MERRY CHRISTMAS

Capitalism & Freedom wishes you a joyful merry Christmas!

FRANCE'S ECONOMY

The Economist published a brief outline about France's economy, showing what is actually behind disease of rachitic growth and status quo.

"In the late 1990s, France's economy grew faster than the European average, allowing the Socialist government to indulge in such goodies as the 35-hour work week. But the country's cherished social model has in recent years proved a strong disincentive to growth and to job creation. Unemployment is double that in Britain, and special public-sector pensions and rising health-care costs are straining the public finances.

Discontent with the economy—and the government’s handling of it—played a large part in France's rejection of the EU constitution. But, as usual in France, economic reforms smacking of libéralisme have met strong resistance: in the spring of 2006, after weeks of protests, the government dropped a proposed loosening of first-job contracts. Nicolas Sarkozy, elected president in May 2007, has promised reforms, although his first budget reduced neither public spending nor public debt, and his movement toward public-sector pension reforms provoked strikes."

Source: Economist, Finance & Economics Backgrounder (link)

WILL THE LARGEST EUROPEAN ECONOMY RECOVER FROM A NON-REFORM DISEASE?

The Economist has recently published an article about the current state of Germany's economy. At this time, Germany faces persistent structural problems affect the dynamics of economic performance. The sub-prime mortgage mess has not been stretched to German market as less than 10 percent of German exports go to the United States and thus, German exposure to U.S slowdown is not huge. Germany's economic growth is estimated to fall from 2,6 percent in 2007 to 2 percent or less in 2008. What is actually behind a lingering growth performance? The growth of export performance is likely to decline, facing a drop from 8 percent in 2007 to 4,8 percent in 2009.

Among the economic issues, there was a significant surge of inflation which hit 3,1 percent annually in 2007 mostly due to higher food and energy prices. A detailed analysis of the demand conditions may reveal that the coefficients of price and income elasticity of demand have been quite inelastic, moving somewhere in the interval between 0 and 1. The suppliers know very well, that if demand is quite inelastic and consumer behavior quite monotonic, price increases could prop up their income. Germany's inflation rate may be transiotry as there are strongly supported expectations about the normalization of energy and food prices in the period to come.

Although consumer sentiments remained well-positioned, consumption-inflated spending may not boost the potentials of German economy on the way to recovery from low overall growth.

Germany's future and prosperity will crucially depend on the pace of economic reforms. The policy outcome of current government coalition is mixed. Labor-market reforms contributed one fifth to overall growth but there is a number of issues hampering the ability of German economy to operacompete successfully in a global environment. Bundesbank, German central bank, has shown that the contribution of labor to economic growth is likely a result of drawing unskilled workers into labor supply. Also, German government cut public spending and put limits on the growth of overall spending. Quite logically, the investment picked up an incentive and grew at a higher rate.

An impeding obstacle to Germany's prosperity is the attitude oriented against the economic reforms. The preference of economic justice over the need for tomorrow's change is a road to self-destruction. The consequence of such a misty combination of political and voting behavior is the lack of willingness and political courage to implement much-needed reforms. Steming away and streaming for status quo is what causes riots, dissatisfaction and an endless cycle of statist propaganda inflated by politicians, interest groups and the media.

Unemployment benefits, raising the minimum wage in public sector and similar policy implementation strongly discourage the economic performance from going to growth to searching for privileges from the state through various mechanism such as tax system, collective bargaining and public sector. In Germany's case, the raise of minimum wages in a state-controlled postal company, is nevertheless a sign of rent-seeking. If such collective demands are granted, the steps in the wrong direction will multiply. There is hardly any argument for the minimum wage. On demand side, minimum wage is a form of taxation that raises the overall cost of labor and increases the probability of being fired or unemploymed in the future. On supply side, the minimum wage reduces the productivity potentials and does not stimulate labor supply to spend more hours in the market.

Regulating job market will not boost job creation subject to external pressure on the allocation of labor resources and productivity of the labor supply. The pursuit of various form of unemployment insurance, which has flipped Germany into a mirage of structural unemployment, discourages laborers from seeking a job. It rather encourages seeking priviliges from the state and the lack of incentives to search job due to unfavorable working environment and the influence of trade unions on job growth and labor market.

The question is whether Germany will move out of the cage of low growth and discouraging structural picture. The answer is mix of particular sets of policy conditions and macroeconomic estimates. On macroeconomic level, inflation expectations remain favorable and consumer price index is expected to normalize subject to transitory shock on particular prices. On fiscal level, estimates suggest that more should be done to decrease public spending, cut taxes on productive behavior and reduce government size and consumption. Many futures answers to thequestion of where Germany will stand in the future, will depend on whether the polocymakers will give up the political payoffs emerged from rent-seeking and special interest groups.

Going in the reverse way, where political decision-making neglects economic costs, further makes it quite difficult for policymakers to implement long-range reforms regarding health-care, welfare state and labor market. In those areas, the presence of pressures from interest groups and trade unions will radically oppose the economic reforms to protect the benefits handed to special groups and priviliged from the state. There is no need to endure old-styled western European type of corporatist society where the interests of stakeholders are protected at first hand.

There is always a need for change in economic and structural terms, just as deregulation and openness created German economic miracle after the World War 2. Change is the engine of tomorrow's freedom and progress and an opportunity is rare, while a clever man will never let it go.

Rok SPRUK is an economist.

Copyright 2007 by Rok SPRUK

KENNETH ARROW ON CARBON EMISSIONS AND CLIMATE CHANGE

Kenneth Arrow, a Nobel laureate in Economics, discusses the state and future implications of climate change (link).

The benefits are the avoided damages, including both market damages and non-market damages that account for health and ecological impacts. Following a “business as usual” policy, by 2200, the losses in GNP have an expected value of 13.8%, but with a degree of uncertainty that makes the expected loss equivalent to a certain loss of about 20%. Since the base rate of economic growth (before calculating the climate change effect) was taken to be 1.3% per year, a loss of 20% in the year 2200 amounts to reducing the annual growth rate to 1.2%. In other words, the benefit of mitigating greenhouse gas emissions can be represented as the increase in the annual growth rate from today to 2200 from 1.2% to 1.3%.

Source: Kenneth Arrow, The Case for Mitigating Greenhouse Gas Emissions, Project Syndicate, The Economists' Voice, 2007 (link)

JOHNNY MUNKHAMMAR: GUIDE TO REFORM

In a thorough, understandable and comprehensively written book “Guide to Reform” Johnny Munkhammar addresses some fundamental issues and perspectives about the need to implement long-term economic and structural reforms. The content of the book is divided into several chapters. Each of them reflects key areas of economic reform and each of them highlights the essentials on the road to prosperity through today’s change towards tomorrow’s benefit. In this brief review, I shall highlight the main premises drawn upon the economic reform. As an economist, I will attempt to make essential conclusions regarding author’s groundbreaking book.

The first question is whether economic reform is good. The author of the book has concluded that the main purpose of the economic reform is to pursue economic freedom and guideline the course of public policy instituted upon the ideas that brought nations an unparalleled increase in prosperity. Such conclusion is relevant and supported by countless empirical evidence. The general parameters that reflect the quality of macroeconomic and business framework are crucial to essential conditions regarding growth performance and increases in standards of living. What distinguished sound business environment and macroeconomic picture from restrictive and risky type of macroeconomic framework is the extent of coercion and government involvement into business affairs and personal lives. There is a positive correlation between high real GDP per capita and high level of economic liberty. Nations that have pursued economic freedom and the principles of limited government have observed what could (in German) be described as “Wirtschaftswunder”, an economic miracle.

Let’s start with a methodological, theoretical and empirical grounds and arguments for structural change and major long-range reforms. The author of the book supported the arguments with a significant and incredible amount of economic and political literature. As for an economist, the quest for economic reforms is fairly simple. The economist is interested about the outcome of the reforms and how to design a theoretical framework after data collection, data analysis and after relevant and empirically-tested conclusion are finalized. Throughout the course of the book, the author used a series of graphs and charts to show the how economic activity and standards of living grow together with fundamental economic reforms regarding welfare state, labor market, business environment, health care system, education system and structural performance.

The author succinctly shows how reforms implemented in recent years and decade worked tremendously well in countries that have adopted them. From the theoretical point of view, it depends which side of the economy is taken into the analytical account. The experience such as stagflation has shown that Keynesian economic perception about the real economy was wrong. John Maynard Keynes believed that the economic performance can be restored by the acceleration of aggregate demand. Keynesians also believed that government intervention and a significant monetary expansion can boost the growth performance. However, if newly printed money is injected into the economy, the inevitable consequence is higher inflation which negatively affects the ability of the economy to operate at the optimal capacity regarding long-term sustainability of economic growth. The main consequence of high inflation is a deep negative shock on price behavior resulting from the overweight money funds chasing too few goods.

