Archive for the ‘International Economics and Development’ Category
Looking at Austerity in Greece
Since 2009 Greece has been at the epicenter of the euro crisis, and after last week’s parliamentary election, it looks like its departure from the common currency is a matter of weeks. Everyone agrees that Greece didn’t get into trouble because it spent too little, just the opposite. When George Papandreou became prime minister in October 2009, he found that his conservative predecessor had cooked the books and left him with a staggering fiscal deficit of 12.7% of GDP. The socialist Papandreou was then forced to shelve his promises of more handouts and implement a program of fiscal austerity in exchange for multi-billion bailouts from the European Union.
Two and a half years on, things look as bleak as ever for Greece, with an economy that is still shrinking and unemployment on the rise. Today, many people claim that, even though profligacy was the source of Greece’s problems, austerity is now making things worse by cutting spending too fast too soon. Time magazine’s Fareed Zakaria explained the dynamics yesterday in his CNN show GPS:
“The problem is that as these governments cut spending in very depressed economies, it has caused growth to slow even further – you see government workers who have been fired tend to buy fewer goods and services, for example – and all this means falling tax receipts and thus even bigger deficits.”
Zakaria is not the only one describing austerity as mostly spending cuts, and some pundits even dramatize the term by adding adjectives such as “deep,” “brutal,” “savage,” or “self-defeating.” Let’s look at how brutal these spending cuts have been in Greece:
Source: Source: European Commission, Economic and Financial Affairs.
Spending has declined to approximately its 2007 level in nominal terms, while in real terms it actually continues to go up. (I look at spending in real terms because that’s what Ryan Avent at The Economist said we should look at in a reply to Veronique de Rugy’s initial graph on austerity in Europe. Note that, as in my previous posts on Britain and France, I’m using the GDP deflator to calculate spending in real terms). If we look at spending in real terms, there haven’t been any spending cuts in Greece. On the other hand, Tyler Cowen observes that “in the short run it is supposedly nominal which matters (that said, gdp and population [and inflation] are not skyrocketing in these countries for the most part).” Let’s look at nominal then. Since 2000, public spending rose in Greece at an annual rate of 7.8% until 2009. Then it declined by 8.3% in 2010 and a further 4.1% in 2011. This is certainly a cut in spending, but far from brutal.
Some argue that we shouldn’t look at spending levels when talking about austerity, but rather at spending as a share of the economy. In that sense, government spending in Greece went up from 47.1% of GDP in 2000 to 53.8% in 2009 and it has come down to 50.3% in 2011—approximately its 2008 level. However, I don’t buy the argument. Does it mean that the government has to spend an ever increasing share of the GDP in order to keep the economy afloat? Is half of the economy not enough when it comes to government spending?
What about Zakaria’s argument of the crippling effect of firing government workers on growth? Last January, The Economist looked at the situation in Greece and noted that “Of the 470,000 who have lost their jobs since 2008, not one came from the public sector. The civil service has had a 13.5% pay cut and some reductions in benefits, but no net job losses.” As for what “austerity” means for most Greeks, the magazine added, “Since Greece’s first bail-out in May 2010, the government has imposed austerity, increasing taxes so much that people can barely manage.”
The Economist is not alone in pointing out the extent to which taxes have gone up. Even the IMF has done so. Back in November, Poul Thomsen, the IMF mission chief in Greece, said that the country “has relied too much on taxes and I think one of the things we have seen in 2011 is that we have reached the limit of what can be achieved through increasing taxes.” Since then Greece agreed to eliminate 15,000 government jobs (2% of its public sector workforce) in exchange for a second bailout. Once again, that figure pales when compared to the number of people who have lost their jobs in the private sector.
The evidence shows that in Greece austerity has meant significant tax increases and timid spending cuts.
No Thanks to Aid, Africa Is Getting Better
In spite of our humble efforts, the arguments concerning the efficacy of foreign aid go on. The aficionados of the debate are no doubt aware of the latest controversy involving Columbia University Professor Jeffrey Sachs’ Millennium Villages Project (MVP). In 2006, Sachs convinced wealthy donors – from the United Nations and the government of Japan to Goldman Sachs and Pepsico – to sponsor economic development in 14 villages in 10 African countries. If aid in those villages worked, Sachs theorized, the program could be scaled upwards and vindicate those who advocate in favor of large foreign aid transfers from wealthy countries to poor ones.
