Now we are all working for the State

A consequence of increasing economic intervention by the state is that we are now expected to breed more taxpayers in future and draw down on our state pensions for less time. Our productivity must be improved as well, thereby maximising our state’s tax revenues.

With respect to the democratic process, is this really what we have signed up for? It is hardly surprising that we are losing individual freedom. We are now working for the state, instead of the state working for us.

This role inversion is the logical outcome of turning our backs on free markets and ceding a role to the state in the management of our personal and economic affairs. And it is further justified by statistical analysis that supports the role of the state, but on examination turns out to be thoroughly misleading.

In this article, I comment on the economics of population growth as discussed by mainstream economists, show how we are being badly misled by productivity statistics, and by the true value of GDP which is to enable the state to estimate future tax revenue.

But the states’ habitual predation on their private sectors is coming to an end, because it will become impossible to finance. The end of the long-term trend of falling interest rates will see to that.

Birth/death rate

Economists routinely comment about national relationships between births and deaths. Typically, an aging population is seen to be a problem, principally because of the consequences for state pensions. It affects all countries experiencing improved life expectancy, upsetting the relationship between earners paying taxes and retirees who in the main do not. 

The costs associated with childcare are also rising. The childcare cost factor hits advanced economies particularly hard, because women are increasingly prioritising career and lifestyle choices over having children. And the sheer expense of complying with laws and regulations which parents in the last century did not have to face coupled with increasingly high taxation makes it uneconomic for many to have children.

The combination of an aging population and falling birth rates are ringing alarm bells. But why should this be the concern of governments and their economists? The answer is that socialising governments have taken increasing responsibility for our own actions and are now cavilling at the cost. They are trying to raise retirement ages, forcing people to work longer and pay taxes instead of drawing pensions. It should come as no surprise that lifting retirement ages is causing riots in France.

In the UK, there was controversy over the “triple lock” on pensions, and whether election promises to maintain it should be honoured. The triple lock refers to the state pension being increased annually by the greatest of 2.5%, the rise in average earnings, and prices as measured by the CPI. In other words, the Conservatives in their election manifesto had promised to protect state pensioners from the inflationary consequences of government policies. That was an entirely reasonable proposition.

But government bean-counters took a contrary view. They saw it as a transfer of national resources from the tax paying employed to the tax draining retirees. In a nutshell, this defines the vested interest of government in its electors. No longer is the statist establishment representing the electorate, it represents itself. And it sees the electorate as a source of funds for whatever schemes the state deems desirable. It is creeping socialism that has now made the state the public’s masters, not there to do the public’s bidding.

But this is a situation we must live with. Government actuaries are correct, that pension commitments are leading government finances into a deepening crisis which must be addressed. But in the UK and a number of other countries, they ignore the even more costly per head crisis created by index linked pensions for government employees – a burden to be shouldered by others, naturally. And there are also the escalating costs of healthcare — but in Britain, the health service is deemed an inviolable national treasure to be shielded from any vulgar attempt to improve outcomes while reducing costs. And now that we face a potential recession and increasing unemployment, additional associated costs are mounting for the not-so-benevolent state as well.

Rather like the use of leeches and bleeding in olden times to cure all ills, the resort to increasing levels of taxation on the productive elements in society leaves the economy in a depleted state without curing anything. The reality is that the socialising of economies has reached a crisis point. If it is to be avoided, public expectations in advanced economies must be managed to accept that a reversal of the trend to increasing government spending is inevitable. Does the West have the statesmen and women with the common sense and ability to understand and deliver this outcome? Don’t hold your breath…

Even well-meaning politicians depend on civil servants for advice, and government statistics for evidence. Once elected to office, they are no longer in a position to argue in favour of reducing the state as a proportion of the total economy and it is hard for them to resist increasing state intervention “for the common good”. 

For evidence of how the system misleads us statistically, there are few better examples than that of productivity.

The productivity myth

Every now and then, there’s a rash of commentary on national productivity. And for the British, productivity was an important part of the Brexit debate, with the OECD, the Treasury, the Bank of England and Remainers all saying the average Brit’s poor productivity just goes to show how much they need the certain comfort of being in the EU. 

Following Brexit, the OECD came out with a paper repeating its disproved nonsense about the economic consequences of Brexit, even recommending Britain should hold a second referendum to reverse the Brexit decision. To back up its analysis it claimed Britain’s labour productivity was at a standstill, while that of France, Germany the United States and the OECD averages were all improving.[i]

Regular readers of my articles will know I have no truck with statist statistics, averages, and the neo-Keynesian analysis that goes with them. The econometricians’ analysis of productivity is a prime example of why statistics derived from questionable information should be disregarded entirely, as I will show. You can prove anything with statistics, except the truth. The OECD, which is the principal source of the productivity statistics quoted by politicians everywhere, uses statistics as a cheerleader for statism. Being based in Paris this institution is particularly sympathetic to the basic concepts of the European Union. 

