Keeping the free market faith

For Radio 4:

The financial crisis has made many on the political right question their faith in free market capitalism. Jamie Whyte is unaffected by such doubts. The financial crisis, he argues, was caused by too much state interference and an unhealthy collusion between government and corporate power.

Interviewees include: Matthew Hancock MP, Minister for Skills and co-author of Masters of Nothing. Luigi Zingales, author of Capitalism for the People: Recapturing the Lost Genius of American Prosperity and a professor at Chicago Booth School of Business.

The programme was first broadcast at 8:30 PM, 8 Oct 2012. It is available on iPlayer and in MP3 format through the BBC Analysis podcasts site.


Forcing others to obey is the issue, not greed

Many of those occupying Wall Street and the City of London object to corporate greed. Yet greed is usually harmless.

For example, I may well be greedy. I would like to earn more despite already earning what many of the protesters would consider more than enough. But my greed is harmless because I cannot force people to give me their money; I must persuade them to part with it. And I can do that only by offering them something they want in return. Given my impotence, my greed is beneficial to others. It inspires me to come up with valuable things to offer them.

Continue reading at City A.M.


The corporate virtue of bankers

Senior bankers make a lot of money and take a lot of risk. This combination strikes most commentators and politicians as revealing sad failures of personal morality and corporate governance, failures that must be rectified by the regulation of bankers’ pay. They are confused.

The principle challenge of corporate governance is to align the managers’ interests with the owners’. A simple way is to make managers owners too, by paying their bonuses in company shares. Yet this is an imperfect solution, because it fails to give managers the same “risk appetites” as other shareholders.

Few of a company’s shareholders are investors in that company alone; most hold a diversified portfolio of stocks. Provided these stocks are not perfectly correlated, the volatility of the portfolio’s value is lower than the average of each stock’s volatility. When held in such a portfolio, the optimal volatility of each individual stock is higher than it would be if held on its own.

The risks of company managers, by contrast, are concentrated in the firm they work for. Not only are they partly paid in its shares but, if the company fails, they lose their incomes. A company’s managers are therefore more risk averse than its owners, even when their bonuses are paid in shares.

This fact helps to explain the high salaries, huge bonuses, “golden parachutes” and other elements of “fat cat” compensation that outrage the popular press. They are designed to relieve corporate executives of their natural caution and bring their risk appetites up to the level of the other shareholders’. Contrary to popular opinion, it is low paid and risk-averse bank managers that would represent a failure of corporate governance.

But surely, some will protest, the financial crisis shows that bankers took too much risk. It does not. Shareholders of a limited liability company enjoy an asymmetric exposure to its performance. If it does well, there is no limit to how much their equity can appreciate. If the company fails, however, the most they can lose is what their shares cost to buy. This means that shareholders benefit from risk.

A simplified example will make this clear. Imagine you are a shareholder of a firm with a leverage ratio of 10:1. If the assets devalue by 10 per cent, you lose all your equity. However, if their value increases by 10 per cent, you double your money. If the probability of each outcome is 0.5, your equity is worth 1 (=2×0.5+0x0.5). Suppose the firm now increases its risk by taking its leverage to 50:1. If the assets increase in value by 10 per cent, then your equity is worth 6. If the assets decline in value by 10 per cent, then your equity is again worth nothing. The expected value of your equity is now 3. The extra risk has made you better off.

Why then do companies not increase their risk ad infinitum? The answer is that they are prevented from doing so by their creditors. Because a firm’s creditors do not participate in its profits, they gain nothing from its extra risk taking. On the contrary, the more risk the firm takes, the less likely its creditors will be repaid and, hence, the greater the “risk premium” they will charge for their lending. It is the increasing cost of borrowing that constrains corporate leverage and other risk taking.

This market mechanism breaks down, however, when the corporates concerned are banks, because lending to banks is made (almost) risk free by government guarantees. These guarantees are explicit in the case of “retail deposits” and unstated but dependable in the case of “wholesale” bank creditors.

