Archive for the ‘International Economics and Development’ Category
Data in New World Bank Report Shows that Large Public Sectors Reduce Economic Growth
When Ronald Reagan said that big government undermined the economy, some people dismissed his comments because of his philosophical belief in liberty.
And when I discuss my work on the economic impact of government spending, I often get the same reaction.
This is why it’s important that a growing number of establishment outfits are slowly but surely coming around to the same point of view.
- The European Central Bank published a study showing “…a significant negative effect of the size of government on growth.”
- A study by two Harvard economists found that “large adjustments in fiscal policy, if based on well-targeted spending cuts, have often led to expansions.”
- The Organization for Economic Cooperation and Development noted in recent research that welfare programs are economically destructive because they lure people into dependency because “net disposable income would increase despite putting in fewer hours.”
- A study from the International Monetary Fund concluded that “Cuts to pension and health entitlements had the most beneficial effect on economic growth.”
This is remarkable. It’s beginning to look like the entire world has figured out that there’s an inverse relationship between big government and economic performance.
That’s an exaggeration, of course. There are still holdouts pushing for more statism in Pyongyang, Paris, Havana, and parts of Washington, DC.
But maybe they’ll be convinced by new research from the World Bank, which just produced a major report on the outlook for Europe. In chapter 7, the authors explain some of the ways that big government can undermine prosperity.
There are good reasons to suspect that big government is bad for growth. Taxation is perhaps the most obvious (Bergh and Henrekson 2010). Governments have to tax the private sector in order to spend, but taxes distort the allocation of resources in the economy. Producers and consumers change their behavior to reduce their tax payments. Hence certain activities that would have taken place without taxes, do not. Workers may work fewer hours, moderate their career plans, or show less interest in acquiring new skills. Enterprises may scale down production, reduce investments, or turn down opportunities to innovate. …Over time, big governments can also create sclerotic bureaucracies that crowd out private sector employment and lead to a dependency on public transfers and public wages. The larger the group of people reliant on public wages or benefits, the stronger the political demand for public programs and the higher the excess burden of taxes. Slowing the economy, such a trend could increase the share of the population relying on government transfers, leading to a vicious cycle (Alesina and Wacziarg 1998). Large public administrations can also give rise to organized interest groups keener on exploiting their powers for their own benefit rather than facilitating a prosperous private sector (Olson 1982).
In other words, government spending undermines growth, and the damage is magnified by a poorly designed tax policies.
The authors then put forth a theoretical hypothesis.
…economic models argue that the excess burden of tax increases disproportionately with the tax rate—in fact, roughly proportional to its tax rate squared (Auerbach 1985). Likewise, the scope for self-interested bureaucracies becomes larger as the government channels more resources. At the same time, the core functions of government, such as enforcing property rights, rule of law and economic openness, can be accomplished by small governments. All this suggests that as government gets bigger, it becomes more likely that the negative impact of government might dominate its positive impact. Ultimately, this issue has to be settled empirically. So what do the data say?
These are important insights, showing that class-warfare tax increases are especially destructive and that government spending undermines growth unless the public sector is limited to core functions.
Then the authors report their results.
Figure 7.9 groups annual observations in four categories according to the share of government spending in GDP during that year. Both samples show a negative relationship between government size and growth, though the reduction in growth as government
becomes bigger is far more pronounced in Europe, particularly when government size exceeds 40 percent of GDP. …we provide new econometric evidence on the impact of government size on growth using a panel of advanced and emerging economies since 1995. As estimates can be biased due to problems of omitted variables, endogeneity, or measurement errors, it is necessary to rely on a broad range of estimators. …They suggest that a 10 percentage point increase in initial government spending as a share of GDP in Europe is associated with a reduction in annual real per capita GDP growth of around 0.6–0.9 percentage points a year (table A7.2). The estimates are roughly in line with those from panel regressions on advanced economies in the EU15 and OECD countries for periods from 1960 or 1970 to 1995 or 2005 (Bergh and Henrekson 2010 and 2011).
These results aren’t good news for Europe, but they also are a warning sign for the United States. The burden of government spending has jumped by about 8-percentage points of GDP since Bill Clinton left office, so this could be the explanation for why growth in America is so sluggish.
Last but not least, they report that social welfare spending does the most damage.
