Making the Invisible Hand Visible: Reflections on the Political Economy of Freedom
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Making the Invisible Hand Visible:Reflections on the Political Economy of Freedom
Professor Hannes H. GissurarsonPorto Alegre 9 April 2013
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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
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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
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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
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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
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37 Million Soldiers Killed in Wars
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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
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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
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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
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The Four Chinese Economies 2011
Singapore
Hong Kong
US
Taiwan
EU
China
0 10000 20000 30000 40000 50000 60000 70000
GDP/capita $
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Seven Nordic economies 2010
Minnesota
South Dakota
Manitoba
Sweden
Iceland
Denmark
Finland
0 10000 20000 30000 40000 50000 60000
GDP/capita $
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Swedes in Different Economies
Swedes in Sweden
Average US
Swedish-Americans
0 10000 20000 30000 40000 50000 60000
GDP/capita 2008 $
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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
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Moral Hazard of Banking
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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
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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 $
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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
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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
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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
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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)
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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 $
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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 $
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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
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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)
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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
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The Unseen Challenge
19921994
19961998
20002002
20042006
20082010
20122014
20160
5
10
15
20
25
30
Proportion of Gross International Product
EUUSChina and IndiaBrazil
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Parting Ways: Australia and Argentina
19291934
19391944
19491954
19591964
19691974
19791984
19891994
19992004
0
5000
10000
15000
20000
25000
30000
AustraliaArgentina
GDP/capita $
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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
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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
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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
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