Since 1988, 28 of the world’s largest 100 financial institutions have failed. This equates to a 1.3 per cent annual probability of default. Nevertheless, the top 100 banks have enjoyed an average credit rating of A+, which corresponds to a 0.05 per cent annual probability of default. This apparent anomaly is easily explained by the fact that in only two of these 28 cases of bank failure did the national government allow creditors to suffer losses.

By eliminating the normal “risk premium” on bank debt, government guarantees subsidize bank risk-taking. A bank that took so little risk that it was no more likely to default than the government could borrow at the same low rate of interest even without the guarantee. Its managers would effectively be rejecting the government’s offer of a subsidy. By contrast, the greater the risks taken by a bank, the greater the subsidy it extracts from the government guarantee.

If the virtue of senior bankers’ is still not clear, imagine two tobacco companies, Holy Weed and Noxious Weed, both eligible for government subsidies of tobacco production. Whereas the CEO of Noxious Weed accepts the subsidy, Holy Weed’s CEO rejects it. Who has been irresponsible?

Perhaps the CEO of Holy Weed has performed a public service, but that is irrelevant. He is not a public servant. He is responsible not for public welfare but for the welfare of his firm’s shareholders. Rejecting a subsidy would be a dereliction of that duty, since it would drive down the value of Holy Weed shares.

Similarly, a senior bank manager who refused to take government subsidized risks would be derelict in his duty to his shareholders. It should surprise no one that banks whose senior executives had the greatest shareholdings also took the greatest risks. The bankers who “brought the economy to its knees” were only doing their job.


Bank debt-holder guarantees and risk regulations

Legislators in Western countries are in the process of rewriting financial sector regulations. Most commentators encourage the politicians in this mission. Yet few politicians or commentators pause to ask themselves why such regulations are required in the first place – that is, why market mechanisms alone do not properly constrain banks’ risk taking.

The answer is that government guarantees of bank deposits greatly reduce the “risk premium” that banks must pay on their debt capital. Retail deposits (i.e. deposits under some threshold) enjoy the explicit guarantee of the government regardless of the bank’s credit worthiness. Only bank creditors who are not guaranteed by the government (e.g. large commercial depositors and other “wholesale” liability holders) will demand higher interest rates when banks take more risk. And even they will do so only to the extent that they doubt the government will cover their losses should their debtor bank fail.

The history of bank bailouts – especially for the “too big to fail” institutions – vindicates the view that debt holders will be made whole, and therefore justifies the low levels of “bailout doubt” observable in the prices wholesale bank creditors charge banks. Since 1988, 28 of the world’s largest 100 financial institutions (as measured by assets) have failed. This equates to a 1.3% annual probability of default, which should equate to a BB credit rating. In fact, the top 100 banks have enjoyed an average credit rating of A+, which equates to a 0.05% annual probability of default. This apparent anomaly is easily explained by the fact that in only two of these 28 cases of bank failure (Lehman Brothers and Washington Mutual) did the national government allow creditors to suffer losses.

These explicit and implicit government guarantees of bank creditors effectively subsidize bank risk-taking. They remove the normal market discipline on risk-taking: namely, the premium that creditors charge for risk. Given this subsidy, banks can extend their risk taking, and the revenues that come with it, well beyond the point where an unsubsidized risk premium would have stopped them.

Excessive bank risk taking is simply another example of the general principle that subsidies create excess supply. And, as usual, to avoid a wasteful misallocation of resources, governments must then try to rein in the overproduction created by their subsidies. In agriculture, this is typically attempted by imposing production quotas or “caps” on the crops for which the government guarantees above-market prices. In banking, the standard cap used is on leverage. Banks are legally required to fund no less than a specified percentage of their assets with equity capital rather than debt. Since the advent of the Basel Accord on Banking Supervision in 1988, this minimum capital requirement has been expressed as a percentage of “risk weighted” assets.

