Saturday, December 22, 2007

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 lib√©ralisme 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)

Thursday, December 20, 2007

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

Tuesday, December 18, 2007

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)

Friday, December 14, 2007

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)

Wednesday, December 12, 2007

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)

Monday, December 10, 2007

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

Sunday, December 09, 2007

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)

Wednesday, December 05, 2007

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)

Monday, December 03, 2007

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).

Saturday, December 01, 2007

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.