Governments are big in Europe mainly due to high social transfers, and big governments are a drag on growth. The question is whether this is because of high social transfers? The answer seems to be that it is. The regression results for Europe, using the same approach as outlined earlier, show a consistently negative effect of social transfers on growth, even though the coefficients vary in size and significance (table A7.4). The result is confirmed through BACE regressions. High social transfers might well be the negative link from government size to growth in Europe.
The last point in this passage needs to be emphasized. It is redistribution spending that does the greatest damage. In other words, it’s almost as if Obama (and his counterparts in places such as France and Greece) are trying to do the greatest possible damage to the economy.
In reality, of course, these politicians are simply trying to buy votes. But they need to understand that this shallow behavior imposes very high costs in terms of foregone growth.
To elaborate, this video discusses the Rahn Curve, which augments the data in the World Bank study.
As I argue in the video, even though most of the research shows that economic growth is maximized when government spending is about 20 percent of GDP, I think the real answer is that prosperity is maximized when the public sector consumes less than 10 percent of GDP.
But since government in the United States is now consuming more than 40 percent of GDP (about as much as Spain!), the first priority is to figure out some way of moving back in the right direction by restraining government so it grows slower than the private sector.
The World Bank Backs African Trade Liberalization
The World Bank has come out with a wonderful short video explaining the benefits of trade liberalization among African countries:
Cato has addressed that topic in a 2005 paper:
[Accordingly,] in 1997 SSA countries levied an average applied tariff of 34 percent on agricultural exports from other SSA countries. Industrial countries, by contrast, imposed an average applied tariff of 24 percent on SSA agricultural exports. Similarly, SSA countries maintained an average applied tariff of 21 percent on nonagricultural exports from other SSA countries. Industrial countries imposed an average applied tariff of 4 percent on SSA non-agricultural exports.
According to the WTO, only 10 percent of African (including sub-Saharan African) exports were intraregional (i.e.: traded to other African countries). In contrast, 68 percent of exports from countries in Western Europe were exported to other Western European countries. Similarly, 40 percent of North American exports were to other countries in North America.
Unemployment Insurance Fraud: Chile Has Solution
Like other government hand-out programs, the unemployment insurance system suffers from a substantial fraud problem. The Washington Post reports that 90 D.C. city employees and 40 former employees are being investigated for grabbing UI benefits to which they were not entitled. The cost of this fraud has been about $800,000 since 2009.
It’s not hard to rip-off federal subsidy programs, and UI is no exception. The Post reports that “the alleged fraud is not complicated, nor is it uncommon in unemployment insurance programs: Workers apply for checks and receive them legitimately for a time but fail to inform authorities when they go back to work.”
Other sources of UI fraud include the misreporting of earnings, the provision of false ID to gain benefits, and falsifying reasons for employment termination. Nationwide, the Department of Labor estimates that the improper payment rate for UI is about 11 percent, which amounted to $17 billion of wasted taxpayer money in 2010.
What’s the solution? The nation of Chile appears to have found it. In 2002 it created a system of UI personal savings accounts to replace the traditional government hand-out system. The new system built on the success of Chile’s Social Security personal account system. UI personal accounts help solve the fraud problem because workers would only be stealing from their own accounts if they took unjustified benefits.
There are other benefits to the Chilean system. A detailed study in 2010 found that the nation’s savings-based UI system helped improve work incentives and reduced unemployment. Such accounts can also add to the long-term retirement savings of workers.
For a full analysis of the failures of our UI system and possible reforms, see my co-authored essay on DG here.
Mexicans Deserve Substance Over Style in Presidential Race
Josefina Vázquez Mota won the nomination of the incumbent National Action Party (PAN) for Mexico’s upcoming presidential election. Most of the coverage in the international media today focuses on how she is the first woman to have a real shot at Los Pinos (the official residence of the president of Mexico). However, the real story should be what new ideas (if any) Vázquez Mota brings to the table. Unfortunately, there’s isn’t much to report.
The same can be said of the other two presidential contenders, Enrique Peña Nieto of the Institutional Revolutionary Party (PRI) and Andrés Manuel López Obrador of the Democratic Revolutionary Party.
Perhaps William Booth of the Washington Post sums it up best when he writes about the three choices Mexican voters face in July:
“The popular former mayor of Mexico City with a messianic self-regard [López Obrador]; a telegenic leading man who wrote a book but has been vague about which books he has read [Peña Nieto]; and a perky, gal-next-door type who does a lot of smiling but has been blank on specifics [Vázquez Mota].”
