Thursday, 6 December 2012

Robbing Sketchers to pay Autoglass

Today I want to meander off into a slightly odd region of defence procurement and talk about a chap called Frederic Bastiat, a 19th Century French political economist and classical liberal, who did much work on the subject of Opportunity Cost (The relative value of one course of action over other alternatives), which led to his 1850 essay "That Which Is Seen, and That Which Is Not Seen", which included a section that has since become known as "the parable of the broken window".
It's another one of those terribly exciting things (as you can imagine) that I've been looking into recently, after a brief summary caught my eye a few months back. With all the talk we often here about how x amount of government money could be spent on y defence industrial capability, creating jobs etc, there is probably not a more apt avenue to investigate than that of opportunity cost.

To start getting to grips with the idea, we'll look at this parable of the broken window.

Essentially Bastiat tells the story of a shopkeeper who finds one of his windows broken by his careless (and soon to be adopted) son. Locals passing by comment on the shopkeepers misfortune, but offer the sagely piece of wisdom that at least it will provide some employment for the local glazier, for what would glaziers do if not for broken windows?

Bastiat acknowledges the basic logic of the argument, but cautions that the effect is only that which can be seen and under no circumstances should the breaking of windows be considered a good thing.

He remarks that if the window cost six francs to replace then the unseen consequence of this accident is that the shopkeeper is now six francs poorer for no appreciable gain. He has his window back, which means he's back to square one, but is now six francs worse off.

Bastiat questions what would - had the window not been broken - the shopkeeper have spent his money on? Perhaps a new pair of shoes? Or a book? So while it's correct to argue that the glaziers trade has been boosted by six francs, potentially the bookseller or the cobbler has now lost out. Our shopkeeper could have spent the six francs just the same, but this time he would have benefited from the purchase of a new pair of shoes or a new book to read, instead of just paying to restore his property to its original form.

Of the two possible outcomes (one where the window is broken and the other where it is not) the second is generally preferable to the first. The same amount of money has been spent, but the shopkeeper receives a better outcome. Thus society has lost value by the breaking of the window.

Bastiat uses this example to infer that; "we must assent to a maxim which will make the hair of protectionists stand on end—To break, to spoil, to waste, is not to encourage national labour; or, more briefly, "destruction is not profit.""

He goes on to share a variety of other examples that we won't go into here which, ironically enough for this blog, includes an argument about whether to keep or disband a unit of soldiers. Basically though all of the examples follow the common theme; taking money from one place to spend in another provides a visible benefit, but it also contains a hidden penalty. Money can only be spent in one place.

Thus we have to stop and think for a second when we discuss the matter of using government money on certain projects in the name of creating jobs and investment.

I have to admit that I don't agree with everything Bastiat says in his essay. He acknowledges that if there is a great benefit to society to be had by taxing people and spending that money elsewhere (such as the minimum level of spending on defence required to secure the nation) then it is acceptable, but he does somewhat underplay the value that can be had from some level of additional taxation.

If, for example, I were to tax this nation of 60 million people an extra 2p a year per head, that's £1.2m that could be spent on various public schemes. It's difficult to argue that as individuals we could put that 2p per year to better use (a sherbet saucer perhaps? Or a cola bottle) than we could by collectively pooling our money for one or two larger causes.

But broadly speaking Bastiat has a point that is worth examining. This goes doubly so in the defence sector.

Now before anyone takes up arms against me and excuses me of lobbying against defence, that's not what I'm doing. I happen to be of the opinion that the way we use aid spending under the MoD budget to artificially inflate it up to the required NATO level is rather cheeky, and believe that we could do many great things with a little more cash in the defence kitty.

This is merely about playing devils advocate. We cannot allow our own preferences in this particular moment to blind us to other arguments and other concepts that may prove of sound use in the future. Perhaps if political parties were less idealistic and dogmatic in their approach to government and more flexible to alternatives that better fit the times then we wouldn't have some of the problems that we do in this country.

Back to the defence sector then and through the lens of Bastiat's approach we begin to question the validity of spending money on defence in the name of preserving jobs and skills.

I always frown a little for example when people say that we will lose skill xyz if we allow such and such shipyard to close, or such and such aircraft factory to shut down. I don't want to see such facilities close, but the argument that skilled workers will be lost to the economy forever is somewhat tenuous.

Consider this; the people who work in the defence sector do so because they possess certain complex skills, knowledge and traits that are in demand. They are not simply casual labourers, lifting items from one place to another. They have very specific, valuable skills. Skills that could be applied elsewhere.

The field of aeronautics for example goes far beyond just things that fly, like the recent boom in wind turbine design and manufacture for example. Welders have use outside of just welding warships together. Nuclear engineers can work on designs for civilian power generation.