This approach, of trying to regulate away the excess risk taking encouraged by debt-holder guarantees, failed catastrophically in the crisis of 2007-08. The standard response of policy makers and advisers has been that the approach is right in principle and that the catastrophe was caused by nothing but faulty execution. The regulations need only be corrected. Unlike the Basel 1 and Basel 2 accords, whose measures of bank risk taking were hopelessly inadequate, the post-crisis Basel 3 regulations will get things right.

This is difficult to believe. Bankers will seek out activities whose risks are overlooked or mispriced by the new regulatory regime. In other words, they will continue to engage in the “regulatory arbitrage” that occurred on a massive scale under the Basel 1 and Basel 2 regimes. It is mere wishful thinking to believe that it will not also occur under Basel 3.

“More active supervision” is the mantra that encourages many to indulge in this childish optimism. No matter how “active”, supervisors cannot be expected to win this game of cat and mouse. For the mice have too many advantages. They are more numerous, mostly smarter, better informed and, given the complexity of modern financial products and the global scope of the financial markets, they have a near limitless supply of nooks and crannies in which to hide their risks. What’s more, bankers are far better incentivised to win the game than government employees are.

This inevitable regulatory arbitrage is disastrous, not simply because it prevents regulations from having their intended effect of reducing aggregate bank sector risk-taking, but because it distorts the allocation of capital in the economy. Debt capital is allocated not to those uses that deliver the best return on risk; it goes to the uses that deliver the best return on the bank equity capital required by the government’s rules. In short, bank capital rules undermine the market mechanism that ensures resources go to their most valuable use.

Nor will the politicization of lending be restricted to such unintended effects. The government’s role in deciding the cost of lending to various classes of borrowers (through the risk-weightings and other rules) provides a strong incentive to lobby government officials for preferential treatment. The borrowers who seek discounts, the banks who serve them and the politicians who wish to be seen as the champions of these groups all have an incentive to distort the framework and thereby add to the misallocation of capital. Such shenanigans have already been incorporated into the 2010 Dodd-Frank Bill, which requires banks to hold 5% of loan securitizations on their own books, except when the securitized loans are “qualified mortgages” (which are yet to be specified).

The perverse result of tighter risk regulation will be more risk, as bankers seek ever more ingenious ways of evading the rules, and lower economic growth, as the rules distort the allocation of capital in the economy.

Government guarantees of bank debt-holders and risk regulations are a package deal; the former demands the latter. But the package is calamitous. The regulations cannot do their intended job of eliminating the “moral hazard” created by the guarantees, and the failed attempt merely perverts capital allocation. The guarantees are the problem. The solution is to eliminate them and the attendant regulations that prevent market participants from pricing bank risks properly.


Economic vandals

Shortly after taking power, our new coalition government decided to withdraw the previous government’s pre-election promise of a £80 million loan to Sheffield Forgemasters, a steelmaking company. On Newsnight, David Miliband called the decision “economic vandalism”. Paul Kenny, the general secretary of the CMB union, told The Times the same thing.

They have got things exactly the wrong way around. Making the loan would have been economic vandalism. To see why, consider my current predicament.

I have an idea for a business that I believe would provide its customers with a valuable service and employ five or six people. Alas, I need about £1 million to set it up, which I do not have. I plan to approach potential investors. If they choose not to invest, will they have committed economic vandalism? Obviously not. They have not damaged my property, nor done me any other wrong.

Suppose now that, frustrated by what I take to be their short-sighted refusal to fund my business, I get my computer wizard friend, Big Jim, to hack into their bank accounts and transfer £1 million to mine. Big Jim and I are surely the economic vandals here. Without consent, we have plundered other people’s property.

We have probably harmed society too. Those investors believed there were better uses for their money than investing in my business. My confiscation of their money benefits society only if I am right and the investors are wrong – only, that is, if there really is no more valuable alternative use of their money than investing in my business. But I am almost certainly wrong about this because, unlike the investors, I do not know what their alternatives are.

Yet what Jim and I might have done here (but didn’t, honest) is precisely what the government would do by lending to Sheffield Forgemasters. Forgemasters could not raise £80 million from voluntary investors, at least not on terms that suited them. So they got their mate Gordon Brown to take money from people who did not choose to make the loan – that is, taxpayers – and give it to Forgemasters.