Unfortunately for Sachs, some of MVP’s previous claims about the beneficial effect of aid on human wellbeing in the millennium villages have been called into question. The latest installment in this saga involves the MVP’s claim that “the average rate of reduction of mortality in children younger than 5 years of age was three-times faster in Millennium Village sites than in the most recent 10-year national rural trends (7.8% vs. 2.6%).” World Bank research, however, found that “under-5 mortality has fallen at just 5.9% per year at MVP sites, which is slower than the 6.4% average annual decline in under-5 child mortality in the MVP countries nationwide.”
Whatever the actual decline in the Millennium villages, note the remarkable reduction in the mortality of children under the age of 5 (per 1000 live births) in selected African countries. As I noted elsewhere, Africa has just experienced a decade of robust economic growth fueled by economic reforms and high commodity prices. That, evidence suggests, may be better at explaining the fall in child mortality than foreign aid.
Facebook Billionaire Gives Up Citizenship to Escape Bad American Tax Policy
It is very sad that America’s tax system is so onerous that some rich people feel they have no choice but to give up U.S. citizenship in order to protect their family finances.
I’ve written about this issue before, particularly in the context of Obama’s class-warfare policies leading to an increase in the number of Americans “voting with their feet” for places with less punitive tax regimes.
We now have a very high-profile tax expatriate. One of the founders of Facebook is escaping to Singapore. Here are some relevant passages from a Bloomberg article.
Eduardo Saverin, the billionaire co-founder of Facebook Inc. (FB), renounced his U.S. citizenship before an initial public offering that values the social network at as much as $96 billion, a move that may reduce his tax bill. …Saverin’s stake is about 4 percent, according to the website Who Owns Facebook. At the high end of the IPO valuation, that would be worth about $3.84 billion. …Saverin, 30, joins a growing number of people giving up U.S. citizenship, a move that can trim their tax liabilities in that country. …“Eduardo recently found it more practical to become a resident of Singapore since he plans to live there for an indefinite period of time,” said Tom Goodman, a spokesman for Saverin, in an e-mailed statement. …Singapore doesn’t have a capital gains tax. It does tax income earned in that nation, as well as “certain foreign-sourced income,” according to a government website on tax policies there. …Renouncing your citizenship well in advance of an IPO is “a very smart idea” from a tax standpoint, said Avi-Yonah. “Once it’s public you can’t fool around with the value.” …Renouncing citizenship is an option chosen by increasing numbers of Americans. A record 1,780 gave up their U.S. passports last year compared with 235 in 2008, according to government records. …“It’s a loss for the U.S. to have many well-educated people who actually have a great deal of affection for America make that choice,” said Richard Weisman, an attorney at Baker & McKenzie in Hong Kong. “The tax cost, complexity and the traps for the unwary are among the considerations.”
Apocalypse 2.0
In 1972, the Club of Rome published an extremely popular and influential neo-Malthusian tract called The Limits to Growth. This apocalyptic warning about over-population, over-consumption, and environmental destruction sold some 12 million copies and was translated into 37 languages. According to the authors of The Limits to Growth, “Serious stresses involving population, resources, and environment are clearly visible ahead. Despite greater material output, the world’s people will be poorer in many ways than they are today.”
How accurate were those predictions? As I wrote on May 4 in the Washington Times, since the late 1960s,
[The] world population has doubled from 3.5 billion to 7 billion, inflation-adjusted average annual income per person has risen from $3,147 to $5,997, and life expectancy at birth has increased from 59 years to 69 years.
The world’s daily caloric intake per person rose from an average of 2,610 in 1990 to 2,790 in 2006…. In sub-Saharan Africa, the caloric intake increased from 2,290 to 2,420 in just 16 years. To put these figures in perspective, the U.S. Department of Agriculture recommends that adult men eat between 2,000 and 2,500 calories a day and women between 1,800 and 2,300 calories a day.
Often seen as hopeless, Africa has made other significant gains. In spite of wars, massive economic mismanagement and the ravages of AIDS, the continent’s population has more than trebled — from 280 million to 854 million — since 1968, and life expectancy has increased from 44 years to 54 years.