Thus, there is a paradox given the fact that money injection into the economy inevitably reduces consumer purchasing power. On the other side, the neoclassical growth theory supports the view that the essential condition for long-term growth is the quality of growth engines such as human capital, low tax burden, investment, and productive behavior in general. At the end of 1970s, stagflation, rising inflation and unemployment, indicated the collapse of the Keynesian politico-economic doctrine. From a theoretical perspective, productivity growth is the essential condition for the increase of living standards. Any kind of particular burden that hampers productivity growth also reduces the potentiality of higher living standards and general welfare.

Throughout the book, the author underpins the classical essence of economic success: good governance, limited government, low taxes, sound monetary and macroeconomic framework, low regulation, privatization of public services and competitive product markets, including labor market. In moving towards the solutions and proposals suggested by Johnny Munkhammar in the book deserves an analytical outline of the policy areas that impede economic growth and increase risk of low growth, weak economic performance and an overall decline.

The author suggests radical cuts in public expenditure. The proposal is relevant since reductions in public spending boost growth and productive behavior. In fact, low tax rates on labor supply, savings, investment and entrepreneurship positively correlate with economic growth. The evidence has shown that tax cuts do not reduce revenues following the Laffer curve statement, saying that tax revenue is higher when tax rates are low. The author makes a strong point for privatization and cutting-edge competition in policy innovation. He says that “different reasons may exist for selling publicly owned activities, for example increasing competition, improving management or increasing citizens’ ownership… Competition brings innovation, variety, improvements and lower costs. Increased competition is necessary in publicly provided services and this can be achieved by several methods”.

The author has put a significant amount of effort in the analysis and key policy solutions pertaining to the areas that hinder the evolutionary process of sustainable economic growth. Among the most vital reforms are labor market reforms, product market deregulation, tax cuts, the introduction of competition and private initiative in health-care and education system under sound capital and financial markets, solid infrastructure and the reform of the business environment. He also lists a growing list of nations that implemented productive reform solutions; Estonia’s competitive advantage of early tax reform in boosting investment, the introduction of vouchers in Sweden, the reform of the labor market in New Zealand and the remarkable economic transformation of Slovakia from a lingering performer into high-growing Tatra tiger. The author also outlined how Ireland went from the “poorest-of-the-rich” as how The Economist described Ireland in January 1988, to the Celtic tiger in nearly a decade. The arguments for economic reforms are put ahead in a very intuitive and interactive way nevertheless.

The main problem in implementing the economic reforms is not that politicians are unaware of the economic reforms but the fact that their political support is subject to special interests emerging from rent-seeking patterns of behavior placed in societies where the weakness of institutions enables interest groups to gain privileges from the state, codified into the law and made permanent. Powerful stakeholders in the corporativist model of society will thus resist change at any cost. Such case is the collective bargaining which distorts the competitive equilibrium in the labor market at the cost of lower productivity growth and slower structural adjustment to economic change and globalization. Special interest groups possessing a degree of coercion and political influence will inevitably refuse reform proposals and mobilize its force to do everything possible to prevent the implementation of economic reforms by the means of fear and propaganda.

The author suggests a strategic set of combinations of political decision-making, game theory and tactical methods that could reduce the opposition to economic reforms and structural advancement. As an important feature, the author also makes strong point on the continuum of economic reforms as the main policy asset that reformist politicians should embrace. True, there will always be those who oppose economic reforms everywhere but, as Harold Wilson said, “those who reject change are the architects of tomorrow’s decay.”

The book is not only a great source of inspiration but also a great educational material that provides important data, information and answers to some of the greatest tasks of tomorrow’s challenge.

Rok SPRUK is an economist

Copyright 2007 by Rok SPRUK

BULGARIA IS NOW AN OFFICIAL MEMBER OF FLAT TAX CLUB

Sofia News Agency reports that Bulgarian lawmakers passed flat tax reform. Bulgaria is now an official member of the flat tax club.

OBWALDEN APPROVES 1,8 PERCENT FLAT INCOME TAX RATE

Obwalden is a Swiss canton situated in central Switzerland. SwissInfo reports that Obwalden has recently become the first Swiss canton to adopt 1,8 percent flat income tax rate on all categories. In December 2005, Obwalden decided to slash the corporate tax rate to 6,6 percent. The canton also decided to impose degressive tax system which was later declared as unconstitutional. In the first six months of this year, the canton saw an astonishing 230 percent growth of company registration. In addition, 90,7 percent of voters approved changes in tax regime.

THE ECONOMIC PERFORMANCE OF ICELAND IN 2008

The IMF estimated that Iceland's economy could slid into a mild recession in 2008. Meanwhile the rate of inflation is estimated to reach 3,3 percent (link).

The empirical data has shown that Iceland experienced one of the highest coefficients of fiscal revenue elasticity, whether it is measured in terms or relative changes in private consumption or in terms of effective real exchange rate. On the other hand, rigorous tax reform in previous decade returned a soaring growth of fiscal revenue which reflects the broad range of revenue elasticity as well as the effects of tax cuts on supply side of the economy and fiscal parameters.

Read also:
Anthony Arnett: Toward a Robust Fiscal Framework for Iceland; Motivation and Practical Suggestion, IMF Working Paper 07235, International Monetary Fund, 2007 (link)

ARE GROWTH AND SIZE OF CHINA'S ECONOMY OVER-ESTIMATED?

The Economist recently published an article discussing the size and growth of China's economy (link)

DEATH TAX

The Economist discusses the issue of death tax (link).

ECONOMICS, DEMOCRACY AND PUBLIC POLICY

"In theory, democracy is a bulwark against socially harmful policies but in practice, it gives them a safe harbor."

Source: Bryan Caplan, The Myth of the Rational Voter, Princeton University Press, 2007 (here, here and here)

ALAN GREENSPAN ON MORTGAGE CRISIS

In OpinionJournal, Alan Greenspan places an emphasis on the roots of mortgage crisis. He concludes that numerous price bubbles cannot be safely by policy initiatives.

Overnight, financial risk surged the price of risk, thus pushing the interest rates on various assets compared to relatively riskless U.S. Treasure Securities.

Global economic growth increased steeply and the level of risk suddenly became underminded which led to overnight speculations and mispricing of secured sub-prime mortgages. Thus, a crisis was a well-known accident waiting to happen sooner or later.

Source: Alan Greenspan, The Roots of the Mortgage Crisis, Opinion Journal, Wednesday, December 12, 2007 (link)

INTERVIEW WITH JOHN NASH, THE 1994 NOBEL LAUREATE IN ECONOMICS

PBS has published an interview with dr. John Nash of Princeton University. John Nash received a Nobel prize in economics in 1994 for pioneering the equilibrium analysis of non-cooperative games. The interview can be read and seen as a video here.

On Discovering Math

"I was in grade school. I would be doing arithmetic, and I found myself working with larger numbers than other students would be using. I would have several digits, and they would have maybe two or three digits. I would do multiplication and basic operation, but with larger numbers. Later on in adolescence, I got some practice in using a calculator machine, where you could multiply and add, subtract and divide really large numbers like 10 digits."

John Nash

OECD CUTS GROWTH FORECAST

The OECD questions whether financial shocks and housing market turmoil will push the growth rate to the slowest in five years (link)

SWEDEN, FREE-MARKET ECONOMY AND WELFARE STATE

At LewRockwell.com, Nima Sanandaji wrote an article about the well-known Swedish system (link). The author emphasized Sweden's unparalelled increase in prosperity between 1890 and 1970 and a lingering economic performance from 1970s onwards. In 1970, Sweden was the fourth wealthiest country in the world. After 1970, the Swedish system turned into troubles, having left a painful effect which ended in early 1990s when Swedish economy slid into a disastrous recession.

To browse the posts on this blog about Sweden, click here.

HOW MUCH DO YOU KNOW ABOUT THE GLOBAL ECONOMY?

Source: Prof. Greg Mankiw (link)

HIGH TAX JURISDICTIONS ARE AS BAD AS MONOPOLIES AND OIL CARTELS

FALLING U.S. DOLLAR

The Economist has published a sound analysis of a falling U.S. dollar (link).

An interesting article brought up a couple of issues to be discussed. First, dollar crisis would be disastrous. The U.S economy is now expecting a recession. Even if it looms, the financial markets would force FED to raise the rates, slowing the recovery from recession. Consequently, euro would probably soar to new record-highs.

A major slice of global traded is accounted in dollars and most central banks hold the majority of foreign reserves in dollars. The tightness of euro has handed a chance of switching from one currency to another, pushing the value of U.S. dollar downward. However, different gueses about the possible worst-case scenario are nothing else but pure fears.

On the other hand, U.S. government bonds have fallen as investors haven't expected higher asset premiums. The dollar has peaked in 2002. Since then, consumption-induced borrowing has boosted current-account deficit. Recently, various incentives to import less and export more, have lifted the account deficit from 7 percent of the GDP to 5,5 percent.