This is the organisation that leads official international statistical analysis of economics, while being funded entirely by self-interested governments. It works hard to decrease tax avoidance, having led the charge against tax havens in the 1990s. It is a firm advocate for a level playing field in corporate taxes, which means imposing minimum rates globally to protect corporate tax rates in high tax jurisdictions.

The OECD is the cheerleader for European-style socialism and is a primary source of international labour statistics. However, on the face of it, estimating productivity should be uncontentious, and hard to criticise. GDP divided by the number of hours worked is simple. How can it be misleading? Read on.

The OECD’s approach to productivity

The OECD’s brief paper, Defining and measuring productivity, quotes Paul Krugman:

“Productivity isn’t everything, but in the long run it is almost everything. A country’s ability to improve its standard of living over time depends almost entirely on its ability to raise output per worker.”[ii]

Krugman implies in this quote that productivity is a function of government and therefore by implication not that of the employer. This is plainly in contravention of the facts: an employee only produces if he or she is employed by an employer for profit. It is up to the employer to make that decision, not government. That the OECD quotes Krugman confirms the OECD’s approach is in line with his thinking.

From here, the statistical errors commence, starting with the relevance of GDP. GDP is designed to capture final consumption and underplays the production of goods of a higher order, for example machinery and service inputs, by not recording the intermediate steps in production. Consider the difference this way: if you add together the gross sales of suppliers, businesses, services, and logistics, you get a far larger number than simply the net value of the final product. When it comes to employment productivity, it is the relevant statistic, not GDP. I have more to say about GDP later in this article.

This important point was recently conceded in the US by the introduction of a new statistic, gross output (GO), devised by Mark Skousen, an economist at Chapman University. GO is now reported quarterly by the Bureau of Economic Analysis, and it is roughly double the GDP number. 

Therefore, in the US, where GO is twice GDP, GDP per hour worked is roughly half the realistic measure of total production output. GO confirms that using GDP in a productivity formula is outrageously misleading. But the OECD does not estimate GO, and it should be noted that different countries have varying degrees of intermediate production, which makes it impossible to compare their gross output on a like-for-like basis anyway.

We can also expose the concept of labour productivity as baloney in our daily affairs. For example, if you are in retailing, you may judge your sales staff to be productive, because they produce sales. But most of the footfall into your store probably has nothing to do with the salesman’s skills. The window-dresser may or may not have contributed, and are the cleaners and accountants productive, along with the warehouse staff and the van drivers who deliver to the store? Taken individually, they are a cost, difficult or impossible to relate to final sales, which makes up GDP. This is why running a business is about teams of people with complementary inputs, and to record the production of individuals in GDP terms is nonsensical. But it is these wider activities that form the basis of GO.

Labour productivity must also be considered in its wider economic context, being only one form of capital. In free market economies, arbitrage tends to even out returns on all forms of capital employed across the full range of businesses, of which labour is only a part. In addition to labour, there is capital investment in the establishment of production, the purchase of equipment, and the provision of working capital. Taking all these elements together, if one business line stands out in its profitability, it will attract competition. 

When capital is not redistributed to better effect, including labour, it is nearly always because the state intervenes. The state doesn’t want businesses to lay off workers who are part of a failing industry. Instead, the state obstructs the redistribution of labour by subsidising the uncompetitive businessman. Government also penalises profitable businesses by sequestering their profits and in many nations taxing employment as well. 

Furthermore, different industries deploy their capital in different ways, so within statistical averages such as the OECD’s database, the contribution from human effort varies considerably. A mechanic on an automated production line supervising expensive robots should not be averaged with a park attendant. 

The government’s own contribution to the GDP statistic must be excluded from any productivity calculation, as it is a drain on genuine production. 

The problem with statistics such as productivity is that everyone thinks they mean something. And, of course, the political class, including finance ministers, stand for nothing and fall for anything. That notwithstanding, let us ignore the fact that this econometric gem is only paste, and recast the figures into something more meaningful. Something that a businessman will find useful as a basis for comparison in the quest for the best jurisdiction to establish his business. Something that will guide him about whether he should relocate from Britain to mainland Europe or vice-versa.

For this purpose, we shall select four countries in Europe from the OECD’s database, including the UK. In Table 1, we see the following:

These are the OECD’s figures upon which successive British finance ministers have based their whingeing about how unproductive their taxpayers are, and if only they could be exhorted to work more productively, tax revenues would improve. For that is the state treasurer’s real interest in the matter. Admittedly, according to the OECD, official productivity has improved over what it was which even put Britain behind Italy and France before the Brexit vote. What has changed is that the level of unemployment in Italy and France has dropped, so there are more employed persons, more hours worked, and therefore lower productivity per hour. Of course, we have no idea how productive those hours of working are, because unfortunately productivity itself cannot be actually measured, only assumed.

