Thursday, December 18, 2008


Belarus is another Eastern European economy joining the flat tax club. The Ministry of Finance has proposed the shift from progressive tax system (with 35 percent top tax rate) to 12 percent flat tax rate. Recently, Financial Times discussed (link) the state of Belarussian economy, focusing essentially on liberalization prospects, tax reform and regulatory reform. According to WB's Doing Business, Belarus's business climate is more favorable after liberalization efforts were endorsed (link).


The Economist (link) has nicely discussed Russia's medium term macroeconomic outlook, focusing on energy prices, rubel's depreciation, inflation outlook and growth performance.

Wednesday, December 03, 2008


As a candidate country, Slovenia has been under a detailed observation by the OECD, particulary in areas regarding macroeconomic outlook such as the stability of public finance, fiscal prudence and growth prospects in the short, medium and the long run. Recently, OECD published a preliminary edition of Slovenia's economic outlook in 2009 (link). As expected by estimates and short-term projections, output growth in 2009 will narrowly decline from this year's 4,8 percent to 2,1 percent. A detailed decomposition of growth contributions can be seen here.

Aside from curious structural analysis of the Slovene economy, this year has been accompanied by a turn in the election with center-left government being in charge of forming new coalition. Expectedly, the set of economic policies by the Ministry of Finance is fashioned in the light of this year's financial crisis and a lot of media attention has been devoted to the recovery from the financial crisis.

This year's financial crisis has affected the Slovene stock market. The annual return from SBITOP, Slovene blue-chip index, is -63,12 percent. The rate of return from SBI20, Slovene main stock market, hit -64,36 percent. The collapse of Lehman Brothers where the banking sector has put portfolio investment and mostly the stock market slump in the U.S, Asia and Europe has affected the Slovene economy respectively. Nonetheless, rachitic and inherent problems of the Slovene stock market are not a result of an integration with world capital markets but a harsh consequence of the prevailing insider trading and relative underdeveloped of Slovenia's capital market. The political opposition to the privatization of NKBM, Slovenia's second largest bank, resulted in a rapid decline in the rate of return of NKBM. From January to December, the share of NBKM yielded -73,48 percent respectively. While the correlation between annual yield trends for each enlisted share is very high for the entire SBI20 and SBITOP, the main structural weakness of the Slovene stock market is that stock prices have been heavily overrated as measured by the P/E ratio (link), reflecting the asymmetry of insider information with respect to the evaluation of share prices.

Macroeconomic outlook in 2009 is less favorable due to external shocks that would curb output activity and consequently restrain investment as well. The slowing of investment activity in construction sector, which contributed 1,7 percentage points to output growth in 2007, may curb output growth from medium-term trend line. While decreasing commodity prices boosted deflationary pressures in Q3, inflationary outlook, given ECB's accomodative monetary policy, will crucially depend on the nature of fiscal policy. A decrease in government spending or at least a neutral stance of fiscal policy is essential to the containment of inflationary pressures. Nonetheless, it is crucial to neutralize wage pressures that could boost the inflationary pressures and hinder macroeconomic stability.

Friday, November 21, 2008


The Economist designed an interactive mapping with data, factsheet and forecast for 80 countries in the world (link).


The newest study by the KPMG surveyed tax rates on individual income around the world (link). The study finds that average top rate on individual income is less than 29 percent. In Slovenia, it is 41 percent (link).


I will come back with more comments regarding government bailout of Detroit's "Big Three" auto industry. Gary Becker (link), Dan Mitchell (link), Matthew J. Slaughter (link), The Economist (link) and Mitt Romney (link) provided an opinion regarding the bailout of the auto industry.


Amity Shlaes nicely outlined (link) the upcoming return of Keynesian economic policy initiated by efforts to boost consumer spending despite the empirical evidence about the lifetime path of consumption pattern. While president Obama has a very smart and knowledgeable team of economic advisers such as Jason Furman, David Cutler and Jeff Liebman, he opposed free-trade agreements with South Korea and Columbia, while he supported the proposal to raise tariffs on Chinese goods in case Chinese government would not allow yuan to appreciate relative to the U.S dollar. There is an overwhelming evidence that an increase in government spending negatively affects output, employment and productivity while proposals to extend health care benefits over the boundaries of tax scheme are a worrying threat to growth and stability of the U.S economy and the overall fiscal stance of the United States.