The state of the U.S. currency is very much related to so called "cyclical divergence" between the U.S. and the economies in the rest of the world. Financial markets have prolonged the expectations about the interest rate cut. But, a weakening dollar is not a consequence of a single feature. A sizeable amount of assets have been stocked in the U.S. dollar, affected by credit-crunch mess. As growth prospects were weaker, the currency became cheaper. There is no doubt that a widening current-account deficit has left the dollar vunerable to external pressures.

In addition, rising oil prices and weak dollar has raised inflation expectations in gulf countries. Economically, those countries would have to let their currencies to rise to curb the inflation pressures and expectations. If their currency appreciate, other reserve currencies would arise. If the dollar-falling would continue to slide faster, the interest rate cut would have to be held back to prevent the decline in the value of dollar. True, there would be some trade-off pressures.

Speculations about the U.S currency situation are often overblown and there's little evidence, empirical and actual, that the dollar could slide deep into a chaotic slump. Yet, there is a question how long will dollar remain the world's leading currency (link).

PRIVATIZATION OF STATE ENTERPRISES: THE CASE OF SLOVENIA

Dr. Joze P. Damijan, the professor of economics at Vienna University of Economics and Business Administration, recently wrote an article about the need to accelerate the privatization of state enterprises in Slovenia. The article can be read here and here.

In Slovenia, 65 percent of the GDP is composed of private sector while public sector is extensive, accounting for about 35 percent of the GDP. There is a numerous empirical evidence in favor of privatization. In fact, the allocation of scarce resources is the key argument for privatization. Managers in state enterprises have different interests than private investors. That's why, private enterprises are more risk-taking in particular investment opportunities. Thus, as an empirical matter, private investors usuallly sustain higher rates of return on equity than managers in state companies.

In Slovenia, the government has been controlling the economy by extensive ownership participation in all major enterprises, ranging from insurance companies (Triglav), pharmaceutical industry (Krka), manufacturing sector (Gorenje) to retail industry (Mercator), banking sector (Nova Ljubljanska Banka, NKBM) and even telecommunication sector (Telekom Slovenije, Mobitel).

There is also a proof that sizeable state entrepreneurship reduces growth and distorts capital allocation nevertheless. In China, there is an average estimate that a decrease in state-owned enterprise share of industrial production increases real GDP growth by 1,14 percent (Phillips, Kunrong 2003).

In Slovenia, political and popular attitude toward the privatization is somehow negative. Yet, the privatzation is urgent. Some privatization is already taking place. Unfortunately, it is taking place very slowly and non-transparently. The withdrawl of government ownership of enterprises is essential to sound economic performance and economic liberty nevertheless.

JAPAN'S HYBRID INNOVATION: NEW ECONOMIC MODEL

The Economist published an article on Japan's business and economic performance. The article outlines the periodic evolution of the Japanese economy. After a prolonged cyclical crisis of low output rates and deflation, which hit the bottom in 1998, Japanese economic performance surged a modest recovery. Indeed, Japan's old industrial model formed the country's economic miracle, but under very different circumstances, such as pyramidal population structure and high growth under 'catch-up' conditions. The old model, known as a binding cross-sectional partnership named keiretsu, ran out of time and hindered both; entrepreneurship and innovation.

However, the time is changing and Japanese economy and business also:

"So policymakers rewrote corporate law to allow Japanese companies to adopt an American-style model of corporate governance, and some companies began to adopt Anglo-Saxon practices such as performance-based pay, share options, outside directors, promotion based on ability, pursuit of shareholder value and hiring new employees in mid-career. The banking system was recapitalised, cross-shareholdings were unwound and companies embarked on a programme of restructuring."

Source: The Economist, Going hybrid, November 29th 2007 (link)

FRANCE'S STREET RIOT SHOWDOWN

Weak property rights, excessive government burden and the lack of rule of law have led to street riots in France. The Economist has published an article describing how French rioters are destroying private property and public means (link).

LAFFER CURVE IN MONTENEGRO

Last year, Montenegro's parliament adopted a 15 percent flat tax on personal income. Tax rate on corporate profits was set at 9 percent and by 2010 Montenegro will have a 9 percent flat tax rate on corporate and individual income (link).

As a result of an expanded tax base and lower tax rate on productive behavior, Montenegro's Tax Administration has collected 36 percent more from annual taxes than in 2006 (here and here).

AUSTRIA'S PROPELLING PATH TOWARDS PROSPERITY

The Economist has published four highly interesting reports on Austria's economic development (here, here, here and here). In addition, Economist Intelligence Unit provides some data on Austria's economic situation (here and here).

SWITZERLAND VS. EU

The EU recently persecuted Switzerland because because bureaucrats in Brussels believe that Swiss market-friendly model of cantonal tax competition is a form of state-aid.

Here is a report by Tax-news.com:

"The European Commission is basing its legal argument against Switzerland on the latter's alleged breach of state aid rules, which, in the EU, are in place to prevent member states from favouring certain companies and industries with beneficial tax rules and subsidies. But the Swiss say that the EC's arguments rest on shaky very legal ground, pointing out that the country is neither an EU member or part of the Single European Market, nor party to the competition regulations of the EC Treaty, including those on state aid. Moreover, Bern insists that even if the tax laws in question were covered by the 1972 Free Trade Agreement, they would not fall under the EU's definition of state aid, because they do not favour certain companies or industries."

Swiss Federal Council issued a report on state-aid to companies (link). Claiming that regional (cantonal) tax competition is a government aid is a myth. In fact, EU countries such as Germany and France maintain a bulk of government-owned enterprises.

An example of government intervention into the course of market forces is EU's Common Agricultural Policy (CAP) massively endorses income redistribution from European taxpayers into the hands of agricultural lobbies. Another obscure example of statism is EU are subsidies as a "third-party" payer problem.

The majority of EU's budgetary means and fiscal expenditures are funded directly into farming in the form of subsidies. 65 percent of all EU subsidies go to manufacturing, causing disallocation and the distortions in output and productivity. In addition, there're vast sub-funds whereby subsidies and handouts are granted to enterprises in the EU.

On the other hand, there is no such thing in Switzerland. Even more, Swiss government does not penalize businesses competing in low-tax jurisdictions compared to EU's expanding of the power of government such as efforts to establish tax harmonization.

CROATIA'S EXPOSURE TO MACROECONOMIC CRISIS

In recent years, external indebtedness of Croatia has grown at the fastest pace in Europe. Croatia is, after Lebanon, the country most dependent on foreign loans. The business environment in Croatia has regionally low economic growth rates, high tax burden and inefficient administrative framework such as widespread corruption, weak property rights and extensive market regulation. The paper released by the IMF has shown how banking risks rise in Eastern Europe's case of rapid credit growth (link). On average, Croatia's economic growth between 2002 and 2006 was below 5 percent. In addition, external debt has reached 89 percent of the GDP. High government spending, exceeding 50 percent of the GDP and non-prudent fiscal policy contributed to structural risk of Croatia's economy. While expenditures and consumption-inflated indebtedness have been growing steadily, total factor productivity grew slightly by 1,2 percent. On the other hand, short-term debt increased by nearly 70 percent, from slightly below 4 percent of the GDP to way above 10 percent of the GDP. In a paper issued by the IMF, it is shown that external foreign debt liabilities of Croatia's banks are growing exponentially since 2004.

In such a turbulent picture, there is a significant amount of macroeconomic risk. In addition, there's an extensive availibility of literature and reading on the probability of macroeconomic crisis in Croatia. I suggest the website browsing of the Adriatic Institute, and a paper released by the IMF "Vunerabilities in Emerging South-Eastern Europe - How much Cause for Concern?". There're also few nice articles describing Croatia's macroeconomic prospects (here, here and here). Also, there is an article about Croatia in Washington Times (link).

AFTER YEARS OF TREMENDOUS GROWTH, THE ECONOMY OF ICELAND FEELS THE HEAT

Financial Times just recently posted an article about the macroeconomic and financial prospects of Iceland regarding recent turmoil in financial markets.

Throughout 1990s, Iceland's economy recovered signficantly subject to economic and structural reforms. As a result, fishing, which still remain the dominant source of export revenue decline from 16 percent in 1980 to 6 percent last year, being replaced by finance, insurance and real estate. Moreover, Iceland's three largest banks, Glintir, Landsbanki in Kaupthing have asset capitalization of more than 110 billion EUR, which is more than eight times Iceland's GDP.

So how have the prime movements in credit markets affected risks associated with financial turbulence? A report from F. Mishkin and T. Herbertsson has shown that Iceland's economy is stronger than ever, concluding that fears of rough landing and possible recession were overblown. In a broader sense, Iceland's banking sector was not intensively exposed to credit market turmoil as banks increased their operating capacity by switching to retail deposits as a pattern of funding.