Mexico will face serious challenges in the next six years, not least of which is a crippling war on drugs that kills thousands of Mexicans every year, but also a sluggish economy due largely to the sclerotic effects of public and private monopolies in key industries. This presidential election should be more about substance and less about style.
Cutting the Government—Greek Style
After much wrangling and consternation, the Greek government has agreed to the latest round of “drastic austerity measures,” the most significant of which is the promise to cut 15,000 government jobs. In return, the Greeks will receive 130 billion euros ($170 billion) of European bailout money to keep the Greek state afloat and, crucially, in the eurozone. That, anyway, is the plan.
The leaders of the political parties that “support” the Greek technocratic (i.e. unelected) government still have to approve the cuts, which they might not do because the unions threaten a general strike. But, there are additional problems as well. First, many of those 15,000 government workers will likely come from the ranks of those who are close to retirement. While the number of government workers will thus shrink, the government’s unsustainable social security burden will worsen. Second, the government workforce (i.e. public servants and employees of the Greek parastatals) account for over 22 percent of the Greek labor force of 4.4 million. That means that the number of people working for the government will decline from 968,000 to 953,000—a reduction of 1.6 percent. And that is what amounts to a “drastic austerity measure” in Greece!
Acting as the Typhoid Mary of the Global Economy, the OECD Urges Higher Taxes in Latin America
Is it April Fool’s Day? Has somebody in Paris hacked the website at the Organization for Economic Cooperation and Development? Have we been transported to a parallel dimension where up is down and black is white?
Please forgive all these questions. I’m trying to figure out why any organization—even a leftist bureaucracy such as the OECD—would send out a press release entitled, “Rising tax revenues: a key to economic development in Latin American countries.”
Not even Keynesians, after all, think higher taxes are a recipe for growth.
Ah, never mind. I just remembered that the OECD is a hotbed of statism, so the press release makes perfect sense. After all, the U.S.-taxpayer-funded organization has become infamous for reflexively advocating big government.
- The OECD has an anti-tax competition project designed to prop up Europe’s bankrupt welfare states.
- The OECD is pushing a “Multilateral Convention” that is designed to become something akin to a World Tax Organization, with the power to persecute nations with free-market tax policy.
- The OECD has endorsed Obama’s class-warfare agenda, publishing documents endorsing “higher marginal tax rates” so that the so-called rich “contribute their fair share.”
- The OECD pulled off a hat trick of bad policy in a 2010 document, promoting a value-added tax, Obama’s global warming agenda, and failed Keynesian stimulus.
- The OECD endorsed Obamacare, as I explain in this video.
- The OECD even advocates higher taxes when nations are in the middle of economic crisis.
With this dismal track record, it’s hardly a surprise that the Paris-based bureaucracy is now pushing to undermine prosperity in Latin America. Here’s some of what the OECD said in its release.
Additional tax revenues enable governments to simultaneously improve their competitiveness and promote social cohesion through increased spending on education, infrastructure and innovation. Latin American countries have made great strides over the past two decades in raising tax revenues.
You won’t be surprised when I tell you that the Paris-based bureaucrats do not bother to provide even the tiniest shred of proof to support the silly claim that higher taxes improve competitiveness. But that shouldn’t be surprising since even Keynesians don’t believe something that absurd.
And the claim about social cohesion also is a bit of a stretch given the riots, chaos, and social disarray in many European nations.
The only accurate part of the passage is that Latin American nations have increased tax burdens over the past 20 years. To the tax-free bureaucrats at the OECD, that is making “great strides.”
Let’s see what else the OECD had to say.
Despite these improvements, significant gaps between Latin America and OECD countries remain. The average tax to GDP ratio in OECD countries is much higher than in Latin American countries (33.8% compared to 19.2% in 2009, respectively). As the countries in the region still find themselves in relatively strong economic conditions, now is the time to consider reforms that generate long-term, stable resources for governments to finance development.
Wow. The OECD is implying that Latin American nations should mimic OECD nations. In other words, the bureaucrats in Paris apparently think it makes sense to tell nations to copy the failed high-tax, welfare-state model of countries such as Greece, Italy, and Spain.
Is that really the lesson they think people should learn from recent fiscal history? Are they really so oblivious and/or blinded by ideology that they issued the release as these European nations are in the middle of a fiscal crisis?