According to the latest World Bank research, global poverty is declining rapidly. In 1981, 70 percent of people in poor countries lived on less than $2 a day, while 42 percent survived on less than $1 a day. Today, 43 percent live on less than $2 a day, while 14 percent survive on less than $1.
The world is not a perfect place, but the last four decades have not been too shabby as far as growth and human progress are concerned. Bearing that in mind, a bit of soul-searching at the Club of Rome’s HQ in Winterthur, Switzerland, would have been in order.
Instead, the Club of Rome’s latest offering 2052: A Global Forecast for the Next Forty Years, “raises the possibility that humankind might not survive on the planet if it continues on its path of over-consumption and short-termism.” Released on May 7, the report states that “We already live in a manner that cannot be continued for generations without major change. Humanity has overshot the earth’s resources, and in some cases we will see local collapse before 2052.”
Niels Bohr, the famous Danish physicist, is supposed to have said that “prediction is very difficult, especially if it’s about the future.” True, no one has a crystal ball, but human experience points to growing abundance, not looming disaster. It is a pity that the Club of Rome has learned so little from The Limits to Growth fiasco.
Looking at Austerity in France
Let’s continue with a look at austerity policies in Europe. Yesterday I wrote that in Britain, austerity so far has meant only tax hikes, since government spending, both in nominal and real terms, continues to grow despite the announcement of deep cuts from 10 Downing Sreet. What about France? The country chose a socialist president on Sunday who, according to Paul Krugman and some media outlets, was elected precisely to fight against austerity.
My colleague Dan Mitchell already showed how there haven’t been any spending cuts in France in the last decade. I’d like to dwell on this issue with another graph:
Source: Source: European Commission, Economic and Financial Affairs.
Once again, it’s pretty evident that there hasn’t been any cut in spending in recent years, neither in nominal or real terms. If we look at total government spending as a share of the economy, it went up from 51.6% in 2000 to 56.8% in 2009, and then it came down a bit to 55.9% in 2011—still the highest in the European Union. I doubt that anyone, other than perhaps Paul Krugman, can seriously claim that a decline of 0.9 percentage points in government spending as a share of GDP represents savage austerity.
However, taxes have indeed gone up, and all the presidential candidates, from the far left to the far right, promised to increase them even further. That’s why The Economist reported that, regardless of who won the election, “big companies and rich families are looking at ways to leave France.”
There is more: France hasn’t had a balanced budget since 1973. Its public debt went up from 20.7% of GDP in 1980 to an expected 87% this year. Its budget deficit in 2011, at 5.8%, stands much closer to that of Spain (6.5%) than that of Germany (1%).
So, what austerity is François Hollande pledging to fight?
Looking at ‘Austerity’ in Britain
I’m going to jump into the debate about austerity in Europe because it is being closely followed in Latin America, and many people are drawing the wrong conclusions about how austerity is strangling the European economies. But first, we have to be clear about what we mean by “austerity.”
As the debate between Veronique de Rugy of the Mercatus Center and Ryan Avent at The Economist shows, there are different definitions of austerity. The term could mean fiscal consolidation only by spending cuts. It could mean a mixture of spending cuts and tax increases (the so called “balanced approach”), and it could even be just tax increases. So when people blame “austerity” for Europe’s economic malaise, we could be talking about a very different set of policies in each country.
Let’s look at Britain, which just entered into a double dip recession because of, according to Paul Krugman, “the evident failure” of austerity policies. If we look at spending levels in the UK both in nominal and real terms, we can clearly see that despite the announcement of deep cuts, government spending continues to rise:
Source: European Commission, Economic and Financial Affairs.
It’s clear that, at least in nominal terms, the rate of growth of spending has declined, but that hardly constitutes brutal cuts as Krugman and others want us to believe. If we look at total government spending as a percentage of the economy, Britain reached a peak in 2009 at 51.5%, and that came down to 49.9% in 2011. Can anyone seriously argue that Britain is in a recession because of that tiny drop in spending as a share of the economy?
