Thursday, November 29, 2007


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)


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).

Monday, November 26, 2007


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).


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).


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

"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.


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).


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.

Sunday, November 25, 2007


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


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)

Thursday, November 22, 2007


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)

Friday, November 16, 2007


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.

Thursday, November 15, 2007


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

Wednesday, November 14, 2007


"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.”

Monday, November 12, 2007


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.

Wednesday, November 07, 2007


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 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.


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)

Thursday, November 01, 2007


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