Principles for a New Social Contract

The manifestation of evil in Europe in the 20 century began and ended with events in Bosnia. An assassination in Sarajevo triggered World War 1. And after the fall of the Soviet empire, the people of Bosnia endured genocide. Today, Bosnia-Herzegovina (B-H) is a fractured territory whose peoples need policies that integrate them into a stable social system. This essay describes the financial principles that would deliver economic prosperity and social harmony. New policies must deliver on two needs:

  • acceptance that the political system treats every citizen equally and fairly, and respects ethnic and cultural diversity; and
  • economic growth that is not disrupted by the systemic failures which continue to create mass unemployment in market economies.

The cornerstone of the new financial model is technically called “economic rent”. Because of intense opposition to reform by the privileged elites, adoption of the necessary tax reforms is not the easy option. Could the People’s Plenums that have emerged in towns throughout B-H override the opposition of the political elites?

The Foundations of Prosperity

The people of B-H were bequeathed with a terrible legacy from the violence that erupted with the disintegration of the USSR. The population is locked into a state of trauma. Reform proposals need to be framed to help the people to recover from that trauma. The sole policy initiative that is capable of leading to re-balanced communities, within which individuals may recover the health of themselves and their communities, is tax reform. The changes would yield social and psychological, as well as economic, benefits.

  • Hope for the future: new freedoms and opportunities would empower people to achieve their goals in life.
  • Health would be recovered: this is one direct result of the restoration of personal dignity.
  • Happiness would be enhanced: the emphasis on co-operation would drive activities to renew economic enterprises, culture and sport.

The model of finance outlined here provides the incentives to personally contribute to both the common good and private welfare. The cumulative effect is a social catalyst that begins to dissolve the pathologies of the last 20 years.

The Context for Change

Our global social and environmental crises stem from political policies that legalise an unjust distribution of income. The problems are the direct result of the public’s pricing mechanism (taxation). Injuries to economic activity are many and complex, but the source of the problems are few and easy to identify.

  • Taxes on earned incomes. When taxes are levied on wages and profits, they reduce productivity and cause the inefficient allocation of capital. Among the effects: unemployment and low wages.
  • Privileged treatment for a minority of citizens. Those with the power to capture the flow of income which is technically called “economic rent” are handed power that results in
      1. corrupt political deal-making: this divides populations into the prosperous and poor;
      2. corrosion of the fabric of society; and
      3. cultural crises: these stem from the dismantling of the community’s immune system – the financial mechanism which is described in §2. The result is a traumatised society (Harrison 2012).

To correct these perverse outcomes, it is necessary to

  • remove taxes from the incomes that people earn, and
  • raise the public’s revenue from economic rent.

This rent is not the “rent” paid for a hired car or apartment. Understanding the social composition of rent is crucial to the formation of policies that serve the common good. Once understood, the rent paradigm illuminates a view of the world that is concealed by neo-liberal prejudices.

Rent is the flow of income that remains after deducting the share that is claimed by labour (as wages) and capital (as profits). Thus, rent is a nation’s net income. Its value stems from two sources:

  • the services of nature One example: the electro-magnetic spectrum which we need for our cell phones. And
  • the services of society These include the administration of law and order, military defence of the territory, public health and education.

The crises that proved fatal for previous civilisations originated when their socially-created rental income was privatised. For the West, today, the consequences of the current tax regime were summarised by Nobel laureate Joseph Stiglitz, the professor of economics at Columbia University and former chief economist at the World Bank. He writes:

We have created an economy and a society in which great wealth is amassed through rent-seeking, sometimes through direct transfers from the public to the wealthy, more often through rules that allow the wealthy to collect “rents” from the rest of society through monopoly power and other forms of exploitation (2012: 266).1

Our economic and environmental crises are the result of property rights and tax policies that were created by the feudal aristocracy. Simply stated, the aristocrat classes of Europe appropriated the common lands that were occupied by the people. This turned the people into dependent tenants. By understanding this history, and relating it to the privatisation of natural resources after the fall of the USSR, we are led to a clear appreciation of why the nations on Europe’s eastern periphery are struggling for survival. This state of affairs need not continue. The policy solution was summarised by Prof. Stiglitz in these terms:

A basic principle of economics holds that it is highly efficient to tax rents because such taxes don’t cause any distortion. A tax on land rents doesn’t make the land go away. Indeed, the great 19th century progressive Henry George argued that government should rely solely on such a tax. Today, of course, we realize that rents can take many forms – they can be collected not just on land, but on the value of natural resources like oil, gas, minerals and coal. There are other sources of rents, such as those derived from the exercise of monopoly power. A stiff tax on all such rents would not only reduce inequality but also reduce incentives to engage in the kind of rent-seeking activities that distort our economy and our democracy (2012: 212-213: emphasis added).