France: Google’s Free Map Service Unfair To Commercial Map Sellers
We at Cato enjoy citing Frederic Bastiat’s 1845 classic of free-trade pamphleteering, the “Petition of the Candlemakers,” which addresses the French Parliament as follows:
…We are suffering from the ruinous competition of a rival who apparently works under conditions so far superior to our own for the production of light that he is flooding the domestic market with it at an incredibly low price; for the moment he appears, our sales cease, all the consumers turn to him, and a branch of French industry whose ramifications are innumerable is all at once reduced to complete stagnation. This rival… is none other than the sun…
The satire goes on to demand that the government banish the unfair competition and restore proper encouragement to domestic industry by requiring that owners exclude sunlight from all building windows.
Once again real life is making it hard to tell satire from reality — appropriately, in Bastiat’s France. According to an Agence France-Presse account, a French commercial court has ordered Google to pay 500,000 Euros to a local map company for unfair practices that constitute an abuse of the “dominant position of its Google Maps application.” In particular, Google provides its maps for free, unlike complainant Bottin Cartographes, which charges good money and has apparently run into trouble holding onto its customers on that basis. Cory Doctorow at BoingBoing:
Bottin Cartographes argued that Google was only planning to give away the service for free until all the competitors had been driven out of business and then they would start charging. This seems implausible to me, and contrary to Google’s business model (give away services, make money from mining the use of those services). Google says it will appeal.
The problem with being a libertarian satirist is that government’s real-world doings keep matching and outrunning the satire.
P.S. Note that the French case arose not from Google’s furnishing of its free map service to individual end customers, but from its furnishing of its map API to businesses that typically adapt it for use in their own sites; as commenters at BoingBoing note, Google has indeed introduced fees for its largest business users of this type (which has caused some of them to adapt by switching from Google’s API to OpenStreetMap, a free wiki-based map service). In short, the complaints about free pricing of too excellent a product draw on the antitrust theory of predatory pricing, which American courts have held in general disfavor since the Chicago antitrust revolution but which continues to hold sway in some other parts of the world. For more on the predatory pricing theory, see these Cato publications.
A Brewing Institutional Crisis in Panama
Panama is in turmoil due to the efforts of President Ricardo Martinelli to resurrect a defunct specialized court within the Supreme Court that would allow him to pack that body and possibly pave the way for his reelection.
First, some context: The nine-Justice Panamanian Supreme Court is divided in four specialized courts dealing with specific areas of the law (civil, criminal, administrative and general government business). The first three specialized courts have 3 justices each, while the fourth one (dealing with general government business) is formed by the presidents of each of the three other specialized courts.
There used to be a Fifth Court dealing with constitutional issues. However, in 1999 Congress passed a law that abolished that body. Now, constitutional cases are dealt by the nine-Justice Supreme Court as a whole.
Last year the Supreme Court, whose chief justice is a close associate of Martinelli, ruled that the law abolishing the Fifth Court was illegal. This created a legal vacuum since nobody knows for sure whether that means that the old Fifth Court should be reinstated or a new one should be created.
Martinelli seized on the controversial ruling by the Supreme Court and introduced a bill in Congress that would create a Fifth Court. If approved, the new court would have three new justices (appointed by Martinelli) and would deal with constitutional issues, one of them being the constitutionality of presidential term limits. The Panamanian Constitution currently bars a sitting president from running for a consecutive term. The president has to step out for two terms before running again for office. Many in Panama fear that Martinelli’s ultimate goal with the Fifth Court is to get rid of term limits.
Let’s not forget that a similar ploy was recently used by Daniel Ortega in Nicaragua to run for reelection despite the Constitution explicitly barring him from doing it. There, a friendly Supreme Court ruled that presidential term limits were unconstitutional and thus enabled Ortega to run again (and win the election).
Despite enjoying a large majority in Congress, where Martinelli has bought off many lawmakers, the opposition was able to filibuster the bill creating the Fifth Court. However, thanks to the nebulous ruling by the Supreme Court last year, Martinelli is now threatening with appointing the 3 new justices even without a law passed by Congress. A constitutional crisis seems inevitable.
A recent poll published by the daily La Prensa showed that 70 percent of Panamanians regarded Martinelli as “authoritarian” and 73 percent were concerned for the future of democracy their country. Amid strong criticism for his autocratic tendencies, for his attacks against freedom of speech, and for using tax audits to persecute his political opponents, the Fifth Court affair certainly shows that Ricardo Martinelli is the most dangerous man for democracy and rule of law in Central America after Nicaragua’s Daniel Ortega.
