Monday, December 14, 2009

Paul A Samuelson & the Keynesians

The great economist Paul Samuelson died last Sunday 13 December 2009 at age 94. He brought mathematics to economic analysis along the line of Keynes. His textbook, "Economics" brought him wealth but it was his PhD thesis on 'The Foundations of Economic Analysis" which brought him fame and the Nobel prize.

There are many excellent orbituaries written on him around the world.

Below I will put in some thoughts on what I was taught about his theories, for the purposes of talking about economic analysis in the hope that it will not be taken as an attempt at a cheap shot at a giant at such a sad moment, which this is not. It is about ideas, not person.

Samuelson can be credited for bringing mathematics into analytical rigour in economic theorising. While many major implications can be brought out from the established framework (or paradigm), nonetheless, the danger, in the views of his opponents, was that it prevented people from thinking outside that established box. Here, Keynes' theory degenerated at the initial attempt by Hicks (with his ISLM model) through Alvin Hansen (Samuelson's teacher) to Samuelson into what is now called the Neoclassical Synthesis.

The Neoclassical Synthesis is an attempt to incorporate Keynes' ideas into a Neoclassical model, resulting in a Neoclassical model with Kynesian characteristics, principally in the form of the demand for money function which replaces the demand for loans equation. The rest remained essentially unchanged.

Disatisfaction by the "true" disciples of Keynes over the Neoclassical Synthesis rages in the form of the Capital Theory Controversy which attempts to show the tautology in the Neoclassical construction. If the profit rate is the return on capital, what is "capital" and how do you calculate it without the resorting to the return on capital which is the profit rate and the rate of interest, in equilibrium. Joan Robinson, followed GC Harcourt and then Paul Davidson won't let go.

The capital theory controversy still lingers in the minds of bored Keynesians, while the rest of the world happily ignores this logical inconsistency and runs the global economy down to ground with zero interest rates. Is there no such a thing as "profit" except the extraction of surplus value?

Thursday, December 10, 2009

What Is So Sacrosanct About the Stock Market?

Greg Mankiw picked up a piece by his old prof, the one who wrote A Random Walk Down Wall Street, who recently argued that a transaction tax on the stock market will kill the economy by discouraging stock market speculation and hence the inflow of cash into the US to fund its budget deficit. Is the stock market so sacrosanct?

The only major reason for economists to argue that there should be no tax on stock market incomes is that there is no value add in stock market incomes - that the people involved in the stock market do not add any value to the economy. What they are engaged in is merely the transfer of income from one pocket to the other.

But the current argument by the stock market guru that there should no a transaction tax on stock market trading because it will hinder the functions of the stock market.

"Transactions taxes would make most current high-frequency trades unprofitable since they depend on the thinnest of profit margins. Trading volume would collapse, and there would be a dramatic shortfall in the tax dollars actually collected by the government. Market liquidity would decline, bid-offer spreads would widen, and all investors would pay significantly higher costs on their trades."

But brokers do get paid for doing transaction work for investors. But the article argued that transaction costs have come down due to technology and a transaction tax on stock market trading will raise the transaction cost and make that market uncompetitive.

So the argument is really not about whether there should be a tax or not, but how much.

Which means that the stock market is not sacrosanct.

The stock market survives on two major factors in descending order of importance:
1. Value of the companies on the stock market. No amount of speculation will raise that intrinsic value which is based entirely on correct investment and value addition.
2. Liquidity which will arise if the corporate values are intrinsically good and when the central bank becomes silly by pumping loads of cash into the system to inflation market prices which result in a diversion of focus from investment in companies to speculation in the stock market.

We have seen from the Malaysian experience of the 1990s, and the US and Europe today, how an extremely active stock market has ruined the resolve of corporate investors in undertaking proper business plans.

In a highly liquid global market that we are in today, the fear of not illiquidity but lack of investment ideas - which leads to an oversupply of the same old stuff that everybody has already.

Furthermore, the stock market leads to a massive redistribution of wealth (since there is no income generated), and a transaction tax can be seen as a mild wealth tax, on the argument that traders on the markets are savers and investors with the wealth to invest.

A transaction tax will hopefully divert investor focus from the frail financial world to the real economy.