A man or woman employed to design the sleek form of a new fighter jet could potentially otherwise be designing a break through new design for a fuel efficient car. The person employed on creating a new warship radar could potentially be turning their talents to some other electronic endeavour, one that might create an unprecedented break through in communications or computing for example.

In terms of government finances we also have to consider the maximum use of each penny. We often believe that by spending at home we will secure our manufacturing base for the future. What if we could purchase equipment cheaper abroad though? The difference saved could be spent on other projects, while freeing domestic scientists and experts to work on other programs and industries that could be more bountiful in terms of exports?

It's an angle that has to be considered first before we dive head long into some of the well meaning arguments about supporting British defence manufacturing. Money given to BAE or Lockheed Martin UK does not just appear out of nowhere. It has to come from somebody or something.

If you leave the national budget untouched then some other department must bear the burden in order to increase defence spending. If you opt to increase the national budget in order to accommodate new spending then you either have to tax the people more heavily, resulting in losses to local economies, or you have to borrow more money from the markets... money that has to be repaid through future taxation.

Money spent to boost employment in defence is money not being spent to boost employment in health, or transport, or the energy sector. Unless there is a sound (or relatively so) benefit or need for additional defence spending, then spending on defence for defences sake becomes an unproductive waste of valuable national resources that could be turned to other uses that would serve to enrich our nation (figuratively and/or literally) to a greater extent.

I think this is worth keeping in mind as we debate back and forth. Those of us who blog, tweet, read and comment about defence naturally have a slight bias in favour of greater defence spending, but before we commit unwaveringly to extra funds for new submarines, frigates, fighters and tanks, we should always be mindful about asking ourselves whether we really need all the things that we covet, and what is the hidden cost - That Which Is Not Seen - to the nation?


  1. Interesting post Chris; never come across that parable before. Just a few thoughts that occur to me, rather than immaculate argument that I will defend to the death, or something....

    Defence is increasingly island-like, in (frequently false) perception and technological reality; rather than being just an organic part of the whole system.

    In terms of looking at problems in defence, it tends to be examined in much the same way as focusing on how to fix that broken window, that's part of a house that's rotten and falling to bits.

    The usually un-examined core of everything that folks like us debate is, "What, as a nation, should we be?" Defence is a big part of that, but the magnitude of the opportunity cost of fixing that broken window varies according to the bigger picture: Cost in lost trade if we don't fund the military force that would have protected it; cost in prestige and that influence that you're so fond of (heheheh...); effectively decreased cost if we went back to having more of an emphasis on a design and manufacturing economy (or a more nationalist rather than globalist one), and so on.

    It's funded in a very island-like way, rather than looking at the other things that it gives back and adjusting the budget accordingly: As you mention, things that should really be coming out of other budgets (aid, humanitarian and diplomatic work, all of the 'Good for Business' stuff etc); and there should be some rebate if the MoD buys more-expensive British (the eventual ~40% claw back from jobs, taxes etc) than cheaper, foreign OTS.

    Probably the main problems are more the defence being a technological/manufacturing island ones mentioned above: If we're going to keep moving away as far as nationally possible from being a design and particularly manufacturing economy then that's going to increasingly clash with maintaining our relatively shrinking little defence island within the economy; which is massively exacerbated by 'defence inflation' and the ever-widening tech gap between defence kit and everything else. Then further exacerbated by hyper-specialisation.

    The Astute programme showed the problems of letting a sovereign ability lapse then trying to start it up again, but also the problem in keeping the sovereign ability then ticking over (the loss of the eighth boat, but effectively still paying for it to not be built).

    If we were back in the Cold War, where pushing the tech envelope all over was important as a big "Eff U!" to the adversary, then there would be enough glorious white elephants being worked on to give these gifted designers and high-tech building industries something to do, to keep their eye in and keep them sharp - but now defence is a shrinking industrial island (most civilian tech is now more interested in consolidating the existing plucked mound of low hanging fruit than reaching higher, and cheaper rather than better).

    And even within that tiny island, hyper-specialisation causes further problems: I haven't looked deeply into the exact whys of this or anything, but if you look at the US' domination of fighter AESAs, but incredible problems in ship AESAs, then merely shifting gifted people about as needed doesn't seem to be as simple or effective as you suggest.

    S'ppose my final point would be that where our goodly shopkeeper might have spent that window repair cost on something worthwhile like shoes or a book; the government would likely only spend that money on something stupid and sh*t that would just wind everybody up (or it would just disappear), if it wasn't buying highly visible ships and planes etc.

    Effectively, even with all the waste, defence spending is actually nearer to being the shoes or book, and if it wasn't spent on that then it would be spent on window breakers (plenty of them little darlings round my way), and then maybe the 'necessary' window fixers if we were lucky and lived a 'nice' area.

