It Didn’t Work For The Soviets, It Won’t Work For Us

The way to get ourselves out of our present economic difficulties is not to emulate the Soviet Union. That bloated, inefficient command economy rightly collapsed and died more than two decades ago and is only missed by the likes of Vladimir Putin and hard-line Stalinists. Oh, and Keynesians apparently. They want us to adopt the very same policies of state intervention.

The problem with Keynsians and communists alike is they don’t trust the people. We can’t be trusted to spend our own money on things we regard as a priority. No, they have to take our money from us in higher taxation and spend it on what they think are higher priorities. That way the economy will generate more revenue and they’ll be able to tax that too and spend still more money on things they think are important. On our behalf. In our name. Without our consent.

We were pretty much a command economy not so long ago. The government owned companies that made cars, trucks and ships, that ran the telephone service, ran the trains, ran the buses, ran the economy into the ground. Talking of ground, the government even dug for coal. The government built the roads, built the railway lines, built airports. The government owned the houses that ordinary working people lived in. The government ran the hospitals when they were ill, ran the schools their children went to. The government even ran radio and television stations. The list goes on.

Thank God for Thatcher.

Some things should be run by the government for and on behalf of all the people. But generating the country’s wealth is best left to us. The government simply has to get out of the way and Margaret Thatcher did us an enormous service by privatizing whatever was not the government’s business.

“Austerity” is a misnomer. It should be called “Liberation”. It is the process of the government getting out of our way and liberating us from state control. However it is under threat at the moment from those who believe it is not working and cannot work. They want to increase taxes, to take more out of our pockets and reduce the amount of money we have to spend, which means, of course, we will spend less. Only they’re not so daft as to announce they want to increase taxes, no, they simply say they want to increase government spending. As if we don’t know where the money is coming from. Increasing taxes and taking money away from us will increase austerity, not reduce it.

How can we possibly be better off with less money coming in?

If you want us to be better off, reduce the taxes we have to pay. Cut VAT or increase the tax threshold. Leave more money in our pockets.

It won’t feel so austere then.

Adam Smith’s Pin Factory, updated

Adam Smith would be horrified with what passes for an economy today. I have this image in my mind of his fellow Scotsman Billy Connolly indignantly bellowing “What the fuh?” as he regales an audience with some tale of outrageous observational humour. Adam Smith used real-life observations as well to illustrate his economic theories, a notch or two down from The Big Yin admittedly. But try it for yourself, look up at that statue of him peering down from his high plinth on the Royal Mile in Edinburgh and ask yourself if you can’t hear him shouting “Are you kidding me?” Because, really, it is unbelievable.

Here’s an example. To illustrate the benefits of cooperation and specialisation Adam Smith explained in “The Wealth of Nations” how pin manufacturing could be made more efficient. He noted that a factory employing ten men might produce upwards of 48,000 pins a day when one man working on his own would struggle to make twenty pins a day. He showed how self-interest was served by combining talents with those who might otherwise be thought of as competitors.

So let’s imagine a group of pin-makers were inspired by his insight. Let’s imagine they formed themselves into a company, bought machinery and set up a production line with each worker doing what he was best at, and as a result they multiplied their individual output many times over, just as Adam Smith had predicted. Then over the years as the company prospered they were able to buy a plot of land and build their own purpose-built factory on it.

Fast-forward to today. The Edinburgh Pin Company has provided a steady living for generations of pin-makers. The business couldn’t be in better shape: they have a strong market presence for a wide range of high quality products at reasonable prices, straight pins, map pins, drawing pins, safety pins; the company owns the factory and thus pays no rent; the partners all work in the company and draw wages that are fair but not exorbitant; there is cash in the bank and the company has no overdraft or mortgage and no investors to pay.

But as with so many businesses, the global financial meltdown has had its effects. Turnover is down as customers cut back on buying and so the company seeks out new markets and new products. They find a big new customer who wants to place a massive order which with their present equipment they can’t deliver on for price and quantity. Time for a major investment. For the first time ever they go to the bank for a loan. The bank says no. The fact the company can show a contract for sufficient sales to completely cover the sum to be borrowed matters not a jot. Despite the government having bailed-out the bank which is now majority-owned by the taxpayer, and the Bank of England issuing fresh reserves to facilitate additional lending by the banks for exactly this sort of need, this bank won’t play ball. There’s not enough money in it for them.

There is a way out though, the bank tells them: get listed on the stock market. And as luck would have it, the bank could help them with that. For a fee. Well, for a lot of “fee” actually. There is a lot more money in it for the bank than merely lending the company the money they need. In fact, by the time they’ve paid for endless lawyers, accountants and other special advisors, drawn up a prospectus and made relevant filings, signed-up with a team of brokers and been well and truly taken to the cleaners by the bank, they’ve used up all their cash reserves and the partners have all had to inject cash from their own private funds. “Don’t worry,” says the bank, “you’ll all be millionaires soon.” Ha.