Fed chairman says (link) deflation might resurge as a worrying threat to the U.S economy.

Friday, November 14, 2008

Friday, November 07, 2008


Ed Glaeser of Harvard University provides a detailed insight on the importance of human capital for economic growth (link):

"Schools can also attract more talent with an environment that welcomes talented outsiders instead of erecting bureaucratic barriers that prevent their success. The literature on teacher certification finds few benefits from that hurdle. By contrast, Teach for America has achieved remarkable results by putting capable young people, often with little formal training as teachers, in classrooms. The experience illustrates that it isn't easy to assess teacher quality with standard teaching credentials. If attracting a wave of good people into teaching is the first step, the second step is keeping the best teachers and redirecting the rest. Performance in the classroom is the best way to know if a teacher is a success. Teacher promotion and tenure needs to be based on clear performance measures, including student test scores. Perhaps teachers unions could start endorsing the use of test scores to evaluate their members and determine tenure."

Thursday, October 30, 2008

Tuesday, October 28, 2008


Here (link) is Harvard's Department of Economics web, listing articles and opinion by Harvard economists on current financial crisis.

Top suggesstions: here, here and here.


FT reports that Fed is likely to endorse a further interest rate cut (link):

"The Federal Reserve will probably end up cutting interest rates by as much as 50 basis points by the end of its policy meeting on Wednesday, but it will do so without any great conviction.
Senior policymakers do not think that reducing the federal funds rate from its already low level of 1.5 per cent will have a big effect on financial markets or the US economy..."


Iceland's central bank lifted the key interest rate to 18 percent from 12 percent after Icelandic krona lost 70 percent during this crisis (link). Secondly, Iceland's GDP is expected to contract by up to 10 percent, unemployment is expected to reach 8 percent or higher while inflation rate could hit as much as 20 percent. In fact, IMF recently predicted the rise in the inflation rate to 11,2 percent. Here (link) is a brief outline of Iceland's state of the economy, analyzing the macroeconomic background of country's current crisis as well as rapid expansion in the latter decade.

Wednesday, October 22, 2008

Monday, October 20, 2008


The Economist has published an interesting insight into Iceland's recent economic crisis (link):

"Iceland has been growing smartly in recent years. The country has low unemployment and income per person is somewhat above the average in the European Union. Huge investments in green energy and aluminium smelting have drawn inflows of foreign investment and promise to underpin exports for years to come. But on these sound foundations, Iceland has also built a financial house of cards. The country’s three largest banks have expanded headlong abroad since two of them were privatised in 2003, amassing assets of about €125 billion ($180 billion) by the end of 2007, compared with an economy of just €14.5 billion. Many of these assets were funded by lenders in fickle wholesale markets. In early 2006 less than 30 cents in every loan issued was backed by deposits. Iceland’s households also racked up debts amounting to 213% of disposable income. Britons and Americans owed just 169% and 140% of disposable income respectively—figures that make them seem almost sober by comparison."


Icelandic government announced $6 bn rescue package to stabilize the economy (link) after an increase in government debt which is expected to reach as much as 100 percent of the GDP. Here is some interesting insights into financial crisis in Iceland (link). Meanwhile, Fitch downgraded Iceland's long-term foreign currency rating to BBB- and long term IDR (issuer default rating) to A- (link). Here is also a brief factsheet of Iceland's economic indicators in this year's September (link). IMF's official inflation and output estimate for Iceland suggest output decline and inflation surge in 2009 (link).


Here (link) is an interview with Anna J. Schwartz, the co-author of Monetary History of the United States 1867-1960 (link), highlighting the latest issues associated with Fed's policy measures, credit market shocks and economic fluctuations.