  2. Hello Tsz,

    I think the deal with the US AESA is not so much that the radars are not good, they're just built for a different purpose. We anticipate ships operating alone, so we build with that kind of mentality in mind, whereas the USN has the luxury of much greater AWACS coverage.

    You have a point about how government spends money, in the sense that overseas aid for example leaves the economy and may or may not be returned through some other means, whereas defence spending tends to stay within the economy.

    I'm still working on that 40% clawback figure though. The deeper you look into it, the less convinced I am that it comes back in that proportion, at least not for a long time.

  3. Hi Chris,

    I think that the US is having a problem with its ship radars (that may or may not be AESAs): Previously they would have taken pride in building their own new ones, but now we're seeing: SPY-1 variants being pushed for ships where it just isn't the best option (eg proposed Frigate adaptations of Freedom), or continued with fairly minor tweaks/patches; old US (not SPY-1) radars being fitted to new ships; foreign radars being used or proposed in the minor combatants that won't always be under the CBG umbrella (LCSs, NSC, proposed frigate adaptation of NSC); and the swanky new dual-band radar for the Zumwalts being an on-going failure (too heavy).

    [Please note that I agree that continuing with SPY and Aegis is the best choice for the ships that will tend to be used as CBG escorts under the E-2D umbrella and/or BMD work: I'm talking only about everything else. Also note that they wanted to standardise around S Band, and back in the day they would have created a cheap, light S Band AESA rotator of their own, but they haven't (or managed to standardise around S Band), so that might indicate a problem.]

    Given their excellence in fighter and AEW radars (and historical tech-industrial excellence in everything, and 'not invented here' attitudes), it's an interesting thing to look at as a possible case study. It's probably more down to LM's near-monopoly and general dodgy corporate-political doings these days, than the designers/engineers actually being lacking in some more fundamental way; but we would have exactly the same problems with BAE.

    It's not insurmountable, but I'm just saying that if we wanted some way of efficiently starting up and switching off sovereign industries as needed, then we have to change an awful lot of our civilisation in order to give that even a fighting chance of success. The idea that you can simply shuffle folks around to where they're currently needed, without losing anything in the process, is one of the big communist fallacies (now constantly being repeated by business) best avoided.

    Re: the ~40% claw-back: Aye, it does need more work (and cheers for doing so!) but I think that it's about right, but only with the qualifiers "a long time" and my "eventual". But presumably the UK will still be around for a long time, so it's another matter of 'merely' adjusting the country's approach to how these things *actually* work over time, regardless of the (artificial) election cycle or financial year ending.

    The more that Defence becomes a very special case (as the high-tech design and manufacturing wider economy continues to disappear), the more it will have to be treated differently than everything else if it is to continue.

    [BTW, we were having a bit of a chat about Successor options but TD wanted the general discussion to stop, so I did out of respect for him. I hate loose ends so I'll drop my reply to your questions from back then (having had a bit more of a ponder) onto your post about it here later on today. Nothing amazing but might as well get the loose ends tied off.]

  4. What if the glazier then spends his six francs in the bookseller and the cobbler? Who both then spend their money in the shopkeeper's shop? The economy has experienced an increase in wealth of eighteen francs given MV=PT. By not repairing his window the shopkeeper would see the capital stock of the economy decline and reduce effective demand- essentially pushing the three-shop model into a recession.

    Similarly, government spending has a greater multiplicative effect than tax cuts (Ricardian equivalency etc.); it might as well spend its money on something rather than save it. Cancelling spending on defence and giving the money back to its citizens, a government would see its economy shrink- at least in the United Kingdom's situation of a large deficit.

    So the only argument from an economic point of view is whether defence has greater or lesser multiplicative effect than any other government department- assuming the multiplier stays constant at all levels of spending. There remains no obvious answer to this, so it all becomes a matter of preference.

    For an argument for preserving national industrial capability there's no way I can express it better than Correlli Barnett's 'The Collapse of British Power' and 'The Audit of War'. The latter two books of the series are well worth the read as well.

  5. Morning gents. I'll answer your questions separately. First then...

    @ tsz52,

    I think the issue with the LCS is that they're too small, lack the power and are supposed to be low cost projects (!!) hence why they've elected to use cheaper, smaller radars from Europe, as opposed to their own failings. They probably could have produced a smaller system for LCS, but only at a disproportionate cost.

    As for the 40% clawback, here's my basic line of thinking (which might help someone else come up with the answer). The proportion of tax paid by the company is only paid on the profits, so that's 23% from next year of only the profits. Then we move on to the staff, who ostensibly pay about 35% when income and national insurance are combined, but that's only above their allowance, so the amount of taxable income is much less.

