Thursday, October 11, 2007


Here is a cut from Greg Mankiw's Principles of Economics (chapter 8):

"In Sweden in the early 1980s, for instance, the typical worker faced a marginal tax rate of about 80 percent. Such a high tax rate provides a substantial disincentive to work. Studies have suggested that Sweden would indeed have raised more tax revenue if it had lowered its tax rates."

Source: Greg Mankiw, Principles of Economics, ch.8: Laffer Curve and Supply-Side Economics, South-Western College Pub; 4th edition (February 15, 2006) (here and here)

The American published a brief article about Sweden's slow-motioning progress in the implementation of structural and economic reforms. Among the signs of genuine reform vitality, there has been a large amount of measures aim to boost the competitiveness and labor supply incentives. Unemployment and welfare benefits were cut, property taxes were abolished, wealth tax - an uninterrupted symbol of the Sweden's socialist past - was also slashed. What about market reaction? It may take a longer period for the market to respond to such incentives. But the fact that the response dynamics is slow, should not be the basis of denying any kind of policy reform. Perhaps I'm going a little bit more normative in this respect, but in economics, experience is a huge lesson. In fact, the fact that markets respond to incentives is #4 principle of economics (link)

The question regarding Sweden's recent outlook as well as broader perspective of economic and structural policy is whether shock therapies are consistent in the long-run.

The answer is, of course, interpretative and each economic school or doctrine may endorse the answer in several different ways. The answer depends on the role and credibility of fiscal policy in response to macroeconomic shocks. Among economists, there has been a widely accepted belief that countercyclical fiscal policies have stabilizing effects on the economic performance. But, the question is whether discretionary actions assume the expectation of policy and market. In fact, analyzing the broad picture on the basis of intertemporal margins is much more efficient, since the employment change and income dynamics reflect the pure effect of fiscal policy against the cyclical trend. A very detailed study on this particular subject was written by David B. Gordon and Eric M. Leeper (link) as their findings comprehend the counter-cyclical effect of fiscal policies:

"This paper highlights these expectations effects. Connecting the theory to U.S. data we find: (1) through this expectations channel, countercyclical policies may create a business cycle when there would be no cycle in the absence of countercyclical policies; (2) nontrivial fractions of variation in investment and velocity can be explained by variation in macro policies alone - without any nonpolicy sources of fluctuation; and (3) persistence in key macro variables can arise solely from expectations of policy."

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