A more sensible approach is to look at productivity from a businessman’s point of view. He employs salary earners and expects to do so profitably. It is out of his sales revenue that he must pay both employment taxes and wages for his employees. In reverse-engineering the OECD’s figures, we must also remove government, because government is a drain on production. Then we must take out the unemployed to arrive at the number employed in the private sector. 

Table 2 quantifies the private sector workforce.

It’s worth noting that there are different ways to count government employees, and that France, for example, has nationalised industries whose employees are not included in its total. In the UK, it is estimated that a further 5% are employed as government contractors, who theoretically should be included as government employees. The distortions to the OECD’s underlying statistics are mounting…

The OECD’s statistics assume people of working age are as young as fifteen, which may be true in an emerging nation, but Europeans remain in education to an average age perhaps of eighteen. We have no option but to ignore these important errors. 

Next, we must derive private sector GDP per private sector employee. This matches the adjustments to the work force in Table 2 with the private sector’s GDP. This is shown in Table 3.

Our Mr or Ms Average is held responsible for producing a share of GDP which is lowest in Italy, and highest in the UK. Who would have believed it! In Table 1, the OECD told us that France was top of the productivity league.

However, to employ our Mr or Ms Average a salary must be paid. Table 4 shows the relationship between GDP per employee, and his average salary

The conclusion of this exercise is that notwithstanding Brexit, the average businessman employing the average employee gets the best return on his investment in human capital in the UK, followed by Italy. If he has a predilection for France, he better secure advantageous terms from the government for the life of his investment. And Britain even beats Germany, hands down. Using the OECD’s own figures, recast to reflect commercial reality, the results deny the OECD’s own conclusions. But…

Houston — we have a problem.

Would the average German be unprofitably employed? And would the French employ people on a marginal basis, before considering onerous employment taxes? And the slender margins in Italy and the UK for average wages suggest that while some employees are employed profitably, they are balanced by many who are not.

Either the statistics are wrong (we know they are), or the wrong statistics are being used. Otherwise, swathes of European production would already have been shut down, being unprofitable or plainly uneconomic.

The problem is not hard to identify. GDP is comprised of final prices, the sum total of value added down the production and supply chains. It does not capture gross output values. As mentioned above, if the EU produced figures for GO, including intermediate processes for goods and services, return per employee would look more realistic. Germany, with its strong manufacturing base is probably most understated, while Italy and France with their tourist industries, perhaps less so. Britain may be somewhere in the middle., similar to GO for the US.

Accepting that we have no statistical evidence of GO, other than an approximate guide that in the US GO is roughly twice GDP, let’s apply that multiple to the four European nations in our analysis. And now we can add in additional employment costs (pensions, employment taxes, welfare deductions etc.) which under OECD figures would have made all European employment a waste of any employer’s resources. Furthermore, the value of human capital being employed to do different things cannot be measured by anyone except by those who have the economic interest in paying the salaries. This is captured in Table 5.

These figures should still be taken with a pinch of salt for all the reasons stated herein. In practice, there are huge national variations in salaries, the taxes relating to employment, and additional costs, such as office space, equipment — the list goes on and on. But, putting all that to one side, the most profitable jurisdiction to employ someone of the four analysed is the UK. 

If you take OECD calculations at face value, which everyone does, you would think France would be the place to employ someone, when it turns out to be the worst. And while on the OECD’s figures there is not much to choose between productivity for the other three, in reality the differences are significant.

Britain has the further advantages of language and culture. Over the decades, she has welcomed migrants to a degree other nations have not. And having ended selective employment tax in 1973, taxation of employment in Britain is roughly half that in Europe.

We must emphasise that the principal of the OECD’s approach is completely wrong rather than argue over the detail. But the OECD approach encourages politicians, and economists beholden to the state, to ignore the impact of employment taxes. It is here that the UK scores relatively well and France is a disaster.

But governments are less interested in statistical method than the messages conveyed with respect to revenue. If the OECD says that the Brits should be more productive, then it holds out the prospect of higher tax revenues, if only businesses could be encouraged to improve productivity.

Instead of criticising the private sector for being unproductive, it is surely more relevant for governments to look at their own increasing burdens on production, particularly with respect to over-regulation which is almost certainly the greatest impediment to entrepreneurial ambition.

Government spending and GDP

The use of GDP rather than gross output to determine productivity is undoubtedly wrong. But governments are fixated on GDP, which must always grow. GDP is not economic growth, but growth in the total currency value of transactions, usually over the course of a year or annualised.