    Eventually those employees will put more back in through VAT etc, but that will take a lot of time to bear fruit and still the percentage that ends back up in the government coffers won't be that huge. I'm more inclined, especially with the low rates of corporation tax on the low profits to think that the figure might be closer to 15-20%, but without hard data from the companies about their pay, it's really very difficult to get a good estimate.

    Then we have the balance off of "if they weren't employed, would they be on benefits?" versus "if they weren't employed by BAE who are constantly pushed to keep their costs down, would they earn more (and thus pay more tax) working in other private industries?"

    So for example would an electrician earn more if they were self employed and working free lance on the open market instead of trading financial income for long term security by working on contract with BAE? How much more tax might they pay doing this?

    An enigma wrapped in a mystery etc, as they say.

  6. @ BertramPantyshield.

    What a thoroughly bizarre, yet brilliant name.

    The glazier might spend his money in the bookshop or cobblers, or he might spend it in any one of a myriad of other industries.

    Bastiat, (who was a part of the French government at one point) was arguing a much wider case (using the shopkeeper as an example) against the idea of wide scale destruction of property as being a good thing. Much like people sometimes argue that crime has an economic benefit because it keeps police officers employed, without considering the wider losses to society caused by unlawful behaviour.

    On to Ricardian, and it should be remembered that he himself disparaged his own theory and was not convinced by its arguments, which I find oddly admirable as he was posing a theory without being dogmatically tied to it, for the sole benefit of learning and advancing human understanding of economics.

    We must consider for example that if government didn't spend as much on defence (assuming there were no threats or needs of any form) then it should be able to ease the tax burden on HM subjects, such as cutting VAT to as little as 13-14%, giving your average Joe Bloggs more money in his pocket and more incentive to spend the money sitting in his account on various items.

    I dream of the day when we can abolish VAT, which I personally consider to be the most burdensome, unequal and vile tax of them all. Just the shear amount of paperwork companies must jump through and the administrative burden of assessing and collecting it is enough of an argument to do away with it.

    1. I must admit, the name is due to Bill Bryson's 'Notes From A Small Island'. It's always been a favourite of the family.

      Ricardo's main concern with his theory was that consumers are not rational nor far-sighted enough to properly comprehend tax liabilities. A cut in VAT wouldn't see a direct increase in the nominal wealth of the average British consumer, simply their purchasing power. If we are to ignore Ricardian Equivalency, thus suggest that consumers will not behave rationally, or have sufficient economic knowledge to cover future liabilities, then it is hard to believe that they would be able to comprehend an increase in purchasing power.

      Hence, economically, it makes far more sense for the government to continue spending to support aggregate demand.

      Bastiat's argument against the destruction capital stock was made before the Second World War, where the large-scale destruction wrought on Germany and Japan saw them deliver above trend-rate growth for decades. Britain had the same chance but, as is discussed in Barnett's 'The Lost Victory', decided to piss it up the wall on empire and welfare.

      As someone who is looking towards working as a tax accountant or auditor in financial services, hopefully the tax code will stay well above 11,000 pages. Sarcasm aside, I'd hope to see 25% across the board of income, corporation, and capital gains. With allowances of £15,000, £100,000, and £0 respectively. Nice and easy to administer- maybe throw in some duties and inheritance. Having spent countless hours on national insurance and VAT payments, I certainly won't be sorry to see the back of them.

    2. Personally I'd like to see 30% across the board, with a £10,000 allowance for income, a higher rate for income over a certain amount (lower threshold than now, but without the progressive removal of the allowance), a basic payroll tax to replace employers national insurance (with income and NI being merged at 30%) and a higher rate for corporations over a certain amount (with no allowance, even for small companies). Plus inheritance and stamp duty etc, designed to make the choice between one investment and another almost irrelevant as far as tax was concerned. In my dream country, the tax system would be as basic and simple as humanly and practically possible!

      As for the general public, I think they'd understand purchasing power a lot easier than they do tax liabilities. Generally speaking you'd expect the average consumer to understand much better the principal that item A in the high street has reduced in price while their income remains broadly the same, always assuming that companies pass on the tax savings to their customers.

      Now Japan and Germany, there are two interesting countries. Heavily invested in and supported by the US to get them back on their feet, buoyed by large American presences in their early years post war, then finally able to go it alone and rebuild from the ashes.

      But if we take Bastiats point to its most logical conclusion, how big would those economies be now if it wasn't for the destruction of WW2? Growth wouldn't have been as impressive, due to the higher starting position, but in all likelyhood both economies would have benefited more from being in a much better starting position. Their potential to embrace and exploit capitalist principles would have been even greater.

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