Now, let’s remember that the Conservative-Liberal Democrat coalition government that came to power in May 2010 adopted what The Economist hailed as a balanced approach of fiscal consolidation based on £1 of tax increases for £3 of spending cuts. To be fair, the British magazine also said that if economic recovery proved hard to achieve, the government should consider a reprieve in tax increases, but not on spending cuts. We all know that the tax increases already took place (the VAT rate went up from 17.5% to 20%, for example). But as we can see, spending cuts haven’t taken place at all. Thus, austerity in Britain consists only of tax increases.
It’s hard to estimate the impact of tax increases on the British economy. Certainly the economic turmoil in Continental Europe has played a role in taking the U.K. into a second recession. But those who claim that “austerity” is responsible for Britain’s economic malaise should be honest and acknowledge that by austerity they mean only tax increases, not spending cuts.
Paul Krugman and the European Austerity Myth
With both France and Greece deciding to jump out of the left-wing frying pan into the even-more-left-wing fire, European fiscal policy has become quite a controversial topic.
But I find this debate and discussion rather tedious and unrewarding, largely because it pits advocates of Keynesian spending (the so-called “growth” camp) against supporters of higher taxes (the “austerity” camp).
Since I’m a big fan of nations lowering taxes and reducing the burden of government spending, I would like to see the pro-tax hike and the pro-spending sides both lose (wasn’t that Kissinger’s attitude about the Iran-Iraq war?). Indeed, this is why I put together this matrix, to show that there is an alternative approach.
One of my many frustrations with this debate (Veronique de Rugy is similarly irritated) is that many observers make the absurd claim that Europe has implemented “spending cuts” and that this approach hasn’t worked.
Here is what Prof. Krugman just wrote about France.
The French are revolting. …Mr. Hollande’s victory means the end of “Merkozy,” the Franco-German axis that has enforced the austerity regime of the past two years. This would be a “dangerous” development if that strategy were working, or even had a reasonable chance of working. But it isn’t and doesn’t; it’s time to move on. …What’s wrong with the prescription of spending cuts as the remedy for Europe’s ills? One answer is that the confidence fairy doesn’t exist — that is, claims that slashing government spending would somehow encourage consumers and businesses to spend more have been overwhelmingly refuted by the experience of the past two years. So spending cuts in a depressed economy just make the depression deeper.
And he’s made similar assertions about the United Kingdom, complaining that, “the government of Prime Minister David Cameron chose instead to move to immediate, unforced austerity, in the belief that private spending would more than make up for the government’s pullback.”
So let’s take a look at the actual data and see how much “slashing” has been implemented in France and the United Kingdom. Here’s a chart with the latest data from the European Union.
Krugman’s Love Affair with the Kirchner Model in Argentina
Paul Krugman once again praises Argentina as a “remarkable success story” in a recent blog post. He blames biased economics reporting for the bad news recently associated with the country (though he is careful not to mention nationalizations, massive capital flight, cooking of official statistics, bans on the importation of books, attacks on freedom of the press, etc.). He points to this graph to prove the “basic fact” that Argentina’s growth outperforms that of neighboring Brazil, and thus it should be taken more seriously:
Krugman’s dismissal of economics reporting about Argentina may explain why he doesn’t mention the fact that the administration of Cristina Fernández de Kirchner cooks the inflation numbers. The story was recently highlighted in The Economist, which even removed the official inflation figure from its indicators page. As the magazine put it, “Since 2007 Argentina’s government has published inflation figures that almost nobody believes.” Apparently, nobody but Paul Krugman.
Since Argentina’s Consumer Price Index significantly understates true inflation (the official figure for 2011 was 9.7% whereas private estimates put the figure at 24.4%), the country’s real GDP is overestimated. By how much is difficult to asses. However, in a report [requires free subscription] for the Argentine consultancy firm Elypsis, economists Eduardo Yeyati and Luciano Cohan, constructed an “Elypsis Coincident Activity Index” (ECAI) using 9 series of economic data from the Monthly Index of Economic Activity (MIEA)—a proxy for the GDP. As expected, they found a high correlation between the ECAI and the MIEA until 2007, when the government fired the head of the statistics office and politicized it. After that year, both indicators increasingly deviate.
Based on Elypsis’ index, I’ve recalculated the GDP performance of Argentina and compared it to Brazil’s:
* GDP performance since 2007 estimated on the ECAI.
