Making the Invisible Hand Visible:Reflections on the Political Economy of Freedom
Professor Hannes H. GissurarsonPorto Alegre 9 April 2013
Role of Political Economy
• To make the invisible hand visible, in other words to explain:
1. How one man’s gain needn’t be another man’s loss
2. How order can emerge without anyone issuing orders; spontaneous coordination
• Also to explain the state, especially unintended consequences of government actions
Parable of Good Samaritan
• Four overlooked lessons from the parable:• We need government to protect us from
highwaymen• We cannot trust the intellectuals, the priest and
the Levite• The Samaritan was a man of means; he could
afford to help• He did good at his own expense, not that of his
neighbours
Nature of the State
• Hegel: State is “March of God through History”• Totalitarian 20th Century: “March of the Devil
through History”• The fantasy of the benevolent despot• Process, not end-of-state: power tends to
corrupt, and absolute power corrupts absolutely• Process: people react to costs, produce less or
more, depending on system
Invisible Victims of Totalitarian State
Russian communists
Chinese communists
Other Asian communists
Other communists
German Nazis
0 10 20 30 40 50 60 70
Number of Victims
37 Million Soldiers Killed in Wars
The Big News: 21st Century Capitalism
• Not the financial crisis since 2008• The big news: BRIC countries, comprising almost
half the earth’s population, joined the world economy, participating in international capitalism
• With economic growth, hundreds of millions migrating into middle class
• Economic freedom has on average not decreased, after a rapid earlier increase
News of Capitalism’s Death Exaggerated
1980 1985 1990 2000 2005 20105.2
5.4
5.6
5.8
6
6.2
6.4
6.6
6.8
7
Index of Economic Freedom: World Aver-age
Economic Freedom in the BRICs
1970 1975 1980 1985 1990 1995 2000 2005 20093.5
4
4.5
5
5.5
6
6.5
7
BrazilRussiaIndiaChina
The Four Chinese Economies 2011
Singapore
Hong Kong
US
Taiwan
EU
China
0 10000 20000 30000 40000 50000 60000 70000
GDP/capita $
Seven Nordic economies 2010
Minnesota
South Dakota
Manitoba
Sweden
Iceland
Denmark
Finland
0 10000 20000 30000 40000 50000 60000
GDP/capita $
Swedes in Different Economies
Swedes in Sweden
Average US
Swedish-Americans
0 10000 20000 30000 40000 50000 60000
GDP/capita 2008 $
Capitalism still alive and kicking!
• International financial crisis reminded us that capitalism is subject to fluctuations, such as credit bubbles which inevitably burst
• But so is government: Lenin, Stalin, Hitler, Mao turned lives upside down
• Government made matter worse: subprime loans in US; low interest rates in US; Basel rules underestimating risks from mortgages and government bonds
• New financial techniques obscuring risks instead of spreading them
Moral Hazard of Banking
What is Unseen about Tax Revenue
• Tax revenue does not necessarily increase with the tax rate (Laffer Curve)
• With higher tax rates, people work less, switch over to untaxed activities, flee into the underground economy, invest less
• By over-taxing, government loses revenue• Switzerland and Sweden: almost same tax
revenue per capita, but different tax rates
Laffer Curve: Useful Simplification
0 6 12 18 24 30 36 42 48 54 60 66 72 78 84 90 96
Tax Revenue in $ by Tax Rate in %
Tax Revenue in $
Switzerland, Sweden: Laffer Curve
0 10 20 30 40 50 60 70 80 90 1000
5000
10000
15000
20000
25000
30000
Tax Revenue per capita in $
Tax Rate % of GDP
SwitzerlandSweden
Will to Work Depends on Tax Rates
0.4 0.45 0.5 0.55 0.6 0.6518192021222324252627
France
ItalyGermany
UK
CanadaIceland
AustraliaPortugal
JapanUS
Weekly average work hours 2005
Average Marginal Tax Rate
More Revenue with Lower Rate
1990 1995 2000 200315
20
25
30
35
40
45
50
55
0.7
0.8
0.9
1.0
1.1
1.2
1.3
Corporate Tax Rate Corporate Tax Revenue % of GDP
Corporate Tax Rate
Corporate Tax Revenue % of
GDP
What is Unseen in Progressive Tax
• Sound philosophical and economic arguments against progressive incomes tax
• Not a tax on being rich, but on becoming rich• With flat tax, the rich contribute more $: 36% of
high income more than on low income• Net tax = Gross tax – Public services and transfers• Since public transfers and services more or less
equal for all, net flat incomes tax indeed progressive (higher proportion paid by rich)
Flat Incomes Tax: Net and Gross
0100
200300
400500
600700
-50
0
50
100
150
200
250
Net Tax Payment by Different Monthly Income
Tax Payment from In-dividualPublic services and Trans-fers to Individual
Monthly Income $
Net Flat Incomes Tax Is Progressive
300 325 350 375 400 425 450 475 500 525 550 575 600 625 650 675 700 725 750 775-5
0
5
10
15
20
25
Net Tax Burden %
Monthly Income $
Tax Rates, the Rich, and Revenue
1980• In 1980, there were 116,800
rich people in the US• Those rich people reported
$36.2 billion of income to the IRS
• They paid $19.0 billion of income tax to the federal government
1988• By 1988, there were
723,700 rich people• Those rich people reported
$353.0 billion of income to the IRS
• They paid $99.7 billion of income tax to the federal government
More Rich People, Higher Revenue
1980 19880
100000
200000
300000
400000
500000
600000
700000
800000
0
20
40
60
80
100
120
Number of Rich (Left Axis)Tax Revenue from Rich in Billions of $ (Right Axis)
Distribution of Tax Burden, US 2000
Lowest Quintile
Next-lowest Quintile
Mid-Quintile
Next-highest Quintile
Highest Quintile
0.0
10.0
20.0
30.0
40.0
50.0
60.0
70.0
Proportion of Total Tax Payments
The Unseen Challenge
19921994
19961998
20002002
20042006
20082010
20122014
20160
5
10
15
20
25
30
Proportion of Gross International Product
EUUSChina and IndiaBrazil
Parting Ways: Australia and Argentina
19291934
19391944
19491954
19591964
19691974
19791984
19891994
19992004
0
5000
10000
15000
20000
25000
30000
AustraliaArgentina
GDP/capita $
Slow Growth, Low Income
1%
2%
3%
4%
5%
0 20 40 60 80
70
35
23
18
14
How many years needed for income to double, by different rates of eco-nomic growth
Years
Econ
omic
Gro
wth
Maximize Growth, not Revenue
0 6 12 18 24 30 36 42 48 54 60 66 72 78 84 90 96
Tax Revenues in $ by Tax Rates in %
Tax Revenue in $
Maximum Tax Revenue
Most EfficientTax Rate
Final comments
• Was the revival of economic freedom a return to the pre-1914 world?
• Two causes for optimism: new technology repeatedly proves pessimists wrong; more world trade, with the BRICs, creates wealth
• Two causes for pessimism: the pre-1914 world did’nt have extensive welfare obligations (to those who do not create or contribute), and it had sound money, based on the gold standard