When a nation collects its rents, it is not actually “taxing” the people. Taxes are arbitrary imposts on people’s earned incomes. The payment of rent into the public purse is voluntary, in the sense that people choose the use they make of natural resources and public services. So they determine how much they pay into the public purse. Those payments are proportionate to the benefits they receive. And we know from studies of Western economies that a growing economy generates more than enough rent to cover the costs of all the public services that a modern nation needs.

Testing the Rent Thesis

Synchronising the public’s finances with the principles of morality and economic efficiency is a radical departure from western practice. The people of B-H need to be sure that this proposal is based on reliable evidence. That reliability may be evaluated by reflecting on the two crises that currently challenge Europe.

  1. The 2008 financial crisis

Market economies are periodically disrupted by economic booms and busts. The primary cause of cyclical instability is land speculation. The quest for capital gains from land distorts the economy in ways that trigger major recessions (Harrison 2005). The historical record is unambiguous, but western governments refuse to reform the financial system to prevent the mass unemployment that stems directly from land speculation.

In 1997, Tony Blair formed a Labour government in Britain. I wrote to him and his closest ministers to inform them that house prices would peak 10 years later (in 2007), and that this would be followed by a depression. The Blair government refused to implement the tax reform that would have protected Britain from the worst effects of the financial crisis. Land prices did peak in 2007 and the banks went into crisis in 2008. (This episode is documented in Harrison 2010).

My 10-year forecast was based exclusively on analysis of rents in the land market. This information was available to western governments, so why did they fail to anticipate the financial crisis? Answer: their economic models exclude rent as an economic category.2

  1. The euro crisis

The euro crisis was a tragedy waiting to happen. All it needed was a trigger. That event took the form of the financial crisis of 2008. The failure of the euro was predictable, because it was constructed on an economic theory that failed to take account of the super-profits that are reaped by rent-seekers. The reforms that are now proposed for the euro will not prevent a further euro-crisis in the future.

When the euro was established, countries were told to comply with a theory known as “convergence”. Reforms had to be adopted, which were supposed to cause all economies to converge onto a common growth path.3 This was a false basis for drawing nations into the euro-net. For under the current tax regime, economies automatically DIVERGE. Europe’s “core” economy grows faster than the periphery, by sucking in labour and capital resources from the outer margins.

Thus, the deepest financial crises occurred among the marginal economies: an arc from Ireland through Portugal, Spain, southern Italy, Greece to Cyprus. If Europe’s economists had provided the correct advice to the European Commission, the euro-crisis could have been avoided. That advice would have been based on how rent-seeking is the major cause of property booms that eventually crash into recession.

Two existential threats

B-H now has the opportunity to rebuild its communities. Its condition requires imaginative action which, through its success, would become a beacon of hope for the rest of Europe. To achieve this, however, the people of B-H have to overcome two existential threats.

  1. Opposition from Rent Seekers

Current laws and practises deliver big profits to a minority. There is, therefore, a powerful lobby that opposes financial reform. Public participation in the Plenums is the one reason for hoping that the people of B-H might overcome this opposition.

  1. Advice from the European Union

The EU’s Stabilisation and Association Agreement with B-H is a threat to the prospects of reform. The revenue policies favoured by Europe are the direct cause of 40% unemployment for some sections of member nations. The EU’s financial policies discriminate against the wellbeing of people who live in the peripheral territories. If B-H uncritically adopted the EU model of values and institutions, we can predict outcomes at two levels.

  • Macro-economically, B-H’s full growth potential would not be achieved. Growth would be undermined by the distortions that lead to cyclical crises.
  • The gap in incomes between rich and poor would increase. This is a consequence of the property rights regime that is enforced in the West.

An example of what happens when a nation redefines itself along the lines prescribed by the EU is provided by Russia. It is a hostage to its oligarchs.

This is not an argument for withdrawing from ties with the EU. But assistance from Brussels should be calibrated to serve the best interests of the people of B-H. For the only way that a country on the spatial margins of Europe can derive the maximum benefit from membership of the EU is to adopt the rent-as-public-revenue mechanism. Take, for example, the EU’s Structural Funds. Money from Brussels funded major investments in highways across Spain, Italy and Greece. This, in turn, rewarded land speculation. It also caused the waste of vast sums of internally-generated capital that was locked up in “ghost towns”. Land speculators milked the honey pot while the going was good, and then got out – leaving families to pay the price in the form of mortgages they could not finance. Banks went bankrupt because mortgage loans turned “sour”. The antidote to this is the public pricing mechanism that cycles increases in land rents into funding public services. By removing the disruptive effects of land speculation, the property market would remain stable and people would not lose their homes or jobs.