In addition, total assets of Icelandic banks remain solid and there has been almost no sign of a liquidity loss, default loans, exposure to subprime mess and credit blowing. But, loan to deposit ratio is still around 300 percent, reflecting the dependence on gross markets. The question is how the sovereign risk may be managed. Explosive growth of financial sector has certainly benefited Iceland's economy but the problem is the long-term sustainability of risk management due to immediate or sudden fluctuations in business cycle and exchange rate. In fact, krona, Iceland's currency, has been one of the weakest performers recently. Agreeably, the information asymmetry plays an important role in this case. It is important how banks perceive macroeconomic risk and respond to imbalances. As a result, market premium shows how the investors absorbed and perceived the information about Iceland's economy accountably.

CONSUMPTION, WELFARE AND ECONOMIC PERFORMANCE

The OECD recently released a new international comparsion of GDP and consumption per capita (link).

GDP is the most frequently used measure of economic activity of the country. It is difficult to estimate income levels across countries. Using exchange rates is not always the best and most appropriate way to compare GDP per capita between two or more countries. For example, Denmark and the United States differ dramatically in this respect. Using exchange rates conversion of the GDP per capita, Denmark has a higher nominal GDP per capita than the United States. However, using purchasing power parity as a method of conversion, the real GDP per capita of the United States is higher than Denmark's GDP per capita. When currency conversion rates are taken into account, Denmark's GDP per capita turns out to be lower than that of the United States. That is because price level is higher in Denmark than in the U.S.

True, purchasing power parity provides a clearer picture of a relative economic performance of selected countries. To compare living standard, consumption per capita is equally important. Higher level of the GDP does not neccesarily mean higher level of household consumption because savings-to-GDP ratio is variable in a cross-country comparision. But the consumption can be misleading, depending on different distribution of government services in different countries. Thus, it is more appropriate to measure the relative household consumption levels and see what households consume actually. It should be noted that there is, however, no static relationship between household consumption and GDP per capita. A GDP of the particular country may be high above the average, while the actual household consumption may be just below or slightly above the average.

Nonetheless, GNI (gross national income) also takes into account international flows and transfer payments. In Switzerland's case, moving from GNI to GDP can respectively change the entire picture. According to OECD's figures, Swiss GNI per capita is 30 percent over the OECD average, which means that net transfer payment pour into Switzerland. The GDP per capita of Switzerland is, for instance, 122 percent of the OECD average. In case of Ireland, the GNI per capita is 146 percent of the OECD. In terms of GDP per capita, the ratio falls to 110 percent of the OECD average. The investigation of GDP and GNI in Luxembourg is similar. In GDP per capita terms, the GNi per capita falls from 246 to 200 percent of the OECD average. This shows the presence of significant net transfers out of the country.

Consumption and Real GDP per capita; An International Perspective

WILL GUAM BE THE NEXT FLAT TAX JURISDICTION?

As a territory outside the U.S., Guam has an ability to choose and design its own tax system. However, the jurisdiction's current tax legislation is subject to the Internal Revenue Service code. The U.S. tax code which Guam uses is marred by complexities, convoluted and heavily complicated. There's a growing probability that Guam will de-link from U.S. tax code. In fact, the latter maintains some regressive provisions which are inapplicable to Guam.

In case of the separation from U.S. tax code Guam would get an opportunity to adopt flat tax. The tax base would increase, there would be less avoidance, double taxation of income would disappear. The simplification of the tax law would also reduce the costs of tax bureaucracy and administrative costs of tax collection. And most importantly, lower taxes would stimulate the growth of output nevertheless.

Source: De-linking from the U.S. tax code makes sense for Guam, Pacific Daily News, November 18, 2007 (link)

PAUL A. SAMUELSON ON CURRENT ISSUES

Paul A. Samuelson, a Nobel laureate and the author of the Economics textbooks portrays the perspective on current issues.

Link: Paul A. Samuelson, Balancing Market Freedom, International Herald Tribune, November 19 2007 (link)

SLOVENIA GOING SLOW ON PRIVATIZATION

Here is a note from Economist on Slovenia:

Slovenia was already economically advanced by regional standards when it gained independence, so that it has experienced slow growth rates relative to other central European economies, and has adopted a more complacent attitude towards privatisation and economic reform... The main economic policy issues include the privatisation process and attempts to improve the business environment. Progress on both is made difficult by the consensus-based nature of policymaking.

Source: Economist, Country Briefings: Slovenia (link)

The empirical argument in favor of privatization is that the allocation of scarce resources is more efficient in private economy than in public sector regardless of the economy's sector. The only argument that could speak against privatization is the establishment of natural monopolies in case if competitive code is not fully enforced. In this case, control over natural monopolies is needed to prevent price speculations that could occur at the expense of consumer welfare.

The quality of Slovenia's business environment is restrained by administrative burden, restrictive labor regulation and high tax burden which disables the creation of productive behavior. The total number of reforms in Slovenia regarding the ease of doing business is zero (link).

The product quality of the country's business environment is, by competitive analysis, as any other market product. Higher the quality supplied (the number of implemented reforms to improve business environment), higher the demand for the product (the number of investors going for business in Slovenia and the growth of start-ups, spin-offs, and wanna-be's) and higher the reputation of the country as an investment location.

STREET SOCIALISM IS THE LAST SHELTER OF SCOUNDREL

Following the headlines of the international media, Slovenia is a fine land consisting of happy people, whose country's nobility is enriched by the fact that Slovenia is the wealthiest post-communist economy which recently entered the European Monetary Union, and a country enjoying the highest GDP per capita and standard of living in the Eastern Europe.

However, the reality is something completely different as I try to demonstrate in the words below.

Being a student is a nice slice of lifetime. I do not pay attention to attending student parties and thus, I rather wisely invest my time into sitting at the library and studying the economic theory, policy and philosophy besides regular study courses. The fact is that the opportunity cost of attending parties is huge and it'd be completely irrational to neglect it or ignore it respectively. For example, Kobe Bryant understands his opportunity cost very well. He can, for instance, spent 2 hours mowing his lawn, having low overall return.

Contrary, he can record a TV commercial, earning $10,000 USD in two hours. His neighbor, Sally, might spent 2 hours working in McDonald's, earning $8 USD. Despite the fact that Kobe might mow the lawn faster than Sally, it'd be rational for Kobe to record a TV commercial while it'd be equally rational for Sally to mow the lawn, because of the opportunity cost.

Economically, my interest as a student is to finish the undergraduate study as soon as possible and get an overall return from the education. The opportunity cost of the education is, of course, my time. But in a broader perspective, higher earnings and human capital value is what shall count as a compensation for investing my time into the education, getting both: better education and better job opportunities.

As an economist, I strongly favor free choice; an ability to choose among the greatest possible set of alternatives in the course of human life. In fact, individual, economic and political liberty and individual responsibility to the fullest possible extent, is what has unlocked creative and talented entrepreneurial and intellectual minds to pursue intuitive and powerful ideas that shaped the economic future.

But I don't understand, why on earth, should the students jump on the streets, wear red suits, head old Soviet flags and shout in favor of the welfare state extensively. Slovenia's student organization, pensioners, public sector employees and trade unions claim that wage increases should be more robust subject to Slovenia's sound current economic shape and, on Saturday morning, they will march on the streets of Ljubljana and promote the spellings of socialism, social security and generous welfare services respectively. Slovenia's student organization says the following:

"An accessible education without scholarships for all, higher pensions and greater social justice. These are the ideas that will make everyone better off."

Over at the faculty field, I noticed a socialistic parole, saying: "Factories in the hands of workers, universities in the hands of the students!" added with Soviet-styled propaganda and typical communist star. This situation rather reminds on a retarded Soviet satelite grunged by Leninism and Marx's diallectical materialism. The origins of socialistic mentality in Slovenia are strong roots of collectivism. In this post, I explain why student protests against pro-growth tax and economic policy, school choice and competition in higher education, reform of the budget-funded health care system and social security reform are based on the false assumptions, myths and hostility against individual, economic and political liberty.

1. Population crisis in Slovenia is estimated to hit negative numbers. Aggregate labor supply is falling respectively and the number of retired persons is growing significantly. In Slovenia, when a person retired, the main slice his pension in financed through 1st pillar of pension fund which is funded directly through taxes on labor supply. The impact is clear: tax burden on labor supply is rising, public debt is growing respectively and fiscal outlays are expanded every year.

Consider the gross cost of an educated and intelligent worker in Slovenia, which an employer has to bear. Assume that monthly salary of the worker equals $3500 EUR in gross terms. The contribution rate to the retirement fund is 15,5 percent. Basic health care insurance deducts additional 6,36 percent. Personal income tax rates are composed into three brackets; 16 percent for the lowest quantile, 33 percent for the middle-income earners and 41 percent for the workers in high-income groups.

Obligated voluntary health insurance contribution rate is small compared to basic coverage rate of contribution, but it deducts the disposable income respectively. Additionally, employers have to pay the payroll tax and enhance the worker's income by compensating the costs of food and transport. In addition, an employer in Slovenia has to slice a contribution share to health care, social security and pension fund, at the expense of worker's productivity. Now, calculate the disposable income of the employee and see the tax wedge, squeezing his productivity after the hours he spends on the market.