As we can see, Argentina’s GDP doesn’t outperform Brazil’s in the last decade. Moreover, I should note three things: First, by using 2000 as the year base, Krugman neglects to show that Argentina was already 2 years into a recession, thus giving an impression of a especially strong performance in the last decade. Second, nobody denies that even when corrected, Argentina has experienced strong growth in the last 7-8 years. However, that has to do with high commodity prices, especially of soybeans, and an expansive fiscal policy that can’t be sustained for much longer (thus the high inflation). Third, by comparing it to Brazil, Krugman picked a low standard of economic performance in Latin America. As I pointed out in an op-ed a year and a half ago, Brazil’s economic growth is far from stellar: “In the last decade, 10 Latin American countries enjoyed higher growth rates than Brazil.”
Paul Krugman’s love affair with the Kirchner economic model in Argentina should be taken for what it is and certainly not as a guide for economic recovery in the U.S. and Europe.
Switzerland’s ‘Debt Brake’ Is a Role Model for Spending Control and Fiscal Restraint
I’ve argued, ad nauseam, that the single most important goal of fiscal policy is (or should be) to make sure the private sector grows faster than the government. This “golden rule” is the best way of enabling growth and avoiding fiscal crises, and I’ve cited nations that have made progress by restraining government spending.
But what’s the best way of actually imposing such a rule, particularly since politicians like using taxpayer money as a slush fund?
Well, the Swiss voters took matters into their own hands, as I describe in today’s Wall Street Journal.
Americans looking for a way to tame government profligacy should look to Switzerland. In 2001, 85% of its voters approved an initiative that effectively requires its central government spending to grow no faster than trendline revenue. The reform, called a “debt brake” in Switzerland, has been very successful. Before the law went into effect in 2003, government spending was expanding by an average of 4.3% per year. Since then it’s increased by only 2.6% annually.
So how does this system work?
Switzerland’s debt brake limits spending growth to average revenue increases over a multiyear period (as calculated by the Swiss Federal Department of Finance). This feature appeals to Keynesians, who like deficit spending when the economy stumbles and tax revenues dip. But it appeals to proponents of good fiscal policy, because politicians aren’t able to boost spending when the economy is doing well and the Treasury is flush with cash. Equally important, it is very difficult for politicians to increase the spending cap by raising taxes. Maximum rates for most national taxes in Switzerland are constitutionally set (such as by an 11.5% income tax, an 8% value-added tax and an 8.5% corporate tax). The rates can only be changed by a double-majority referendum, which means a majority of voters in a majority of cantons would have to agree.
In other words, the debt brake isn’t a de jure spending cap, but it is a de facto spending cap. And capping the growth of spending (which is the underlying disease) is the best way of controlling red ink (the symptom of excessive government).
Switzerland’s spending cap has helped the country avoid the fiscal crisis affecting so many other European nations. Annual central government spending today is less than 20% of gross domestic product, and total spending by all levels of government is about 34% of GDP. That’s a decline from 36% when the debt brake took effect. This may not sound impressive, but it’s remarkable considering how the burden of government has jumped in most other developed nations. In the U.S., total government spending has jumped to 41% of GDP from 36% during the same time period.
Switzerland is moving in the right direction and the United States is going in the wrong direction. The obvious lesson (to normal people) is that America should copy the Swiss. Congressman Kevin Brady has a proposal to do something similar to the debt brake.
Rep. Kevin Brady (R., Texas), vice chairman of the Joint Economic Committee, has introduced legislation that is akin to the Swiss debt brake. Called the Maximizing America’s Prosperity Act, his bill would impose direct spending caps, but tied to “potential GDP.” … Since potential GDP is a reasonably stable variable (like average revenue growth in the Swiss system), this approach creates a sustainable glide path for spending restraint.
In some sense, Brady’s MAP Act is akin to Sen. Corker’s CAP Act, but the use of “potential GDP” makes the reform more sustainable because economic fluctuations don’t enable big deviations in the amount of allowable spending.
To conclude, we know the right policy. It is spending restraint. We also know a policy that will achieve spending restraint. A binding spending cap. The problem, as I note in my op-ed, is that “politicians don’t want any type of constraint on their ability to buy votes with other people’s money.”
Overcoming that obstacle is the real challenge.