Unfortunately, by all the measures the stock market uses to assess the value of a stock, the Edinburgh Pin Company comes out rather poorly. It’s capital is seriously under-utilised because while it owns extremely valuable land it earns no money from it because the company doesn’t bother paying rent to itself. Why would it? That’s silly. Nor is the return on investment good enough because the partners run the company to generate only a modest profit, enough to pay the bills and stay in business. And the biggest sin in the eyes of the market? They’re not deep enough in debt. Most normal people would think that not being up to your eyes in debt is a good thing, but investment bankers are not normal people. Looking at the assets and the level of turnover, the company ought to be able to borrow a substantial sum of money but it doesn’t owe a penny. All things considered, the stock market valuation is less than the partners might have hoped. It would still raise the cash needed to fund the expansion which is what they wanted to do in the first place and which is supposedly the point for a stock market anyway, so they go ahead.

The company is launched on the stock market, the partners get their money back and a bit more besides, and there is still plenty of cash left over to pay for the modernisation. For a while it all goes well and the new contract is being serviced and the new client couldn’t be happier. Everyone is upbeat. As a publicly listed company they now have some obligations to investors in a way they never had before when they were privately owned. They have to appoint a CEO and in the way of things, they have to pay top price to attract the best candidate. In order to ensure everything is done properly, they appoint a remunerations board and the bank helps them find suitable candidates for that too. As a larger company with more employees now, they are also subject to a whole raft of legislation they weren’t subject to before, employment, health & safety, that sort of thing. They also have to join a Pin Manufacturers trade association which replaced the Pin Marketing Board which Thatcher abolished years ago.

After their first year of trading as a publicly listed company, they issue their first annual report and hold their first annual general meeting. This is all a bit of a novelty for them, the report took a lot of time and effort to put together – and cost a lot of money – but holding the AGM in a posh hotel in London was a fun weekend away for them since they always used to have their annual meetings in Edinburgh. What they don’t know is that their company has come to the attention of a particularly savvy venture capitalist. He pores over the accounts with a shrewd investor’s eye. All those factors that keep the share price down are the same factors that could be leveraged to borrow a lot of money. Enough money in fact to buy the company. He approaches his favourite investment bank, they are a different creature to the retail bank that wouldn’t lend the company the money in the first place. They lend the venture capitalist as much as he needs on the basis that when he has taken charge of the company, he can sell off enough assets to repay the loan. And he only needs a 51% stake to control 100% of the company. The CEO can see his big pay-day coming too. He has packed the remuneration board with cronies and put in place a very nice incentive scheme should there ever be a takeover bid.

The stage is set. It’s fill-your-boots-time. After a brief and very one-sided take-over campaign the CEO recommends acceptance of the venture capitalist’s offer, not difficult to understand since the CEO stands to gain enormously if it goes through and nothing if it doesn’t. The take over goes through. The first CEO cashes-out a happy man, and the venture capitalist installs himself as the new CEO. He starts to make major changes to the way the company operates, not all of them work, some are disastrous in fact, but that’s no problem for him, he still gets his bonuses. He sells the land the factory is on to a subsidiary company for enough money to repay the loan he took out to buy the company with and Edinburgh Pin PLC now has to pay “fair market rate” for the premises. The situation is not helped when the health & safety consultant orders them to paint the walls pale green to reduce eye-strain on the workers but the union sues them for exposing the workers to paint fumes. Costs are escalating out of control, the final straw comes when an entire batch of thumb tacks is lost because the curvature of the dome was not in accordance with EU specifications.

The CEO seizes his opportunity. He closes the factory and sources everything he needs from the Far East. The company’s bottom line is now looking spectacular; operating costs are a fraction of what they had been and turnover is still the same. The share price sky-rocketed, his bonus that year was astronomical. On top of that, he sells the land for a fraction of its true worth to a company he secretly owned through an off-shore trust, demolishes the factory and builds an up-market gated housing estate. The company he outsourced production to has snapped up production capacity at other manufacturers as well and has now become a monopoly supplier. Prices go up and quality goes down. The customer loses out. It’s worse for the former partners. They are out of work and just have their very modest share of the proceeds to live on, with nothing to pass on to the next generation. The next generation is everything, they are all our futures, but they have been robbed of their inheritance. The banks, the CEO and all those involved in stripping this company of everything, whether entirely legally or at times breaking the law, all get away with it and live happily and richly ever after.