2. Moderate tax cuts by the center-right government stimulated the growth of incomes by a narrow rate. Modest cuts in the labor taxation showed that tax cuts are self-financing, the unmistakeable notion of the Laffer Curve. Recently, the growth of economic activity in Slovenia reached historic highs. In 2007, the growth is estimated to reach 5,6 percent, which is quite uncompetitive compared to Eastern European economies. In 2006, Estonian economy grew by 7,9 percent, Latvia accounted 10 percent rate of output growth, Slovakia recently announced the data, revealing 9 percent annual growth rate.

By 2012, Slovenia's economic growth is estimated to diminish straight-forward to 3,6 percent respectively, reflecting weak structural advancement, age-dependency pressures and rapid increase in retirement activity. In 2006, the rate of inflation sparked up primarily due to higher food prices and intensive demand for food in Asian high-growing economies. Economically, inflation is a monetary phenomena arising from too much money, chasing too few goods. In a simple equilibrium, the result is the increase in overall price level. By January 2007, Slovenia entered the European Monetary Union, and after fixing the monetary emissions, the growth of money supply calmed down which normalized the inflation rate.

Subject to deteriorating exchange rate regime and periodically stimulated high inflation in the past, it will take time for Slovenian economy to adjust to new stream of monetary policy whereby the money supply is determined through interest rate setup by the ECB.

3. There is no such thing as free education. In fact, somebody has to pay the equipment, rent and maintain the facilities, lecture rooms, provide the electricity and heating. In addition, somebody has to hire and pay the academic services. Somebody has to pay and provide computers, internet access and modern means of study. Saying that education is free is like claiming that you can go into the mall and take away some furniture without payment. There is a dozen of proofs that private sector education is competitive in terms of quality of the future graduates.

The best and most respected universities in the world are private ones. Eight Nobel-winning economists have come from Chicago University which is funded by private means as well as Stanford University. Investment in education provides the best interest in the future. The time you give up to consume, is the cost you have to bear to have greater returns and personal welfare in the future.

There is no such thing as free lunch, and the education has never been a free lunch. Scholarships, by empirical proof, improve the standards of education and provide opportunities for thousands of individuals to unlock knowledge potentials and empower the intuitive mind whether it be in entrepreneurship, design, economics, medicine, mathematics and everywhere else.

4. The essential to understanding complex phenomena in society is the economic literacy and education. Thus, Slovenes should know that despite the same length of working time as Austrian or German workers, the latter earn more because of higher productivity and technological progress which stimulates the productivity through effective individual management of creativity and knowledge. In addition, Slovenia is, as shown above, one of the most taxed countries in the world (link), thus giving investors a sign of avoidance as an investment location. Empirically and practically, labor supply is highly sensitive to tax rates, meaning that the labor supply is elastic, ceteris paribus.

It means, that the labor supply strongly responds to the marginal changes in taxation of income. As a result of higher taxes, gross labor cost in Slovenia is huge, discouraging job formation and denying the opportunities to thousands of intellectual and entrepreneurial minds to show their skills and talent. I wonder whether trade unions and its anti-growth intellectual leaders will bear full responsibility for the actions they presume as socially just. To say it again, social justice is a mirage and a trojan horse riddled by the totalitarian governments and supported by the individuals who deny economic and personal liberty to others. Those who deny the enforcement of economic and personal liberty as a property right to others, neither deserve it for themselves.

The demands of trade union such as full employment, high taxes on productive behavior, high wages, expanded income and profit redistribution, extensive welfare and social security services, would propel the stagnation of growth as well as the productivity potentials which is the main engine of growth in standard of living. Claims of egalitarian pursuit of redistribution, material and income equality, under which trade unions in Slovenia delegate the course of living order, can only be met under governments with totalitarian powers. Extensive unionism and its influence on structural and economic policy is perhaps the most powerful evidence that Slovenia is de facto the most socialist country in Europe.

5. At last, Slovenia's economic policy in the past 15 years is the most notable proof about the negative impacts of gradualism entailed into the course of public policy. Slovenia kept persistently the highest inflation among advanced countries in Eastern Europe. When the left-wing government took over the chairmanship in government, wages in public sector trimmed up enormously by 40 percent, creating an additional source of inflation pressures. The deadweight loss from economic depression was vast. Meanwhile, Slovenia's international competitors grew rapidly and thus a development was geared-up. In addition, the policy of early retirement enabled the formal retirement before the age of 50. In just one year, between 1992 and 1993, the number of retirees rolled-up by more than 100 percent.

Over the years, Slovenia's pension system, in terms of outlays, has been financed through budget and the first pillar of retirement insurance is estimated to be depleted in the medium run consequently because of the abovementioned reasons including early and beneficial retirement, high pensions and sky-rocketing continual spirals of wage increases in the public sector, adding a burden to high government spending.

6. In 1950, in terms of current prices, Slovenia's real GDP per capita was higher than Austria's which suffered war losses. From 1960 onwards, Austria's prosperity increased tremendously after Austrian early reformist government and its minister of finance Reinhard Kamitz adopted low taxes, imposed deregulation and liberalized trade and prices, while Slovenia's GDP growth started to trick towards relative stagnation. When Austria's technological development accelerated productivity growth, its standard of living grew tremendously, at the fastest pace in Western Europe.

When Austria enjoyed the fruits of market economy and remarkable output growth rate, Slovenian economy was mischiefed by socialist self-management which demolished the efficiency of entrepreneurial investment by wrongful decisions embraced by politicians, political entrepreneurs, workers and union leaders, who knew neither risk nor ambitious agenda, as there was no private means of production under socialism.

Finally, when Slovenia gained independence from communism, Austria's economy advanced the output growth while "the wealthiest ex-communist country" slid into depression while its central bank tacitly led the policy of high inflation through deteriorating exchange rate. Thus, the hourly output per average Austrian worker is higher relative to the output of Slovenia's worker per hour, because of higher productivity, greater innovative and entrepreurial capacity, and succinctly utilized gains from hours spent in the market.

7. Tomorrow, the streets in Ljubljana will shout and scream again, reflecting the misery of sub-Alpine socialism, which has always known nothing else but envy, misery, lies and deception. I will rather spend my time studying and reading Friedrich August von Hayek's The Constitution of Liberty, Greg Mankiw's Principles of Economics, Imre Lakatos's Proofs and Refutations, Karl Popper's Logic of the Scientific Discovery, James Buchanan's Demand and Supply for Public Goods, Kenneth J. Arrow's Social Choice and Individual Values and Wilhelm Roepke's Economics of Free Society.

Rok SPRUK is an economist

Copyright 2007 by Rok SPRUK

THE EFFICIENCY OF PRIVATE ENTERPRISE VERSUS GOVERNMENT FAILURE

"Everything the government does, private enterprise can do for half the cost."

-- Milton Friedman



Just a few days ago, Dallas Fed posted previously unreleased conversation with Milton Friedman. It can be found here.

Here is an opinion of the Nobel-winning economist about several issues:

On the impact of globalization:
“…it's a curious situation. You read the newspapers and you think the world is going to hell. You think the economy is doing badly. And yet, the truth is, that we have never in our history had as productive an economy as we do now.”

On China:
“You cannot maintain, in my opinion, today's political structure and today's economic structure.”

On Government Spending:
“…as government has increased spending, we make ourselves a less attractive society in which to set up business, in which to run a business.”

On Social Security:
“My favorite solution…would be to give every individual who's in a Social Security system now—either as a recipient or as a payer—a bond equal to the present value of what they so far have actually earned and then close the system down.”

FLAT TAX EXPANDS INTO GEORGIA

Alvin Rabushka of the Hoover Institution briefly outlines the adoption of the flat tax in Georgia as well as the implications of the tax reform on growth and revenue. Here is some remarkable data: by January 2005 Georgia adopted 12 percent flat tax, replacing previously imposed four-bracket system. The tax reform lower the rate of taxation on productive behavior which, in turn, had dramatic effects on economic growth, averaging 10 percent in the past three years. Tax revenue increased from 14.5 percent of gross domestic product in 2003 to 22 percent in 2006, and should reach 24 percent in 2007.

CONGRATULATIONS, DR. GARY BECKER

Nobel winning economist and a professor of economics at the University of Chicago, dr. Gary Becker (here, here and here) has won the Medal of Freedom. After Milton Friedman and Friedrich August von Hayek, Gary Becker is the next influential economist who received this prize of intellectual and professional greatness in economic science. Here is a speech by president Bush, honoring the academic pursuit of dr. Gary Becker:

"Our first honoree, Dr. Gary Becker, once said, "Many intellectuals, many economists, use obscure language when they write. Sometimes it's a way of disguising that they are not saying a heck of a lot." This economist, however, is different. Gary Becker's many books and articles, and his 19 years as a weekly columnist, have provided -- proved him to be a thinker of originality and clarity.