P.S. A special thanks to Pierre Bessard, the President of Switzerland’s Liberales Institut. He is a superb public intellectual and his willingness to share his knowledge of the Swiss debt brake was invaluable in helping me write my column.
11-Year-Old Entrepreneur Discovers Business Can Be a Picnic
In my home province of Quebec, an 11-year-old boy is building children’s picnic tables in his garage (using jigs his father built for him) and selling them at a very reasonable price at local home stores. You won’t need to speak French to get the gist of it. What he’s learning is surely invaluable, and it seems as though, in a sane world, this sort of activity would be readily available to all children who enjoy working with their hands.
Thanks to the rapid productivity growth enjoyed by earlier generations of North Americans, families in this part of the world no longer have to rely on the income generating capacity of their children for survival. But does it make any sense to divorce work and entrepreneurship from education as thoroughly as we currently do? In the places where co-op work experiences are being offered to high school students, the practice seems popular. And in a truly free education marketplace, there would be an incentive for educators to meet that demand wherever it exists.
Portuguese Finance Minister Admits Keynesian Stimulus Was a Flop
President Obama imposed a big-spending faux stimulus program on the economy back in 2009, claiming that the government needed to squander about $800 billion to keep the unemployment rate from rising above 8 percent.
How did that work out? One possible description is that the so-called stimulus became a festering pile of manure. About three years have passed, and the joblessness rate hasn’t dropped below 8 percent. But the White House has been sprinkling perfume on that pile of you-know-what and claiming that the Keynesian spending binge was good policy.
But not every politician is blindly ideological like Obama. Vitor Gaspar, Portugal’s Finance Minister, is willing to admit error. Here are some relevant excerpts from a New York Times report.
Mr. Gaspar, speaking to The New York Times last week, has a message for observers who say Europe needs to substantially relax its austerity approach: We tried stimulus and it backfired. Like some other European countries, Portugal tried what Mr. Gaspar called “a Keynesian style expansion” in 2008, referring to a theory by economist John Maynard Keynes. But it didn’t turn things around, and may have made things worse.
Why does the Portuguese Finance Minister have this view? Well, for the simple reason that the economy got worse and more spending put his country in a deeper fiscal ditch.
The yield on Portuguese government bonds – more than 11 percent on longer-term bonds — is substantially higher than the yields on debt issued by Ireland, Spain or Italy. …The main fear among investors is that Portugal is going to have to ask for a second bailout from the International Monetary Fund and the European Union, which committed $103 billion of financial aid in 2011.
Maybe the big spenders in Portugal should import some of the statist bureaucrats at Congressional Budget Office. The CBO folks could then regurgitate the moving-goalposts argument that they’ve used in the United States and claim that the economy would be even weaker if the government hadn’t wasted more money.
But perhaps the Portuguese left doesn’t think that will pass the laugh test.
In any event, some of us can say we were right from the beginning about this issue.
Not that being right required any keen insight. Keynesian policies failed for Hoover and Roosevelt in the 1930s. So-called stimulus policies also failed for Japan in 1990s. And Keynesian proposals failed for Bush in 2001 and 2008.
Just in case any politicians are reading this post, I’ll make a point that normally goes without saying: Borrowing money from one group of people and giving it to another group of people does not increase prosperity.
But since politicians probably aren’t capable of dealing with a substantive argument, let’s keep it simple and offer three very insightful cartoons: here, here, and here.
World Bank: Anti–Money Laundering Rules Hurt the Poor
I’ve complained many times about the pointless nature of anti–money laundering laws. They impose very high costs and force banks to spy on their customers, but they are utterly ineffective as a weapon against criminal activity. Yet politicians and bureaucrats keep making a bad system worse, and the latest development is a silly scheme to ban $100 bills!
It also seems that poor people are the main victims of these expensive and intrusive laws. According to a new World Bank study, half of all adults do not have a bank account, with 18 percent of those people (click on the chart below for more info) citing documentation requirements—generally imposed as part of anti–money laundering rules—as a reason for being unable to participate in the financial system.
But this understates the impact on the poor. Of those without bank accounts, 25 percent said cost was a factor, as seen in the chart below. One of the reasons that costs are high is that banks incur regulatory expenses for every customer, in large part because of anti–money laundering requirements, and then pass those costs on to consumers.
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