Apart from the fact that when politicians do such things they are legal, there is no relevant difference between Brown’s conspiracy with Forgemasters and Big Jim’s with me. Like Jim and me, they deprive the investors (taxpayers) or any choice in the matter. And, like Jim and me, they have no idea if there are better uses for the money.

It is not surprising that politicians have given themselves the legal privilege to do what would land anyone else in prison. Such “investments” of “public money” are an excellent way of winning votes in marginal constituencies and rewarding party donors. But it is still scandalous.

The new government defends itself from the accusation of vandalism on the ground that they have cancelled only 12 of 200 such bungs. They are as confused as their critics. They have committed 188 acts of economic vandalism.


Subsidizing Risk

Industrial policy is back in fashion. Our new coalition government claims that the financial industry is too big. They promise to “rebalance the economy”, mainly in favour of high tech and green industries. These excellent but mysteriously under-funded industries will be encouraged with subsidies.

Industrial subsidies are a bad idea. They replace the judgement of investors risking their own money with the judgement of politicians playing with other people’s money. Not only does this reduce the chance of wise investment, it distracts entrepreneurs from their proper business. They devote themselves to winning the sympathy of the subsidy dispensers rather than producing things that consumers will pay for voluntarily. A planned economy is an economy of political favours.

But these perverse effects of subsidies are not my concern here. An even simpler point about subsidies suffices to show where our politicians have gone wrong in their analysis of the financial crisis and our inflated banking sector. And that point is this. If a subsidy is offered, it will be accepted.

Whatever doubts Messers Cameron, Osborne and Cable may harbour about their industrial policies, it has surely never crossed their minds that they will be defeated by techies and greenies refusing to take taxpayers’ money. Perhaps a fiercely independent farmer once refused an agricultural subsidy, but I doubt it.

If our politicians could only remember that subsidies are always accepted, they would see that it was their own policies, not the peculiar greed of bankers, that caused the financial crisis and that they will almost certainly cause another. For they offer a subsidy that bankers can cash-in on only by taking the excessive risks that lead to financial crises.

The subsidy I have in mind is the government’s guarantee of loans to banks. Before the financial crisis the government explicitly stood behind loans to banks of less than £35,000 (retail deposits). If the bank failed to repay the depositor, the government would. Where larger, “wholesale” loans were concerned, the government did not explicitly promise to repay bank creditors. But it was widely and rightly assumed that they would.

Such a guarantee makes lending to a bank as safe as lending to the government, no matter how risky the bank is. Which means that banks need not pay their creditors a “risk premium”: that is, the higher rate of interest that creditors demand in return for lending to riskier borrowers.

If a bank took very little risk, making itself as unlikely to default as the government, then the guarantee would be worthless. Even without it, the bank would be able to borrow at the same low rate of interest. Only by increasing its risk – for example, by increasing its ratio of debt to equity – can a bank cash in on the guarantee.

Consider, for example, a bank with £500 billion of debt. If it takes risks that would normally carry a 1 percentage point risk premium, then the government guarantee is worth £5 billion a year. And the more risk the bank takes, and hence the higher the risk premium it would normally have had to pay, the greater the value of the guarantee. The government guarantee means banks can pursue the revenue that comes from risk-taking without having to pay the price that would normally constrain them.

In the run up to the financial crisis, government subsidies of bank risk-taking ran into the hundreds of billions of dollars. So it is unsurprising that banks took so much risk. It is just another example of the immutable law of economics that if a subsidy is offered, it will be accepted.

The politicians who arranged the subsidy now like to complain about the greed and irresponsibility of the bankers who accepted it. This is like a man who has had his wife murdered protesting in court that he never imagined the hitman would be so wicked as to do what he was paid for.