Dr. Becker has shown that economic principles do not just exist in theory. Instead they help to explain human behavior in fields well beyond economics. He has shown that by applying these principles to public policy, we can make great strides in promoting enterprise and public safety, protecting the environment, improving public schools, and strengthening the family. Dr. Becker has explained, as well, the real value of investing in human capital -- he knows full well that an educated and well-trained workforce adds to the vigors of our economy, and helps raise the standard of living for all of us.

"This longtime professor at the University of Chicago has helped train hundreds of talented economists. He has been a wise and challenging presence in the lives of his students, and they remain devoted to him. One close friend said, "A 15-minute conversation with Gary Becker can change your thinking forever." He is without question one of the most influential economists of the last hundred years. With today's honor, he is one of only two persons to have received both the Nobel Prize in Economics and the Medal of Freedom. The other was the late Milton Friedman. And I know that today Dr. Friedman would be very proud of his friend, and student, and colleague, Dr. Gary Becker. Congratulations." (link)

Our web log, Capitalism & Freedom congratulates dr. Becker for the Medal of Freedom which professor received.

THE PARADOX OF FARM SUBSIDIES: EUROPEAN UNION SHOULD ABOLISH FARM SUBSIDIES

The Economist shows graphically that farm subsidies are decreasing. Between 2004 and 2006, the average OECD expenditure on farm subsidies was $280 billion in annual terms. This means 29 percent of all farm receipts. Norway, Iceland and Switzerland are the most generous subsidy-givers. Subsidies in these countries present 66 percent of farmer's receipts. Back in 1984, New Zealand ended discriminatory farm subsidies (here). The profitability and productivity of farm sector increased rapidly without subsidy handouts (here).

European Union continually retains high quotas tariff rates on imports from third-world countries. In addition, farm subsidies further harm the economic performance in third-world countries. Currently, these countries mostly have a competitive advantage in farm products export and agricultural production, so it is not hard to figure out that high level of agricultural protectionism in Western Europe discourages the export performance in countries with low level of GDP per capita, as producers and exporters have to pay "higher-than-otherwise" price on the exchange of products which they produce.

REGIONAL OUTPUT GROWTH IN CHINA

Dozens of popular opinions have claimed that the size of government and state-owned enterprises does not actually and potentially affect growth performance.

In real terms, the empirical argument in favor of privatization is a simple theoretical and practical fact that the allocation of resources in private ownership is done more effectively than under public ownership. Privatization, in fact, significantly stimulates growth and is a primary tool to reduce external distortions on capital markets and overall economic performance.

When government borrows more, it reduces the amount of capital the investors could borrow, thus raising the level of interest rate. This is a typical situation that describe how resources are scarce and become even scarcier when government funds the budget deficit by borrowing.

In China public ownership is widespread subject to China's economic system. Kerk Phillips and Kunrong Shen's research on the effect of public ownership on regional economic growth in China concludes the following:

"We find that controlling for a variety of other factors, the greater the importance of state owned enterprises, as measured by the proportion of total industrial production they produce, the lower the provincial growth rate. The average estimate is that a decrease in the SOE share of industrial production by ten percentage points increases real GDP growth the following year by 1.14%"

Source: Kerk Phillips, Kunrong Shen: What Effect Does the Size of State-Owned Enterprises Have on Regional Growth in China, Burghham Young University Economics Working Paper, April 2003 (link)

WORLD ECONOMIC FORUM: THE GLOBAL COMPETITIVENESS REPORT 2007-2008

The World Economic Forum released the global ranking of economic competitiveness. The essence of the report is to highlight the areas of competitiveness in each country in a global perspective.

The key fields reflecting the competitive advantage and strenghts of particular economy are divided into three groups which are enhanced into several sub-groups. The pillars in which competitive advantage can be achieved globally are (1) the quality of institutions, (2) the strength of infrastructure, (3) macroeconomic stability, (4) health and primary education, (5) higher education and training, (6) good market efficiency, (7) labor market efficiency, (8) financial market sophistication, (9) technological readiness, (10) market size, (11) business sophistication and (12) innovation.

Thus, the economy can be classified as driven by factors, efficiency and innovation. The gap between each phase is defined as a transition process. The question what makes country competitive is hard to be answered, depending on the input quality of economic policy and company performance, strategies and operations.

Whether the aim of economic policy to boost sustainable growth and the aim of legislature to provide first-class business environment to assure solid conditions for a globally competitive economy, the realm of competitiveness is easier to achieve.

In microeconomic terms, the performance and ability of firms to go for growth and global markets is essential as well as the value-added agenda, sophistication and innovation. Traditional economic environment in which rigidity and cost-reducing strategies dominate has been replaced by fluid strategies, risk and innovation. Less stability is not tragic and damaging.

In fact, firm's growth in a global environment is the purest reflection of instability and a disequilibria. Every day, new firms grow, old ones quit and shut down. The sophistication of the market broadly outlines the stage development of a particular economy, especially in the area of supply-chain sophistication.

Using the powerful inputs and combining the productive set of measures, leadership and strategy is what makes firms globally competitive. Nevertheless, the role of financial markets and the availibility and access to venture capital, equity and investment funds, should not be neglected.

Venture capital is the primary source of a growing firm, and the majority of start-ups are funded through venture capital. The degree of microeconomic competitiveness also depends on the ability of the firm to use its comparative advantages to the fullest in productive purposes.

Innovation is the result of entrepreneurial spirit and behavior to become a global leader in pursuing quality through cutting-edge products and services. It also outlines the degree of competitive mentality in particular country.In this respect, IT plays a tremendous role, taking the edge of comparative advantage in the age of future expectations.

The availibility of skilled and trained labor force is sometimes an essential determinant of the presenece of the firm in the market. Flexibility and deregulation, by empirical means, reduce the scope of risk which firm faces in the market penetration. Regulated and rigid labor market does anything else, but contributes to the overall rigidity and growing non-salary labor costs, reducing the ability of the firm to maximize the productivity and adjust to fluctuations.

In fact, the productivity determines the living standard, not the collective bargaining. The United States has one of the highest living standards due to relentless increases in productivity in past decades; in output per capita and working hours as well. On the other side, Europeans prefer holiday over work. Harvard economist Alberto Alesina and Francesco Giavazzi have written a powerful brief on this topic, The Future of Europe: Reform or Decline.

In macroeconomic terms, stability is ought not to be neglected. Responsible macroeconomic policy, prudent anti-inflationary monetary policy and predictive fiscal policy namely describe the three components of macroeconomic competitive advantage. The outcome is, of course, sustainable growth and dynamic responses to the economic fluctuations without government intervention and similar discretionary distortions.

To be a good economist, you have to keep an eye on three macroeconomic areas: inflation, growth and unemployment. While the inflation pressures have been nominally anchored in many countries (Canada, Sweden, UK) by the exercise of inflation targeting strategy, growth perspective dominate the question of future state and vitality of the economy. Even small, minute differences in annual or periodic growth rates, means the loss of competitive advantage in advance.

Of course, it'd be foolish to predict an unparalleled growth performance with high growth rates through and through. High and possibly robust growth rates have been observed in transition economies and also confirmed empirically. When the catch-up period is ended and GDP convergence process accomplished, the growth rate performs one of the most fundamental laws in economics - the law of diminishing return.

Estonia and Slovakia grow faster than Germany because of the ability to operate at a full capacity and the competitive advantages, and Germany grew faster than the United States when it was growing under catch-up conditions. Over time, when the real GDP per capita is higher, the growth normally slows.

In this year's report, the United States tops the overall competitiveness ranked chased by Switzerland, Denmark and Sweden. The report is availible here. Scandinavian countries performed very well. Despite an uncompetitive tax structure, the business environment deserved an A+, with deregulated product markets and high level of market liberalization, freedom to trade internationally and deregulated business environment in general.

My native country Slovenia performed poorly. It is ranked as the 39th most competitive economy in the world, performing poorly in the areas such as taxes, regulation, labor market flexibility, the structure of the workforce, working ethic, infrastructure supply and access to financing. Macroeconomic stability in Slovenia is risky as government fiscal spending has been reaching historic highs.

When center-left government seized power back in early 90s, wages in public administration and government sector have been increasing tremendously. in the first year, the wage rate increased by 40 percent and has been growing increasingly ever since in addition to widespread government ownership of large corporation, dominating the entire market through politically-managed mergers and acquisitions. Also, the center-right government has not done any better job. The fiscal expenditure grew at a brisk rate, enormously high spending remains anchored in budget deficit and general indebtedness and generous welfare system have set a high debt levied on future generations. Business rules and legislation are hostile to foreign direct investment and the regulation is rampant in this respect.