What would Adam Smith have made of all this? There used to be a pin manufacturing company that produced good quality products at affordable prices and which was able to compete in the marketplace. Now it no longer exists. Where did it all go wrong? How can we put it right again?

The Jungle Book

Many years ago, I designed a new web site for the Adam Smith Institute and they were slightly bemused by my choice of the jungle theme: “It’s a jungle out there,” I explained. And indeed it is, but that’s lucky for us because a jungle with one species of plant and one species of animal would soon become a very unhealthy place to be. Plus boring. A diversity of species and, crucially, the opportunity for new species to emerge and either thrive or fail is healthy for the jungle and everything in it. Everything in it improves over time.

A case in point would be the Royal Mail. A once state-owned inefficient monopoly it is still state-owned but now struggling against a field of private competitors. But it’s an uneven competition, it’s like you’ve taken the king of the beasts and wired his jaws shut. It is burdened with obligations which its private competitors are not and I think that’s unfair, the law of the jungle should apply to everyone equally otherwise it’s not the fittest that survive. However I think one of their newer competitors is worth a closer look. I’ve used Home Delivery Network several times recently and I have to say I’m impressed with what they do. They took a lot of stick in their early days, poor levels of service and lost or damaged parcels, but they’ve really got to grips with that. And that’s what the jungle does. You improve or you die. Any new organisation has teething troubles and they’ve dealt with those, one of which I’m sure was allegations that Royal Mail staff were kicking and damaging HDNL parcels whenever Royal Mail got to handle them. My latest accomplishment was to buy a new book on Amazon one Sunday and have it delivered the next day for a total cost of £4. Including the book.

Adam Smith might have recognised the jungle analogy. He might have called his book “The Jungle Book”. He warned against monopolies and how bad they were and we know all too well today how a monopoly will abuse its market position to stifle competition with predatory pricing or putting pressure on suppliers. We read about these tricks all the time. Adam Smith offered an alternative which was an “invisible hand” guiding the free market through the self-interest of all those active in it. The difference is that a monopoly has all the power, the consumers have none – it can pursue its self-interest while the consumer is powerless.

I would recommend Adam Smith’s book “The Wealth of Nations” except it is heavy going with a lot of examples couched in 18th century trade terms. Far better, I suggest, is Eamonn Butler’s “Adam Smith: A Primer“, and this is the blurb for it:

Despite his fame, there is still widespread ignorance about the breadth of Adam Smith’s contributions to economics, politics and philosophy. In “Adam Smith: A Primer”, Eamonn Butler provides an authoritative introduction to the life and work of this ‘founder of economics’. The author examines not only “The Wealth of Nations”, with its insights on trade and the division of labour, but also Smith’s less well-known works, such as “The Theory of Moral Sentiments”, his lectures, and his writings on the history of science. Butler therefore provides a comprehensive, but concise, overview of Adam Smith’s intellectual achievements. Whilst earlier writers may have studied economic matters, it is clear that the scope of Smith’s enquiries was remarkable. In relating economic progress to human nature and institutional evolution he provided a completely new understanding of how human society works, and was very much a precursor of later writers such as Hayek and Popper. Indeed, with poor governance, protectionism and social engineering still commonplace, Smith’s arguments are still highly relevant to policymakers today. “Adam Smith: A Primer” includes a foreword by Sir Alan Peacock, an introduction by Gavin Kennedy and a commentary by Craig Smith.

It’s a free-market trifecta – Eamonn’s book; from Amazon; delivered by HDNL – you can’t lose.

The Problem With Getting Things Done

Madsen Pirie, president and co-founder of the Adam Smith Institute has written a book about how the think tank was founded. Possibly a dull topic, you might think and you’d be wrong. Founded in 1977, I’ve been a fan of it since at the latest 1986 and possibly earlier because of the influence it had on Margaret Thatcher’s government. She was doing all the right things but I was unaware at the time where some of her best ideas were coming from. I came to understand that in 1986 when I met Madsen.

The value of this book isn’t so much that he tells you how they did it as by reading it you can learn how you can do it yourself. All the obstacles Madsen and his co-founder Eamonn Butler had to overcome are still out there today, throwing a spanner in the works of anyone aspiring to influence government policy. I’m sure David Cameron knows the truth of that all too well. The vested interests, reactionary forces, the not-invented-here syndrome, and sheer inertia, all play a part now as they did back then.

The Adam Smith Institute (ASI) is not what’s known as a “hand shaking agency” that effects introductions for a fee, or what I call a “dating agency” which enables business leaders the opportunity to meet the government minister of their dreams. It’s a policy generator. And it’s unashamedly libertarian, so you know which direction they want to see the country go: less government and more free trade. Less Big Brother and more civil liberty. In short, they want more power for Adam Smith’s Invisible Hand.