When it comes to absurdity, however, our politicians’ rhetorical response to the crisis is nothing compared to their policy response. They have not removed the risk subsidy by eliminating the guarantees – perhaps by making it a criminal offence to administer a bailout of bank creditors. On the contrary, they have made the formerly implicit guarantee to wholesale bank creditors explicit.

But do not fear. This time, things will be different. This time the laws of economics will be suspended and the subsidy will not be taken. Financial regulators will come up with rules that prevent bankers from taking excessive risks, even as politicians increase the subsidy for bank risk-taking.

The most comprehensive attempt to ensure bank solvency through regulation, the second Basel Accord, came into force shortly before the financial crisis. All the banks that collapsed complied with its new rules. Yet this fiasco has not dimmed our politicians’ faith in the wizardry of financial regulators. They persist in telling us that a handful of bureaucrats can prevent the Masters of the Universe from getting their hands on hundreds of billions of pounds worth of subsidies.

Such tenacious wishful thinking might be endearing in children. In policy-makers it is catastrophic.


Bernanke on the Federal Reserve’s exit strategy

Federal Reserve Chairman Ben S. Bernanke has given testimony before the Committee on Financial Services of the U.S. House of Representatives.

If you thought things were moving our way, look at the remarks at the end of note nine.

The Federal Reserve believes it is possible that, ultimately, its operating framework will allow the elimination of minimum reserve requirements, which impose costs and distortions on the banking system.


Labour laws should be abolished

In 2006, the European Court of Justice ruled that the Department of Trade and Industry has misinterpreted clauses 3 and 5 of the Working Time Directive. Clause 3 states: “Member states shall take the measures necessary to ensure that every worker is entitled to a minimum daily rest period of 11 consecutive hours per 24-hour period”. Clause 5 says that workers are additionally entitled to at least one uninterrupted rest period of 24 hours every week.

The tricky word here is “entitled”. The DTI interpreted it to mean entitled. They instructed employers that they must allow, but need not require, employees to take these rest periods. According to the ECJ, however, “entitled” actually means obliged. Employees may not choose to take shorter rest periods, and employers must not give them this option.

The European judges are surely correct on the matter of interpretation. If the words of European legislators are open to several interpretations, then deciding which was intended is simple; it must be the one that most restricts freedom of choice. And if you think that obliged is not a possible interpretation of “entitled”, then there is much you could learn from the judiciary about post-modern semiotics.

If not surprising, the ruling may still seem unfortunate. British employees already enjoyed the right to these rest periods. When it suited them, however, they were free to take shorter breaks – perhaps to earn overtime or to negotiate a longer break for another occasion. This option was surely valuable to them. Why should the manufacturing union Amicus have asked the ECJ to eliminate it? And why should the TUC have welcomed the ECJ’s ruling?

To see why, note that in the labour market employees are the suppliers and employers are the consumers. Employers buy the labour offered for sale by workers. The Working Time Directive, as now interpreted, is a regulation about the kind of service workers may offer for sale.

Product regulations usually impose minimum standards. When it comes to labour, however, we get maximum standards. The ECJ’s ruling means that, with respect to the flexibility of hours worked, employees may not offer a product exceeding a certain quality. And that is precisely why unions support this interpretation. Maximum standard regulations are required by suppliers attempting to fix their prices above the market price.

Consider a different example. Suppose you manufactured a basic type of bicycle. If the most efficient bike-maker could produce such a bike at a cost of £100, then this would soon be its market price. In a free market, price competition between suppliers drives the price of goods down to the cost of producing them. This is nice for consumers but not for suppliers. How might you avoid this unpleasant consequence of competition?

You could try collusion. Create the British Association of Bike-Makers and, at your annual conference, agree that no one will sell bikes for less than £200. Or lobby the government to set a minimum bicycle price of £200.

Alas, a minimum price will not work on its own, because it does not stop competition on quality. If everyone must sell bikes at £200, and my competitors’ bikes are worth £100, then I can get an advantage by producing better bikes at a cost of £110. My competitors will then retaliate with a yet better bike that costs £120 to make. This process will continue until we are all making bikes at a cost of £200, and none of us is better off than when they cost £100. To keep the benefits of our minimum price, we also need to restrict the quality of the bikes on sale: we need maximum standards.

