by Peter Franklin
Friday, 19
February 2021
Spotted
11:53

Why Left and Right alike fall for junk economics

by Peter Franklin
Economics is itself built on concepts which are valid only in some circumstances. Credit: Getty

There’s nothing quite so dangerous as a counter-intuitive idea that is sometimes true — especially if it promises the seemingly impossible.

For instance, what if you could cut taxes and as a result raise tax revenues? It’s a theory that’s tantalised the free market Right for decades — as depicted by the famous Laffer curve (and contained within the wider theory of supply-side economics).

The theory isn’t always wrong. Onerous tax burdens act as disincentive to productive activity. So when rates are very high, cutting taxes can increase revenues by making hard work and bold investment worth the effort.

So here we have a concept that promises a substantial reward, that is demonstrably true in some circumstances and which is sufficiently hard to grasp that getting your head around it provides an ego boost.

When you’ve got a cool weapon like that in your ideological armoury, it’s likely to be overused. Which it has been — especially in the United States.

However, it’s not just the free market Right that’s prone to this sort of magical thinking. Lately, the Left — and not just the hard Left — has had its head turned by Modern Monetary Theory. This is the idea that most limits to what governments can spend are illusory because a state in charge of its own currency can simply create the money it needs. The only real limit is the build up of inflationary pressure, but this can be dealt with using taxation to manage the level of demand in the economy.

So again, there’s the mind-blowing concept; again, there’s the tantalising offer of a seemingly impossible benefit; and again, there is some evidence that there is such a thing as a free lunch (after all, we’ve had a decade or more of rampant money printing by the central banks and we’ve got away with it so far).

In a brilliantly provocative thread, Ricardo Reis of the London School of Economics argues that the pet economic theories of Left and Right have a lot more in common than either side would care to admit. Both are based on a valid insight, but then used as an indiscriminate political battering ram:

“I learned from political scientists that the far left and the far right are closer to each other than to the centre, united by a disregard for moderation. In economic policy, so are left-wing MMT and right-wing old supply-side econ. United by a disregard for fiscal prudence.”
- Ricardo Reis, Twitter

Reis hopes that Modern Monetary Theory will follow the path of supply-side economics and eventually calm down:

“Today, supply side economics is respectable, because it is no longer used in its extreme (wrong) 1980s form. Maybe the same will happen with MMT. Hopefully under a more accurate name.”
- Ricardo Reis, Twitter

Of course, this is an academic perspective. In the political world the tax cutting mantra continues to corrupt conservatives — and I fear that MMT, in its crudest form, is likely to addle Left-wing brains for many years to come.

Finally, while we’re poking fun at the extremes, we shouldn’t forget that mainstream economics is itself built on concepts which are valid only in some circumstances. I’m talking about really basic stuff like efficient markets, rational agents and perfect information.

Increasingly, we’re realising just how rarely these assumptions apply to reality. The fact is that markets are often inefficient, that people are frequently irrational and that we live in a world of radical uncertainty.

Any economic theory — whether of Right, Left or Centre — that doesn’t start from a position of epistemic humility has a lot of growing up to do.

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  • What exactly was the point of this piece? Whatever economists might think or say, they’re not the ones holding elected office. That’s usually lawyers, elected by people who too often think that every issue requires a govt solution. It doesn’t; govt often makes existing situations worse because those lawyers who run it are something less than experts in the various fields where they want govt to intervene.

  • “For instance, what if you could cut taxes and as a result raise tax revenues? It’s a theory that’s tantalised the free market Right for decades — as depicted by the famous Laffer curve (and contained within the wider theory of supply-side economics).
    The theory isn’t always wrong. Onerous tax burdens act as disincentive to productive activity. So when rates are very high, cutting taxes can increase revenues by making hard work and bold investment worth the effort.”
    That’s actually not the correct explanation of the Laffer Principle. The more accurate statement about the value of the Laffer Effect is to say that even if cutting tax rates does not increase tax revenues, it is still worth doing if the only effect is to boost economic activity anyway, and as a consequence to raise GDP and reduce the debt/GDP burden through the denominator effect.
    Secondly, the “incentive” in this argument is never properly explained in my experience, and it isn’t here either. What’s missing is the essential idea that it is not people’s inclinations, desires or tolerances we talking about changing here; it’s the nature and value of the opportunities we are all faced with in living life in general. Specifically when it comes to tax, this boils down to a simple matter of numbers: if a tax rate on a particular enterprise is so high that it makes the risk involved unacceptable, then rational people won’t waste their time and money on it.
    This point is important here because very often, the Laffer principle is presented as something related to the selfish character of the individual, with the silliest examples coming from the extreme ends of the popular debate, when rich people are called selfish for not wanting to pay more tax to support public services etc. That’s not what’s happening at all: what’s happening is that when you change the tax rate on a specific activity, you are changing the risk/return equation itself. There is a point, as you raise tax rates, that the return falls below what is required to cover risk, and that is something that commercially competent people simply do not do, no matter what their politics.

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