Wednesday, December 9, 2009

GST & Tax Reform for Malaysia

In the current furore over the GST, I have been having a rethink on the tax regime in Malaysia.

1. It is not a good reason for the government to tax the people for the purpose of building a bureaucracy or to stimulate the economy. The only good reasons are: affordable or free and good quality education and healthcare for everyone, urban public transport, security and law and order.

2. If the government have to raise taxes, how can it do it most efficiently, in the sense of with minimal cost to the government but without overburdening the people to the extent that the economic growth suffers.

3. In the past, the thinking on tax was that the rich should be taxed more than the poor. The progressive income tax regime of today was designed precisely for the reason of redistributing income. The wealth tax and the property gains tax are to redistribute wealth.

4. The current fashion in tax thinking is to tax consumption rather than income. A major reason for doing this is to reduce consumption and encourage income, so that savings and investment will rise. If this is the reason, then income tax should be abolished and be replaced with the consumption tax which is a tax on both goods and services bought.

5. Abolishing the income tax is not that far-fetch an idea. Many big companies are exempt from paying the corporate income tax, for one reason or another, as an incentive to invest. It is just a matter of extending that privilege to the many small companies as well as salary-earning employees.

6. In turn, the GST can be imposed across the board, although there are many potential problems of implementation. (It creates a huge load of paperwork for many small establishments. Presumably, this can be computerised which implies the need to itemise every transaction. The GST is also subject to abuse by establishments who happy impose a service tax and a government tax. There seem to be no enforcement on extraneous charges on bills.) The poor can be compensated by increasing their allowance, if they have any.

7. The GST may not be the main source of revenue. Other sources should be explored, including taxing stock market transactions.

8. In the absence of the income tax, the government can really go into the Public-Private Partnership (PPP) by designing and specifying public projects which the corporate sector or rich individuals can offer to finance.

9. There should also be a freeing up of government restrictions on areas of entry by the private sector, such as healthcare and education, so that more of these services can be privately funded as charities or business organisations.

10. Alternatively, another way to reform the tax regime is for the government to do a 5% across the board - on corporate incomes, personal incomes, retail transactions on goods and services, stock market transactions, without exemptions for big companies. This will really broaden the tax base.

Friday, December 4, 2009

Scarcity & Markets

Economists talk of scarcity of resources and the role of the market in ensuring the efficiency of resource allocation. Is this true in real life?

To a certain extent, scarcity exists when we talk of what is available at our disposal today, and our ability to transform those available natural resources into things we want or desire.

In reality, given what we already know, there is still immense scope for people to produce the things that we want or desire. It is just a matter of unleashing the productive talent, and things will be produced. A whole new world is being created in China just by the stroke of the pen, and the freedom for people to follow their instinct for survival or security.

The efficiency that economists talk about is really the efficiency of production or getting what we want from the same amount of resources. This reflects our technological knowledge.

Of course, market efficiency can be obtained if the market is not controlled so that more output and lower prices can be obtained by consumers as producers compete to survive.

If we have businesses controlling policy, then the tendency is for policy to ensure prices high enough for business to make money, not matter how inefficient they may be.

But the markets we have in the world today is an exchange market. The market is where different producers of different products exchange with each other their products.

The market is an attempt at diversity, to exchange what we have plenty with others for the little or nothing that we have but where they have plenty. It is not an attempt at unity except probably for the price, and even this is possible only under very special conditions.

But the market does not spread efficiency between those who have with those who have not. Those who have not are excluded from the market. They are outside the market. They cannot participate. To participate, they must attempt at production, and hopefully something which they like and which others like as well. They must also be able to increase the production, so that there is a surplus to trade.

There can be no advantage to be obtained by restricting others in production, so that one can have the market. This will merely result in a lower output level.

The only way that restrictions can work is in commerce, where one can trade but others cannot trade. This assumes that both the market demand and supply are available, without any productive work involved. In this case, with market restrictions, market demand may not be sustainable because there is a constant leakage from the system in the form of rent or profits from restrictions, and the tendency is for the economy to go down on a vicious cycle.

A temporary way out of that vicious cycle is by printing money, when the central bank lends to the government or when banks lend to consumers.

A better way out of the vicious cycle is by increasing confidence and investment, aided by banks lending to businesses and investors.