Trade unionists and employment regulators are devoted to keeping the price of labour higher than its market value. So they must also stop the suppliers of labour from competing on quality. The endeavour is corrupt in principle – indeed, it would be illegal if the product were anything except labour – and futile in practice. The legislation they favour does not eliminate competition between workers; it simply benefits some at the expense of others.

I recently managed a team of two consultants. They were of roughly equal value. John was brighter but Don worked harder, often violating the Working Time Directive. If I had stopped him, who would have benefited? Not Don. He would have been robbed of his ability to compete with John, and his chance of promotion would have been reduced. A ban on hard work benefits not those who work “too hard” but those with other qualities to offer. It rigs the competition in their favour.

It is impossible to eliminate competition between the suppliers of labour. Rule it out in one respect, such as effort, and it will merely shift to something else, such as talent. Rule it out in all economically relevant respects – allow no price or quality competition – and it will shift onto irrelevant preferences of the employer. A bigot might employ foreigners if they came at a discount. But why would he otherwise? Immigrants do better in America than in France, not because Americans are less racist, but because their labour market is less regulated.

Labour laws are intended to protect employees from employers. But no such protection is needed. Feudalism ended long ago, and the labour market is not a monopsony (a market with only one buyer). No one is forced into any particular job. Indeed, unemployment benefits mean that no one need work at all. Labour laws merely distort the allocation of labour and arbitrarily bestow costs and benefits across the population. They should not be interpreted more stringently; they should be repealed.


Demand for Doctors

Jamie Whyte discussed this article on Radio 4 yesterday.

I like most of the doctors I know. They are earthy and unsqueamish, about minds as well as bodies. Few, however, know much about economics. This normally does not matter. But occasionally doctors stray off piste, get onto health policy issues and make fools of themselves. Yesterday’s letters page of The Times contained a vivid example.

Twelve doctors wrote a letter lamenting the fact that about 20 per cent of visits to GPs are for “common disturbances to normal good health, such as coughs and colds”. This costs the NHS about £2 billion a year without making any difference to people’s health, since they could just as effectively treat themselves. According to the campaigning doctors, “the NHS has become the victim of a demand-led culture”.

Then, having got almost all the way to the answer, they miss it. Reading their letter is like watching your one year old with a square peg in hand and the square hole directly in view, trying to stuff it into the round hole. The square peg in the doctors’ hand is the word “demand” and the square hole is the fact that the price of visiting a GP is zero.

Perhaps the most familiar law of economics is that demand increases as price decreases – be it demand for apples, foreign holidays, doctors’ visits or anything else of value. The reason people visit GPs so frivolously is that it costs nothing besides the lost time. The obvious solution to the problem is to charge a fee. £10 should be enough to deter people with sniffles. People with something potentially more threatening will be happy to pay this much.

But the doctors miss this trick. Instead they fall back on the hoary old distinction between real needs and mere wants, which they combine with the popular modern absurdity that people should be educated into acting against their own interests. Specifically, they call on politicians to “enable GPs and practice nurses to give people the confidence to use the NHS at the point of need, not demand; educate people to manage minor ailments …”

If the doctors think that this is a good method for rationing GP visits, perhaps they will like this idea for rationing food. Nationalise supermarkets, set the price of all food to zero, then eliminate the problem of wasteful overconsumption by educating people that they should take only the food they need rather than what they want.

The proposal is obviously absurd. No such education could possibly have the desired effect; no one could sensibly specify which food is really needed as opposed to merely wanted; and, even if they could, why should people be allowed to eat only what they need? All the same goes for visiting a GP.


Do it for the money

Last year two police women (WPCs) were discovered to have a reciprocal child-minding arrangement. It was initially declared unlawful. Child minders who receive payment for their services must be registered with Ofsted. And receiving payment is not restricted to receiving money. Anything of value counts, including “free” minding of your own child. These unregistered WPCs were wrongdoers.