Implementing the Reforms

People in the West are generally dissatisfied with the tax regime. This is dissolving the trust that ought to exist between citizens and their elected representatives. The rent-based form of public finance would restore people’s faith in democratic governance. One reason is that their government’s financial policies would be determined democratically, by the people, rather than arbitrarily, by politicians.

  • . Politicians will only institute the change when they know that this is demanded by the people in general.
  • The public dialogue that leads to financial reform would, in effect, be a form of collective therapy: a democratic process of dissolving misunderstandings and the extremes of dissenting voices.
  • The outcome would be a new social contract that balanced the common good with the freedom of people to choose the lifestyles that suited personal needs.

This process works towards the unification of communities through participative politics. Cooperation is the alternative to the adversarial style that was created by the aristocracies of old, whose mission was to fight over the right to plunder the public purse. The new social contract delivers results that are either denied by the current political arrangements, or are imperfectly available. The social structure would be strengthened.

  • Transparency in dealing with the public’s rents. Data on land rents and title deeds would be open to public scrutiny. This diminishes the risks of corrupt practises of the kind that blights countries in transition (as is now happening in China).
  • Freedoms that deliver the flexibility required by multi-cultural communities. This would ensure co-existence through equality in the distribution of rent-funded public services.
  • Resilience that maximises the rewards for creative activity. The 21stcentury is a dynamic world, and a society needs to be adaptable to the new opportunities.

Participative politics would be matched by cooperative economic enterprises. The market would be strengthened to perform its task. Because prices would not be distorted by taxers, the market would efficiently disclose both (i) people’s preferences, and (ii) the costs and benefits of competing products and services.

Creating the data-base that is needed for this financial model to work is not a problem. Individual locations need to be assessed for their rental values (these values would exclude the value of capital invested in and on land). The ease with which such exercises can be performed was demonstrated in the 1990s in the Russian city of Novgorod. This was during the period when there was market-based data did not assist. One of the experts who participated in the assessment was Ted Gwartney, an American property assessor who recently explained his methodology in China (Gwartney 2014).

Once the data-base and laws were in place, citizens themselves would have a role to play in administering them. In Denmark, when the Land Tax was introduced in 1916, the regular revaluation of locations was undertaken by committees of local citizens under the supervision of a professional chairman (Banks 1989, Ch 11). Regular revision of rental values is important, to ensure a buoyant revenue base for government.

The Citizen’s Rent Dividend

The history of dead civilisations tells us that rent-seeking behaviour is constantly struggling to re-assert itself. Strong-willed individuals impose themselves on public life to try and gain the privileges that are at other people’s expense. Over the past 500 years, the peoples of Europe allowed this to happen, and they continue to pay a heavy price. Can the citizens of B-H remain permanently alert to the risk of rent-seeking? One method would be to create an annual Citizen’s Rent Dividend.

The first claim on a nation’s rents arises from the need to fund the community’s public services. In B-H, resources are desperately needed to re-build public infrastructure and social services. Once these services are secure, the population would be generating additional rents that need to be kept out of the hands of rent-seekers.

  • Part of that rent should be saved in a sovereign fund for the benefit of future generations. Example: Norway’s North Sea oil rent fund. And
  • the remaining rent could be paid to each citizen as a Rent Dividend. This payment would be in recognition of each person’s collaborative contribution to the formation of rent. Example
    : Alaska’s annual citizen’s dividend, which is paid out of oil rents.

The Citizen’s Rent Dividend would create a personal interest in ensuring that the nation’s rents were (i) maximised, and (ii) reserved for lawful social purposes. In the process, society would be strengthened. People would remain vigilantly interested in how the laws of their land were enforced. (For a fuller account of the Citizen’s Rent Dividend, see Harrison [2014a].) Without the vigilance of citizens, rent-seeking resurfaces, because it is driven by a powerful psychological condition – greed. Laws, in themselves, are not a sufficient defence, as we are now seeing in the case of China (see Box).

Multi-cultural Consensus

The spiritual and moral benefits of the rent/revenue policy result in many gains for society. A few of the benefits are identified here.

  • The need for foreign aid is eliminated. Foreign aid creates ideological dependency on others.
  • The competitive spirit is harmoniously balanced with the cooperative spirit.
  • Moral wisdom is complemented by scientific rigour.

This way of raising the public’s revenue is “natural”, in that it is the financial mechanism that made possible the investment in complex urban societies that turned into the first civilisations. As such, it is the one ethical economic principle that has been endorsed throughout history.