Thus, Slovenia has one of the lowest per capita shares of foreign investment in Europe and globally. Labor market, as abovementioned, is one of the most rigid in the world, including staunch hiring and firing practice and the non-salary cost pressure through which generous system of welfare, pension and social security is funded. More hours in the labor market are taxed progressively and labor relations are the most socialistic ones in Europe. I'm saying this also from personal experience, not just from the analytical, data point of view. Therefore, it is not surprising why Slovenia is one of the worst laggards in the EU.

The rankings are availible here and the country analysis can be reached here.

Rok SPRUK is an economist.

Copyright 2007 by Rok SPRUK

MONTENEGRO'S ROAD TO FREE MARKET ECONOMY

The International Monetary Fund recently released the report on Montenegro's overall economic performance, emphasising basic fiscal and macroeconomic policy perspectives. In English the report is availible here while it can also be reached in Montenegrin (here).

Two years after gaining a formal independence from Serbia, Montenegro's economy operated at a full capacity, having seen robust output growth rates estimated to exceed 7 percent by the end of 2007. The growth, mainly driven by a significant amount of foreign direct investment, seems to remain robust in the medium-run despite particular tensions referring to the signs of overheating. Nearly 85 percent of capital value of companies was privatized. Banking sector, telecommunications, oil distribution and import services are 100 percent privately owned. Foreign direct investment is reaching record highs. In 2006, according to Montenegro's central bank, foreign direct investment reached $680 million USD, six times higher than in 2004. In the first half of 2007, foreign direct investment increased by 78 percent, while from January to July 2007, the amount of FDI was $650 million. Thus, Montenegro has one of the highest FDI per capita, $ 1,100 USD, one of the highest shares in Europe.

Montenegro's business environment is weak by international ranking, despite of significant improvement in since the independence year. Montenegro ranks 81st in the world according to the ease of doing business. The failure of public administration to provide the operating business environment at sound quality, long licensing procedures, severe difficulties faced when registering a property, bureaucratized trading environment, and a high level of difficulty in enforcing commercial contracts, reflect the disadvantages of Montenegro's business environment (link).

Affected by international financial turbulence, Montenegro's asset prices soared in the last two years, leading to a remarkably rapid growth of credit which further fueled the investment into real estate industry. However, rapid credit growth posed signs of an overheating economy which has been a particular backlash of Montenegro's domestic economic environment.

On the other side, Montenegro's growth is not drifted by inflationary pressures. Subject to concentrated market structure, retail inflation peaked slightly ahead of central bank's expectations, particularly in the electricity sector which has not yet been demonopolized by the infusion of competitive mechanisms and price liberalization. Electricity shortages occured despite tariff increases.

The economic reforms, such as the privatization of state-owned assets and the openness to foreign trade and investment, contributed to stable macroeconomic position. The budget remained anchored in surplus. Public debt does not currently evince any sign of quick consumption-inflated indebtedness. Total public debt peaked at 38 percent of the GDP while loans denominated into foreign currency presented 27 percent of the GDP by the end of 2006. As a matter of fact, overall public debt was reduced from 88,3 percent of the GDP where it stood in 2002 (link). Foreign indebtedness is expected to decrease in the years to come due to large amount of inflows from the investors' buy-outs of state-owned assets and enterprises.

As a transition economy, Montenegro has experienced typical short-term and medium-term problems due to the rapid convergence of GDP and robust economic growth as well. Transition process, by itself, poses a lot of risk and challenges, ensuring economy's vitality and growth sustainability. First, in Montenegro, real estate and equity prices skyrocketed due to signficant demand-induced pressures and country's valuable tourism potential, which folded residential and coastal property prices upward.

Second, according to IMF, credit growth accelerated at 170 percent by August 2007, pushing the the household indebtedness to record highs. Credit growth has surpasses the amount of inflows from foreign direct investment which Montenegro has received in this year. However, deteriorating current account deficit is not alarming, neither a sign of recession or downturn, whether it applied to established economy or an economy in transition. In case of Montenegro, widening current account is a result of accountable investment imports and capital inflows whose contribution to overall output growth is significant. In relation to credit growth, it is the question whether banking industry is strained by the lack of ability to assess loans in real estate.

Third, external demand-supported pressure on wages poses a significant threat to overall competitiveness of Montenegro's booming economy. If productivity expectations are high, the spiral of wage-increases claims could have been eased by the fact of productivity outcome. But if the productivity expectations are low, the wage-increasing claims could have bursted the triggering of inflation-pressing spiral. In case of Montenegro, public sector has claimed wage increases several times. It is the question whether the sector whose contribution to growth is relatively low relative to the components of the private sector, could claim wage increases on a legitimate basis subject to distortionary effects of wage-increasing claims under conditions of low and possibly rachitic productivity performance. The rigidity of wage claims is mainly derived by the lack of labor market reforms, whereas outdated labor legislation returns uncompetitive effect respectively.

Montenegro's abundant potential of a flourishing tourist industry propelled by market optimism and Stabilization and Association Agreement with the EU, provides sound opportunities to address the abovementioned concerns. Years ago, Montenegro adopted euro as a common currency, thus eliminating the possibility of currency and exchange risk. Monetary policy's ability to tackle demand pressures is thus partly limited and that's why a prudent fiscal stance is needed in lines with transparency and restrictive expenditure agenda.

In a booming economy, such as Montenegro, fiscal policy is a powerful tool in managing the fluctuations and brisk economic progress. In the state of robust output growth rates and soaring private sector productivity, fiscal policy is ought to be countercyclical to prevent the possiblity of overheating where the expansionary fiscal policy could turn a non-inflationary economic performance into inflationary economic growth generated by fiscal expenditures on infrastructure and public or/and foreign indebtedness, while seeing the overheating of economy's overall capacity. Fiscal balance or possible surplus is favorable to the business cycle for two particular reasons: (1) it faces adverse shock with low risk and (2) it gives support when revenue growth cools the impact on public finance. Also, significant import growth, reflecting the current account deficit, presented 4-5 percent share of imports in the GDP.

The role of fiscal policy is ought not to be undermined. As a powerful tool in responding to cyclical fluctuations during a "catch-up effect" period, fiscal stability and low government spending are usually based on surplus mechanisms. By avoiding budget deficit, policy responses may prevent the demand shocks and low level of public spending is a sign of maturity that helps to detach the anticipation of inflationary pressures and its impact on macroeconomic stability.

Tax cuts implemented in previous years may be seen as a policy failure in generating greater revenue. As the Laffer curve succinctly explains, it is able to reach higher tax revenue from a broader tax base, by reducing the rates on corporate and individual income. Since the implementation of low flat taxation on major sources of productive behavior, revenues have increased rapidly. Currently, public spending stands at 45 percent of the GDP (link), and the share of capital investment is 3 percent in this respect.

As a negative aspect of fiscal and structural policy, Montenegro's policymakers approved a significant 30 percent wage increase in the public sector, which is far ahead of current productivity and output growth measures. Such expansionary effects should be wisely avoided to prevent the loss of incentives to boost the economic performance when the growth performance slows. Robert Barro, a professor of economics at Harvard University, has shown empirically that reducing the size of public sector by 10 percent, stimulates growth by 1,3-1,8 percent. As a sign of innovative policy, public sector employment and expansion might be frozen and possibly reduced to prevent further unanticipated shocks such as wage-increasing claims.

In recent years, Montenegro's economic policymakers implemented a rigorous tax reform. Flat tax was implemented on personal and corporate income and it is expected to be dropped slightly in the years to come. Tax cuts were imposed procyclically. However, complex taxation structure such as numerous exemptions, loopholes, breaks and deductions have counter-effects as they raise the cost of paying taxes, notified as a difficult tax compliance and administrative burden which costs firms and taxpayers millions. The aim of tax reform and system is to pursue the efficiency and minimal tax burden levied on firms and individual taxpayers. High tax burden, empirically and practically, constrains growth and does not meed the indicated measure of efficiency. Fiscal reform, such as braking-up the size of government spending, is expected to pursue the objectives of fiscal consolidation which contains easing pressures to anticipated as well as unanticipated external or domestic shocks. The goal of prudent fiscal sustainability in the medium-term is to meet the demands of macroeconomic and structural stability. In the medium run, demands to invest rapidly in infrastructure may be tackled. However, it would be wise to avoid infrastructure investment through the expansion of state-owned enterprises. By the means of risk-taking and efficiency of capital and technology investment, infrastructural investment is easily attainable through private sector. In case if externalities and signs of market failure appear, then public infrastructural investment may be justified, also to prevent the emergence of public or natural monopolies where one firm, in public or private ownership, could substantially abuse its market power, such as in case of railway and highway infrastructure.