Public outrage at the absurdity of preventing friends from looking after each other’s children caused Ed Balls, the Secretary of State for Children, Schools and Families, to intervene. He declared that reciprocal childminding was not a kind of payment after all. The WPCs congratulated him on this small victory for common sense.

Which just goes to show that the common sense of WPCs cannot be relied upon. For, despite Mr Balls’ great powers, he cannot by mere proclamation stop reciprocal childminding from being a kind of payment. His decision simply exempts this barter payment from the tax that Ofsted’s rules and registration fees impose on childminding when other forms of payment are used.

If one of those WPCs quit her police job but offered to continue minding her friend’s child for £50 a day, Ofsted’s requirements would reimpose themselves. The child may be cared for by the same person in the same place, but the introduction of money to the deal would bring with it the state’s administrative and financial burdens. Mr Balls’ “common sense” intervention thus encourages a barter economy in childcare.

This is a silly thing to do. Because money is a better method of payment than barter. While the WPCs barter, they can consume the value of the childminding work they do only in the form of childminding for themselves. This means that they will restrict the amount of childminding they supply to the amount they want to consume. If they paid each other in cash, this restriction would disappear.

As all economists know, money increases the opportunities for trade. Limit its use and many potential transactions will not take place; valuable goods and services will not be produced. And, when they are, they will often be produced by the wrong people.

For where money-based exchange is restricted, people must produce a wider range of goods, either for their own consumption or to increase the chance of having something they can swap for something they want. This is unfortunate, because the more things you do, the worse you will be at them.

In short, discouraging the use of money constrains trade, which limits the division of labour, which leads to inefficiency. Politicians ought not do it. Yet they do it all the time. They impose burdens on activities when done in exchange for money that they otherwise leave alone.

Consider the minimum wage. I am not allowed to pay someone £4 to spend an hour shopping for me. According to our government, that would be unfair, even if my employee agreed to it. Yet I am free to add an hour to my own shopping by walking to a distant supermarket in search of a £4 saving.

I am also allowed to spend an hour cooking my dinner, even if I would be unwilling to pay someone more than £3 to do it for me. Contrary to what you may have read on the Directgov website, working for less than £5.80 an hour is not illegal in Britain. It is illegal only if the payment is made in money.

Taxes have the same effect. Since most are levied on money-based transactions (with the notable exceptions of poll and property taxes), they inhibit trade and, hence, the division of labour. And the greater the rate of tax, the greater this malign effect.

Suppose, for example, that you are willing to pay up to £10 an hour to have some work done, and that the cheapest qualified labourers are willing to work for anything over £9 an hour. Then you should find someone to do the job. But if incomes are taxed at 20 per cent, the most the labourers can earn from you is £8 an hour and they will be unwilling to take on your job. You will have to do it yourself or go without.

Britain’s enormous regulatory and tax burdens on trade lead to an excess of do-it-yourself. People with neither talent nor inclination cook, garden, teach, drive and shop, to name but a few of the more common amateur activities. They are thereby drawn away from doing things they are better at and enjoy more.

What is the cost of such restrictions on the division of labour? Terry Arthur of the Institute of Economic Affairs has estimated that, at current tax levels, the cost is two thirds of every pound of tax collected. In other words, the marginal cost of transferring a pound from private hands into the coffers of Her Majesty’s Revenue is 67 pence.

Mr Arthur may be wrong, of course; estimating such “invisible”, deadweight costs is notoriously difficult. But even if his estimate is three times the real cost, the implications are profound. Taxes, minimum wages and the other regulatory burdens the government places on money-based commerce are far more costly than politicians and voters seem to realise.

Indeed, most do not recognise this cost at all. Some lament the futility of a system in which people are taxed only to receive their money back in the form of government provided services, such as education and healthcare. But they fail to see that the spinning of this money-go-round creates a terrible economic drag.

Alas, there is no prospect of an end to this waste, even if politicians understood it. When invisible costs are incurred for the sake of visible benefits, a politician will never consider them too great.