  • Civilisations of antiquity observed the Jubilee tradition: cancelling debts and restoring land to families that had lost it.
  • The first monotheistic religions endorsed the Jubilee tradition. And Jesus, in his parable of the tenants, identified rent as the sacred income of the community (Mark, Ch 12).
  • Islamic scholars, starting with Abu Zakariya Yahya b. Adam al-Qarashi (d.818 CE), applied reason to advocate Land Taxation in the Moslem world (Azmi [2002], Katbi [2010]).
  • When economics became a social science in Europe, scholars affirmed its wisdom, all the way from Adam Smith (in his The Wealth of Nations) through to the Nobel laureates like Milton Friedman, William Vickrey, Franco Modigliani, Robert Solow, James Tobin and Sir James Mirrlees. See, especially, the Open Letter to Mikhail Gorbachev (Noyes 1991).

Building a Strong State

The power of the citizen needs to be strengthened, but this should be complemented by a strong state.

The weak state is observed in the West today. This state is vulnerable to manipulation by privilege-seekers. Their deals create crony capitalism. When we analyse the evolution of the weak western state, we find that the major flaw is with the way rent-seekers captured the political process so that they could shape the land and tax laws. The alternative is still possible for countries in transition. China is an example. As I have noted elsewhere:

China is now in the unique position of being able to learn from the tragedies of Western nations, to create a post-capitalist society based on the freedom and equality of all citizens. This can be achieved if the financial system is constructed on respect for the division between what the individual citizen may retain as private property, and what must be recognised as the property of society. Western nation-states failed to honour that distinction. The result was the evolution of politically Weak States, which were hostages of a statecraft based on greed (Harrison 2014b).4

This outcome contrasts sharply with the western model of democracy, which is based on a rule of law grounded in rent-seeking as the primary mechanism for distributing income and political power. If the world is to graduate away from greed and hatred, it will take one nation to initiate the change. Could that be the mission for the people of Bosnia-Herzegovina?

Footnotes

1 For a global survey of “rent-seeking” in recent years, see the critique of “crony capitalism” in The Economist (March 15, 2014): http://www.economist.com/news/leaders/21598996-political-connections-have-made-many-people-hugely-rich-recent-years-crony-capitalism-may

2 Advice from agencies like the Organisation for Economic Cooperation and Development (OECD) is of limited value precisely because they exclude land and rent as a component of their models. The OECD (2014: 13) failed to anticipate the 2008 crisis because its model of the economy excluded the banking sector. This meant that it did not even have an indirect early warning signal of what was going to happen as the economy moved towards the end of the last 18-year cycle (1992-2010).

3The criteria included price stability, interest rates and budget deficits, itemised here: http://europa.eu/legislation_summaries/other/l25014_en.htm

4 An assessment of how the rent revenue model could refocus China along a path towards a post-capitalist society was undertaken at a conference in Sichuan University, November 2013. The English version of the papers may be accessed at http://se.xmu.edu.cn/jzyc/LVT.asp

References

Azmi, Sabahuddin (2002), Islamic Economics, New Delhi: Goodword Books.

Banks, Ronald (1989), Costing the Earth, London: Shepheard-Walwyn.

European Commission (2014), Memo: B-H – EU: Deep disappointment on Sejdic-Finci implementation, February 18: http://europa.eu/rapid/press-release_MEMO-14-117_en.htm

Gwartney, Ted (2014), “Land Rents as a Sustainable Revenue Base for China”, in http://se.xmu.edu.cn/jzyc/UploadFiles/2014371830317055475115776.pdf

Harrison, Fred (2005), Boom Bust: House Prices, Banking and the Depression of 2010, London: Shepheard-Walwyn

” (2010), 2010: The Inquest, free from https://sharetherents.org/wp-content/uploads/2013/09/2010-The-Inquest-FINAL.pdf

” (2012), The Traumatised Society, London: Shepheard-Walwyn.

” (2014a), Thesis #10 https://sharetherents.org/thesis/paradise-parasite/

” (2014b), Financial Rules for Constructing a Strong State http://se.xmu.edu.cn/jzyc/viewPaper.asp?id=67

Katbi, Ghaida Khazna (2010), Islamic Land Tax – Al-Kharaj, New York: I.B. Tauris.

Noyes, Richard (1991), Now the Synthesis: Capitalism, Socialism & the New Social Contract, London: Shepheard-Walwyn. http://en.wikisource.org/wiki/Open_letter_to_Mikhail_Gorbachev_(1990)

OECD (2014), OECD Forecasts During & After the Financial Crisis: A Post-mortem, Paris: OECD. http://www.oecd.org/eco/outlook/OECD-Forecast-post-mortem-policy-note.pdf

Stiglitz, Joseph (2012), The Price of Inequality, London: Allen Lane.

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