You need to start with a clear idea of what you want to achieve, and focus on that. Don’t get bogged down with the obstacles negative people put in your way; that’s what negative people do. Don’t go straight to government and say, “Hey, this is what you should do.” Instead, identify problems and work out solutions. Do your research and publish reports and papers of high academic standard. Draw people in, attract academics and subject specialists, engage with the media and help them do their job, stir up public interest and create a tide of opinion in favour of your proposals. Present them to government as an already popular solution, even if they didn’t realise they had a problem, and do it in such a way they can claim credit. Remember, this isn’t an exercise in vanity, you don’t want the glory, you just want your policies implemented.

I highly recommend this book to you: Think Tank: The Story of the Adam Smith Institute

An economy run by Arts graduates?

Sam Leith writes an excellent piece in the Telegraph today essentially saying that Arts Graduates know nothing about how the economy works because it is unknowable. That’s a good point. On that basis, the present sorry government must be Arts Graduates of the highest calibre because the Prime Minister and his Chancellor demonstrate how much they don’t know about the economy on a daily basis. Leith gives credit to those who work in the City and assumes they must be great experts in the economy. There I must disagree. The mistake, which I think a lot of people make, is to confuse what drives the City with what drives the economy. There couldn’t be a greater gulf between the two even though the City has a great impact on the economy as a whole.

Those who succeed in the City, and many do in spectacular style, do so not because they know how the economy works, but because they know how the City works. That should not be a subtle distinction. The reputation of the City has taken a pounding recently, and probably deservedly so, because everything to do with the economy is causing great concern to ordinary people whose daily lives are blighted by miscalculations, misjudgment, or just plain mischief.

That concern was enough to give the Labour government its worst electoral defeat in living memory. The Crewe bye-election will be another opportunity to give them another black-eye. Over in America, things are hardly any better. They have a presidential election taking place right now which provides an insight into some of their concerns. One such is the NAFTA trade agreement which came under fire recently as the cause of American jobs being ‘exported’ to Mexico. We have a similar problem here, but does anyone seriously believe that jobs are going to India or China because wage rates in the third world are so much lower than they are here? Only an Arts Graduate could believe that. The reason jobs are being exported is because City bosses earn huge bonuses from exporting them. If they didn’t earn such bonuses, those jobs would not be exported. Of course I use the word ‘earn’ in the loosest possible sense, in the sense of an athlete who ‘earns’ a gold medal by taking steroids or a mugger who ‘earns’ money by waving a knife in someone’s face. They are merely working the system.

And that’s the root of the problem. It is a system. A system of rules and regulations, of treaties and trade agreements that provide endless opportunities for smart operators to work it to their personal advantage. In what possible way, for example, can it be good for the American economy that an investor can buy into Yahoo! after it had turned down a takeover bid from Microsoft, and then sue the board for rejecting it? He had no involvement in the business beforehand, no concern for the nature of the business, or the interests of its customers or suppliers, but now he can hope to have the bid reopened and see his share-holding soar in value as a consequence. All perfectly legal and proper so far as Wall Street is concerned, of course, but absurd that a market can be manipulated in this way. Plainly Wall Street, and the City, do not facilitate the economy, they distort it. Likewise NAFTA and all the myriad of similar treaties do not create free trade, they interfere with it.

Someone who did know about the economy, and knew it very well, was Adam Smith. When he extolled the virtues of a ‘free market’ he wasn’t writing about a market that was closely regulated to somehow make it ‘free’, he wasn’t writing about states that had treaties to ensure ‘free’ trade between them. ‘Free’ to him meant free from all such interferences in the first place. It would be the invisible hand of self-interest that would drive free trade and ensure it stayed free. He would be astounded by an economy that barred imports that competed with local produce, intervened to buy up surplus stocks to maintain an artificially high price, dumped that surplus stock on third world countries, and in consequence ruined those markets for their local farmers and producers. Such is the EU vision of an economy. He would be equally astounded by an economy that enabled exotic fruit and vegetables to be flown half way around the world, at significant cost to the environment, to be sold at rock-bottom prices, while at the same time fuel prices are soaring and motorists are penalised to reduce their so-called carbon foot-print. This is not an economy that is capable of being understood.

We need reform. In Arts Graduate terms, economics has become like the Turner Prize, devoid of all social worth and intellectual merit. It is ripe for those with no understanding of the real world to exploit and manipulate to their own ends, the people who should matter are shut out. So we need reform across the board, from the City to farming as well as manufacturing, but most of all, we need reform of our government. Capitalism, for that is what is at stake, is as unworkable now as communism was, and look what became of that.