Debase the currency, and you accelerate nominal GDP. Increase government spending, and GDP increases with it. In the past, governments regularly confounded City expectations of GDP growth by the simple expedient of increasing government spending. Stock markets rose on the news, with investment strategists clueless about why they underestimated GDP growth. But if it is good for anything, GDP allows a government to estimate prospective tax income. Otherwise, it is useless and misleading. 

GDP is a state sponsored statistic which is routinely and unconsciously confused with economic progress. But a moment’s reflection will show that progress cannot be statistically measured. And it is almost certain that progress continues or even accelerates in a mild GDP recession. We should know this because it is competition which leads to falling consumer prices, assuming that the currency is stable in its value. 

During the covid crisis when much of the productive economy shut down, UK government spending rose to about 50% of GDP, though since then it has declined to an estimated 43% in the last fiscal year (to April 5^th, 2023). With up to half of it being government, when analysing GDP it is extremely important to decide how to treat government spending.

Government economists are bound to argue that government spending is important in economic terms, and that GDP growth must include it. Furthermore, on a consumption basis spending by government employees must be included. That is certainly a valid point, but it misses the bigger picture.

While it is true that state employees spending is part of the total, the state’s taxes reduce consumer-driven consumption for those not employed by the state, replacing it with the provision of services not freely demanded. You don’t have to look far for examples of how state spending is a burden on overall economic activity, and that the successful economic approach is to free up the private sector, eliminating government and its intervention as much as possible. It is this approach which led to the remarkable success of Hong Kong in the post-war decades, compared with the poverty inflicted on the same ethnic people on the mainland under Mao Zedong where government was 100% of the economy.

Convincing the establishment that targeting GDP ends up suppressing economic progress is an uphill struggle. Instead of accepting the empirical evidence, the statist establishment routinely bolsters GDP by increasing its intervention in an economy, its spending as a proportion of the whole, and by debasing the currency.

This leads to a divergence of interests between politicians seeking to represent the electorate’s interests and the state itself. Politicians on the Right vying for office are usually free marketeers with ambitions to reduce the state’s presence as a proportion of the total economy. They are appointed with a zeal to take an axe on spending and bureaucracy, but there are good reasons why they never achieve it.

When they have ministerial responsibility, their priority changes to protecting their budgets. Any cuts in departmental spending result in a reduction of budget allocation from the Treasury. For ministers and the permanent establishment, it amounts to a loss of power. Therefore, to the extent that savings are achieved, ministers have to come up with other plans to maintain or increase funding levels. The intervention simply racks up, and the government’s share of GDP inexorably tends to increase. And if a proper understanding of the economic damage of targeting GDP is to be recognised, the vested interests of the international economic group thinkers at bodies such as the OECD must be tackled as well as the domestic Keynesian establishments.

Especially in the current economic environment, reducing government spending has become an impossible political task. Besides high spending ministries such as health, education and defence always demanding greater financial resources, there is the problem of price inflation leading to public sector employee unrest. 

Along with many other nations, Britain is almost certainly entering a recession with higher interest rates, and therefore higher bond yields and debt interest due to a credit squeeze as banks attempt to reduce their over-leveraged balance sheets for a higher interest rate environment. The government also faces spending increases on universal credit, other welfare, social care, and state pensions. The lesson from the last contraction in the bank credit cycle showed that UK government spending as a share of GDP rose from 36% in 2006/07 to 40.8% in 2010/11. With the current credit contraction threatening to be significantly more disruptive than that, the government share of GDP could easily exceed 50% in the next fiscal year or two.

At both the Treasury and the Bank of England there appears to be ignorance of the existence of the cycle of bank credit. How the combined offices of the state can formulate policy, whether it is to target consumer price inflation or GDP without this basic knowledge is beyond reason. Against these difficulties, targeting GDP as a means of managing the economy will almost certainly flop.

Conclusion

We have seen how governments have inverted their relationship with electors, becoming their masters instead of their servants. Government statistics, such as GDP and labour productivity are increasingly angled to quantify revenue potential. And the state’s interest in births and deaths is almost entirely fuelled by a desire for increasing numbers of taxpayers, and a declining number of pension claimants.

Ironically, it is the ending of the global debt bubble which will prove government’s undoing. An obsession with revenue-raising potential is leading all western governments into a funding crisis, which is now brought on by the end of interest rate suppression. Only this development will force governments and their permanent establishments to face up to economic reality. 

[i] See Figure 4A on page 19: http://www.oecd.org/eco/surveys/United-Kingdom-2017-OECD-economic-survey-overview.pdf

[ii] See https://www.oecd.org/std/productivity-stats/40526851.pdf