Eminent economist and noted monetarist John Hearn turns his attention to capitalism for his latest offering

Capitalism: Is it worth fighting for?

For capitalism to survive it is necessary to make a number of difficult decisions. I made a twitter list of important things that government must do if they want to manage their economy in an efficient and fair way and reinforce free markets and private property rights. It sparked a number of responses which it seemed only sensible to answer on my blog.

Balanced budgets

In the 19th century Alexis de Tocqueville said "A democracy cannot exist as a permanent form of government. It can only survive until the voters discover that they can vote themselves largesse from the public treasury. The majority will then vote for the candidates promising the most benefits... a democracy always collapses over loose fiscal policy"

In the 20th century Hugh Thomas in "An unfinished history of the world" concluded "I have attributed to the intervention of the state the decay of civilisations and the collapse of societies"

They both observe that fiscal indiscipline creates damage and in my blog "A balanced budget: goodbye fiscal policy" I explained why all governments should be forced into a zero balance between their spending and taxation over a three year term. Keynesian economics and the demand management of output gaps are theoretical constructs that do not work in reality. Trade cycles are not a reason for counter cyclical fiscal policies. In fact the evidence is fairly conclusive that fiscal and monetary management are more likely to be the cause of cyclical events: see "Are demand management policies the solution or a mass delusion"

For political reasons government will never give up the opportunity to spend more money and cut taxes and therefore a law needs to be passed that will force them to observe the suggested restriction. I do not however support the current stance of trying to achieve a surplus as that is also misguided. If we then take away the government`s ability to produce fiscal imbalance how do we ensure that aggregate monetary demand grows at a rate sufficient to achieve a 2% inflation target, especially when I am suggesting that the Bank of England should observe this next rule.

Market rates of interest

The structure of interest rates can be established in all markets where saving and borrowing come together and risk is assessed. It is not necessary for a Central Bank to raise or lower Bank Rate in order to manipulate interest rates and aggregate demand. Monetary demand can be managed by the Central Bank controlling the quantity of money in the economy and the best way of doing this is to force all banks to hold a simple cash to asset ratio.

The Central Bank can then manage the level of cash in the financial system, something that it has total control over, as well as the overall level of monetary demand required to achieve their inflation target. I explain more about this in "Understanding monetary policy", "Understanding monetarism" and "A reappraisal of interest rates" all of which are on my blog

Government spending

Given a balanced budget government spending will be determined by their ability to raise revenue so it is important to identify what government has to do. It is essential that they provide the public good. This is a product that we all want collectively, but no individual will buy because it is not possible to exclude other people from free-riding. Examples include law and order, internal and external defence, street lighting, prevention of environmental degradation etc. Although it is essential that government buy these products on our behalf it is not necessary for them to supply all of them as the private sector can still function in this area.

Arguably merit goods like education and health will be under-consumed in a free market while demerit goods such as alcohol, gambling and cigarettes will be overconsumed at market prices. Here resources could be allocated more efficiently if government raised the price of the demerit good by taxation and reduced the cost of the merit good by a subsidy, and it does not stretch the imagination too far to see something of a trade-off if the money raised by taxing the demerit goods is used to subsidise the merit goods. In addition to this there are other welfare requirements that government spending needs to address and this will be looked at under the next heading.


It is a waste of resources to tax capital and wealth as explained in "Equality or inequality..." Either will raise little revenue relative to the cost of administering and managing the tax. On top of this they actually damage the economy by misallocating resources and this in turn reduces potential growth rates. In my opinion it is only necessary to raise taxes from personal income and all spending. This means that corporation tax is also unnecessary as it is costly and difficult to manage in a world of international companies and there are really big tax raising opportunities if we scrap this tax. The result will be an influx of foreign firms and an expansion of domestic firms whose new employees will pay more income and spending taxes. There will also be a significant acceleration in economic growth.

To finance necessary government spending there are two expenditure taxes required. They are a Valued Added Tax and an Excise Duty as an additional tax on demerit goods. I suggest, but am open to slight variations, three bands for income tax. For each of these I will add some numbers pulled out of a hat just to illustrate how they would work.

Band 1 is a reverse income tax band, say, between 0 -15,000 at a rate of 50%.

Band 2 is 15,001 - 40,000 at a rate of 15%

Band 3 is 40,001 and above at a rate of 25%

The reverse income tax band will provide a 7,500 tax free income to any qualifying adult with no income. This will include the unemployed, pensioners, and even students if we want to improve our meritocracy and get rid of their university fees. This band will replace welfare payments to all those judged capable of helping themselves. It will also remove the poverty trap and make part-time work profitable.

Finally there is a group of people who really need help. These are vulnerable people of any age who can be looked after by a slimmed down Social Services. This will include the mentally and physically handicapped who are not able to look after themselves without additional funding and we will lavish funds on them to make sure that they have a fulfilling life.

The current problems destroying capitalism have been caused by excessive and wasteful government spending, bubble creating low interest rates and a national debt that will require £50 billion each year just to meet interest charges, with no net repayment. The government has therefore intervened in markets to such an extent that these markets cannot function efficiently, and then the government has blamed these markets for being inefficient.

Is there still time for the government do the right thing? The signs are not good as the only discussion currently taking place at the Treasury is to let the government continue to borrow more and point out that it is adding a little less to the national debt than last year; and at the Bank of England it is to keep interest rates low and even consider moving into negative territory.

So we are in the ridiculous position where the causes of the current demise will be tried again just to see if it was a little more of the same that is the solution. Many economists have been supporting this in letters to newspapers. On my blog see my responses to a letter in The Observer 30/10/2011 and in the Financial Times in 30/3/2015

Let me give you a simple example of the end of days for capitalism. A friend informed that 10 years ago he was earning £20k and bought a house in London worth £100k. It is now worth £700k and he is earning £25k. This is not of course exceptional as across the country millions of people are living in houses that they could not have afforded to buy on their current salary. This is the property bubble and as things get worse over the next few years I imagine this will happen: a kindly elderly gentleman will come to power on a promise of building a more caring and sharing society that will remove the damaging inequalities that have developed over recent years. The first thing he will address is inequalities in the housing market.

My friend lives on his own in a 3 bed semi, and a low income family of 4 live nearby in a 1 bedroom flat. A swap will be proposed and as well as taking ownership of his new flat my friend will be given an additional 10k to refurbish it to his own specification. The low income family will be moved in to the 3 bed semi and be asked to pay interest on a loan from the state bank at 3 times salary. No other compensation will be offered. Private property rights, which are the foundation of capitalism, will have been usurped for the greater good in this brave new world.

John Hearn Oct 2015