In monetary area, Montenegro has stabilized low inflation rate and the monetary policy remains anti-inflationary (link). In 2006, inflation rate peaked at 2,5 percent. In the first half of 2007, inflation rate was 1,1 percent (link). S&P has given Montenegro BB+ credit rating. The abovementioned rapid growth of credit has tightened banks to raise capital adequacy ratios. This could hamper the ability of banks as well as equity funds in responding to the demand claims of investors in real estate and stock market industry (link)

At last, structural reforms demand both; challenge and perspectives. One of the greatest potential of structural reforms is to boost economy's potentials. According to the data, the government and state, still own shares in 65 companies. In 53,8 percent of those companies, government has more than 50 percent ownership share. The argument for an accelerated privatization is the fact that the allocation of labor, capital and technology resources is better utilized as well as distributed in the channel of productive use. In fact, as an owner, government has severely different interest than private investors. In addition, the data shows, that privatized companies sustain higher level of productivity than state-owned companies.

The area in which radical reforms should not be postponed, is the labor market. The aim of the labor law is to pursue flexible and dynamic environment, allowing firms to dismiss non-performing employees without high severance costs. As every economist can confirm, collective contracts and bargaining such as oligarhic bundling between monopoly structures such as federation of employers and trade unions, does not match the needs of modern market economy. Instead, flexibility and deregulated labor market are essential to maximize productivity growth and eliminate discretionary wage-increasing pressures and also fight unemployment. In this respect, Montenegro's business environment is free of unnecessary regulation which boosts the potential of private sector growth. In the long run, fiscal risks are inevitable and Montenegro's abundant potentials may be implemented not by government intervention but by low public spending and first-class investment environment that underpins the role of private sector, free of corruption, in the economic performance respectively.

Rok SPRUK is an economist.

Copyright 2007 by Rok SPRUK

DEMOCRACY IN SLOVENIA - A GRAVEYARD SLUT

by Rado PEZDIR

In the fall filled with two national referendas regarding whether Triglav, Slovenia's largest government-owned insurance company should be privatized, and the epilogue of collective bargaining between trade unions and the federation of employers which reminds us on the last sequel of South-American soap-opera, someone could think that Slovenia is a climax of world democracy. It could be thought that this idyllic sub-Alpine landscape is a paradise dreamed by the premise of enlightenment thinkers; a paradise where the wisdom of the citizens tactically paves the road on which society's development takes its own walk. Unfortunately, the reality is completely different and it can be admitted that all sparks of hope for democratization of post-communist society are nothing else but a nostalgic stupidity. In Slovenia, for a long time, the individual does not vote for anything in the elections.

ELECTORAL JUNK

Let's have a look on presidential elections. I think that everyone who wants to explain why we need this junk will face big troubles. Why?

First, in Slovenia, the president has no authorized means of decision-making which would justify the existence of this particular instance. Of course, I assume that institutions are created to have legitimate authorization and not vice-versa.

Second, Slovenia's chaotic institution requires the intersection of legitimacies of democratic institutions, and consequently, there is an inherent probability of institutional conflicts. Mostly because Slovenian policymakers do not actually know which particular legitimacies are ought to be authorized to justify the existence of the institute of the president.

What this means in practical terms, is clearly demonstrated by the latest selection of future governor of the Bank of Slovenia; a situation in which prime minister and the president had an electoral mandate to appoint the governor. At the end, the technical dilemma turned out into an insensible political battle.

Third, some claim that the presidential function is necessary due to its role in representing Slovenia abroad in a remarkable flash. The truth is that the presidential function distorts the other branch of government, the Ministry of Finance, and thus it creates a splash of institutional conflicts. Just think of president Drnovsek's inspirations to solve the Darfur crisis. Was it necessary? At last, if Slovenians want a representative abroad, then gather some money, hire the little boy who knows how to recite the sonnets of William Shakespeare in thirty languages, lock him into the cage, and show him into the international arena. There is no need to waste taxpayers' money.

And at last, a large majority of Slovenians is evinced that the presidential function is necessary because of the need to have a discretionary moral authority such as Plato, Indian gurus, Vatican's cardinal or anti-globalist Joschka Fischer, to morally regulate our lives. Are they serious? Do they suggest voting the highest moral highlight? Excuse me, but this particular construct is a replica of a theocratic state where Ayatollahs are elected and then they submit their opinion on immoral youth and inadequacy of loud music. To exculpate the existence of particular institution with the assistance of an absolute morality is, in a normal democratic state, nothing else but an unrestrained absurdity. In effect, the presidential function is unnecessary and that's why, let's avoid further institutional crash of the splash. My colleague Mićo Mrkaić has thoroughly abstracted the irrelevance of presidential elections in Slovenia: ignorant people need an idol to command from emperor's rooms, the way it was conducted by Kaiser Franz, Maria Theresa, and Josip Broz.

NON-ELECTIONS

The second redundancy is the elections in the State Council this fall. State Council is the remaining creature of fascistic corporate system. Let's summarize how these elections go through. At the end of the mandate, interest groups get together and select a dedicated person who is then authorized to delegate our lives from Ljubljana. Then, the illuminant is sitting in the chamber of State Council by making decisions regarding our everyday lives; without being authorized to do so. How democratically. Suppose that a group of voters proposes a law bill to the parliament and democratically elected parliament passes the bill by a slight margin of votes. In a normal country, this would mean the end of the process, but in Slovenia, the story is going forward. If any of numerous interest groups with representatives in the State Council is not likely to embrace the law bill, it can use the veto and stop the entire process. And then, we're the one who should deal with elections and democratic institutions. The madness such as the undemocratically established body has shown its worth in the initiative of the State Council, suggesting the referendum whether Triglav, the largest asset-holding insurance company in Slovenia, should be privatized or not. Funny; the answer tp the technical question ought to be solved by democratically elected government is proposed by the unelected instance. We already decided to transmit the mandate to solve such a situation to the government, haven't we? I personally think that the State Council exists because a fraction of voters cannot embrace the fact that they're responsible for their lives on their own, while a share of voters would like to regulate the lives of other citizens through the power exercised by the interest groups represented in the fascist-styled State Council.

INTEREST GROUPS CONTROL THE ENTIRE COUNTRY

The fact that interest groups have their own debate luncheons at the expense of taxpayers' money and do whatever they want at any time, is simply a blockade of decisions approved by democratically elected institutions. And even more: it is a blockade that disables the functioning of a democratic system. An ability that interest groups without the approval of taxpayers, are dealing about the way of living that citizens will simply have to embrace and live with it, is coming from the constitutionally approved status of the State Council and collective bargaining. A procedure, in which workers' monthly salary is not determined by his output and productivity, but by the bargaining decisions approved by trade unions; the latter call social justice. As a side-effect, entrepreneurs must give up a fraction of profit due to decisions passed by non-elected institutions, namely trade unions. You're not wrong if you think that such process is a restitution of the situation once common in the Soviet Union. In Soviet Union, wages and salaries had no feedback measures to the output and labor productivity, but instead, salaries were determined collectively subject to central planning. As a matter of fact, what you produce in Slovenia has no effect on your monthly earning but the productivity of labor supply is restricted by the means of collective decisions of trade unions. In addition, there is always no study on how artificially determined salaries affect the economic performance of Slovenian economy. Instead, trade union leaders propagate the ideas that entrepreneurs should give up their own profit. By its means of collective power, trade unions aggressively aim to regulate and flip into the private property of entrepreneurs. It is interesting why trade unions do not invest in particular companies and then give up their profit for the benefit of the labor force. Whether you are asking, when you authorized trade unions to allocate your resources and boost income redistribution, your questioning has no effect since State Council and trade unions collectively make decisions about your lives without a check-up of their proposals in the general elections.

A DEMOCRACY OF WAR MASSACRES

In addition, there are two non-elected representatives in Slovenian parliament approved on the basis of their nationality. What a democracy - a democracy on the basis of Slovenian shame, such as the genocide of Italian, German and Jewish community. Thus, Slovenians have collectively admitted not to aggravate if they have bloody conscience about their own past. Instead, for them it is admirable to have a handicapped democracy which places two non-elected representatives of minorities in the national parliament. If you perceive that as a hang of overdoing, think about suspicious role of those two representatives several times respectively. And if everyone is treated equally, where are the Roma, Serbian and German representatives? Shall we rather dissolve the entire parliament and put in suitable representatives? In case if anyone doesn't know - parliament is a democratic institution whose members are elected on the basis of individual preferences and not on the basis of individual ethical origin. To protect the human rights, there is a judicial system that defends individuals against violations of human rights of all the citizens, including ethnic minorities. It is simply not a seat in the parliament which protects the rights of the minorities.

So if you attend the elections, the impact of your vote will be the same as in the period of socialism - none. That is because of institutional chaos based on Slovenia's constitution. From this point of view, presidential elections are nothing else but a typical junk and wasting of taxpayer's money. In sum, democracy in Slovenia is like a a graveyard slut (also a song sung by Norwegian black-metal band Darkthrone) - it can be bought cheaply by anyone whereas no one cares whether it works or not.

Rado PEZDIR is an economist.

© Copyright 2007 by Rado Pezdir

*An article was translated in English by Rok SPRUK, an economist and the owner of the web log Capitalism & Freedom