The EU Summit Will Fail to Calm Markets
The European leaders’ meeting in Brussels yesterday will likely fail to reassure the financial markets. First, the intergovernmental agreement on stricter budget controls among the members of the eurozone will still have to be approved by national parliaments and could potentially face legal challenges in one or more countries. Second, there is no guarantee that the agreed penalties for countries that run excessive budget deficits are either enforceable or sufficiently onerous to limit government spending. Third, the European leaders failed to make progress on the most important issue facing the EU economies—slow growth. Indeed, it is difficult to see how EU leaders—many of whom backed higher taxes and support more regulation—can be trusted to do anything useful to spur economic growth and private sector job creation in Europe.
Labor Law Professors Defy Death Threats in Italy
Pietro Ichino, a professor of labor law at the University of Milan and a senator in the Italian legislature, is known as the author of several “neoliberal” books and studies recommending that the Italian government relax its extraordinarily stringent regulation of employers’ hiring and firing decisions. As Bloomberg Business Week reports, that means that Prof. Ichino must fear for his life: “For the past 10 years, the academic and parliamentarian has lived under armed escort, traveling exclusively by armored car, and almost never without the company of two plainclothes policemen. The protection is provided by the Italian government, which has reason to believe that people want to murder Ichino for his views.”
They’re not just being alarmist. In 1999 and 2002 leftist gunmen associated with the Red Brigades murdered two other reformist labor law professors, Massimo D’Antona and Mario Biagi. (Details here.) Prof. Biagi, a well-known figure nationally, was shot as he arrived at his Bologna home and dismounted his bicycle. While five members of the Red Brigades are serving prison sentences for his murder, sympathizers remain at large, and Ichino’s name appears on a Brigades hit list. A few years back, reports Bloomberg, police broke up a plot on his life that they said involved two students in his own department. Last year another reformist labor law professor, Carlo Dell’Aringa, “received a death threat, written in red ink on the wall of his university’s bathroom.”
Like his slain colleague Biagi, Ichino started out as a man of the Left — a Communist parliamentarian, in fact — who became convinced that the state-enforced equivalent of lifetime job security actually worked against the interests of ordinary young workers, who were increasingly frozen out from being offered jobs in the first place. Increasingly, moderate European opinion is coming to see that view as persuasive — even if few show as much courage as Prof. Ichino in voicing it. Reports Bloomberg: “For those promoting changes to Italy’s labor laws, the day of Biagi’s shooting has become a rallying point. Sympathizers gather every March 19 to ride their bicycles from the train station to the dead man’s house.”
Chinese Currency and the U.S. Financial Crisis
Some people might have been surprised to read in Sunday’s New York Times magazine that I believed “that all that easy money from China helped make the housing bubble much bigger and last longer, which created a far bigger crisis when the bubble finally burst.” As you might suspect, it was only those two little words “from China” that gave me pause. But I’m very grateful to Adam Davidson and his colleagues at NPR’s Planet Money for giving me a chance to elaborate on their blog. Here’s a brief excerpt:
China was eager to buy our debt, both Treasury bonds and Fannie and Freddie’s debt. But it was Congress that ran the deficits, and the Fed that kept interest rates artificially low. We don’t need to go to Beijing to find the villains in this piece….
Our economy could use plenty of reforms – lower, flatter, simpler taxes; a more stable monetary policy or even a move toward free markets in money; reduced regulatory burdens; the de-monopolization of services from education to mail delivery; and less government spending. In all those cases, the problem and the solution are right here in the USA.
Read it all! And special bonus links: Steve Hanke responds to the argument for a tougher policy toward China at Planet Money. And Adam Davidson talked with me about libertarianism in 2010 (plus a much longer version also featuring Mark Calabria).
EU Credit Rating Agency Hoax
Daniel Hannan’s post on the establishment of the European Credit Rating Agency makes some good points. The recent downgrade of a number of European countries is a consequence of low growth and massive debts and deficits.
Instead of implementing far-reaching structural reforms, however, an increasing number of European politicians talk about an Anglo-American conspiracy to sink Europe’s single currency, the euro. According to one of the most prominent EU parliamentarians, Elmar Brok of the German Christian Democratic Party, credit-rating agencies Standard & Poor’s, Moody’s and Fitch are part of the American economic war against Europe. The EU Commission president Jose Manuel Barroso implied as much some time ago.
So, naturally, what the EU needs is a European credit-rating agency that will provide an “objective” and “independent” analysis of the “true” state of the European economies. (The EU already has an “independent” think-tank called Bruegel that is largely funded by the European governments.)
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