. That is probably because the decision to invest in a country depends on a lot more than tax. The underlying growth rate of the economy and the regulatory climate also play a big part. Independent of their tax rates, for example, South Korean and Turkish companies are investing a lot. Perhaps they are catching up with mature economies, perhaps they are over-investing.
What about the tax take? The picture is complicated here, too. Lower tax rates may just work by pinching revenues from other countries. For example, Ireland, with a 12.5% rate, earns a higher proportion of GDP in revenues than France, at 34.4%. And the headline tax rate may not be decisive. Countries with high rates (like America) tend to offset them with allowances and deductions that bring down the effective rate that companies pay.
The idea of using tax levels to boost revenues does not get much support, either. Most countries sit within the 2-3%-of-GDP range (see bottom chart). The countries with the lowest corporate-tax rates receive a bit less in taxes. But the difference between the top and bottom quartiles is only 0.9% of GDP. Grabbing this extra chunk might be useful revenue, but when public spending is 40% of GDP or so, other sources of funding are a lot more important.
The countries with the highest tax takes (over 4% of GDP) tend to be those, like Australia and Norway, with plenty of natural resources. They can take advantage of captive businesses. But that is not an option for most developed nations, especially given the potential for tax competition. OECD countries are trying to co-operate to stop companies from gaming the international tax system. But it is a tricky task; one man’s tax avoidance is another man’s legitimate business planning.
Two other things are worth remembering. The first is that companies are merely legal entities. To the extent they pay more taxes, they must get the money to do so from elsewhere. Politicians on the left think the money comes from shareholders. But it is not as simple as that (and even if it were, those shareholders may represent the pension funds of citizens). For instance, a large company might not want to reduce the profits it pays out to shareholders for fear of becoming a takeover target. So it could move some of its operations to a lower-tax regime. Or it could recoup the loss by charging consumers more, or by paying workers less.
Second, countries do not just want to attract businesses for the taxes they pay but for the workers they employ and for the extra revenues they create for local suppliers. The effective tax take firms generate (on wages, sales and property taxes) is much higher than the tax on profits alone. So there are dangers in driving business away, something Britain needs to contemplate after the Brexit vote.
Some argue that the profits tax should be abolished. Governments should look through the corporate structure and tax shareholders directly. The problem is that many shareholders, such as pension funds and charities, are tax-exempt, and others are based in low-tax regimes. That would also create incentives for individuals to incorporate to cut their tax bills. So such a move should await much more sweeping tax reform. In the meantime, governments will have to make do with what they currently get. There is no magic trick for collecting a lot more.
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