Wednesday, October 15, 2008


The Nobel laureate in economics in 2008 is Paul Krugman (here):

"IT WAS widely expected that Paul Krugman, who won the the 2008 Nobel prize for economics on Monday October 13th, would claim the award one day. In 1991 he had received the John Bates Clark medal for the best young economist, which is widely seen as a stepping stone to a Nobel award. What is more of a surprise is that he was honoured rather sooner in his life than many other winners. Like most Nobel laureates in economics, Mr Krugman was recognised for research undertaken early in his career—in this case for his pioneering work on modelling trade between countries whose firms grow more profitable the bigger they become. At 55, he is only four years older than the youngest ever winner, Kenneth Arrow, who was 51 when he won in 1972. But he is a fresh-faced youngster in comparison with Leonid Hurwicz, one of last year’s winners, who was 90 when he shared the prize."

Thursday, September 25, 2008


Professors' Gary S. Becker and Richard Posner articles on the economics of discrimination (here and here) gave me an interesting motivation to discuss some economic aspects of discrimination which is a popular question into the economic analysis.

The Framework of Labor Market

Discrimination is a relatively young and still fresh theme in economic analysis. It has been pioneered by professor Becker's The Economics of Discrimination (link). The analytical foundations of the economic analysis of discrimination can be found in the attempt to measure discrimination in the labor market and elsewhere by the empirical analysis. In a simple, two-variable model of labor market determined by wage and quantity of labor, there is not a unique equilibrium of demand and supply in the labor market. The demand for labor is downward sloping, reflecting the fact that lower wage (the price of labor) tends to induce the demand for labor. For example, if the wage for software engineer drops from 8 EUR per hour to 6,5 EUR per hour, then Google, for example, will certainly not feel reluctant to hire more skilled software engineers. It should be noted that the slope of labor demand curve is much flatter than demand curves in partial equlibrium models usually behave. The reason is that firms hire labor supply in order to maximize profits and firm's utility function. However, there is no simple marginal rate of substitution between labor and other means of production and that labor suppliers' knowledge, skills and profession determine the result of firm's production function. Also, there is not a unique picture of labor supply, since workers possess different preferences regarding the allocation of time between leisure and consumption. For example, productivity gains by Google engineers may induce them either to increase the amount of leisure time they consume or to allocate even more time to research and product development. In economics, to sketch a brief picture of labor market, we use regression analysis to depict labor demand and supply curve where the wage as an endogenous variable is determined by the inclination of demand curve and the quantity of labor as an exogenous variable. Since a decreasing wage rate induces the demand for labor, demand curve is, expectedly, downward sloping. On the other hand, labor supply is upward-sloping since employees are not reluctant to supply more free time when the rate of real wages is increasing. Even though labor market is a partial equilibrium model of employer-employee preferences, discrimination has often resulted in a two-sector labor market where skills and knowledge are traded in separate markets as shown by the picture.

How Discrimination is Motivated?

There are two types of discrimination in the labor market. First, employers discriminate when they hire labor supply with higher wage rate, even though other labor supplier are cheaper relative to their productivity than labor suppliers hired by the employer. In this case, discrimination is motivated by employer preference of future employees by race, religion, sex or other human charateristics. An employer who discriminates has a comparative disadvantage compared to employers who do not discriminate since first employer's profits are lower due to the fact that first employer's competitor scores better on productivity performance and profit while his relative market-clearing price of labor is lower. Employer discrimination can be enforced with strong cultural and institutional background. In former socialist economies, such as Slovenia, regulated and rigid labor market protected the premium of insiders while it, at the same time, increased entry and career barriers to future employees. Thus, with the lack of productivity convergence and high tax burden, employers in Slovenia are reluctant to hire high-skilled labor supply because of (1) high bargaining power of trade unions and because (2) age-determined income distribution favors older workers compared to younger workers even though older workers in infant industries do not posses high human capital skills as college graduates do. Consequently, human capital premium has been replaced by age premium. In job advertisment, employers often put experience ahead of knowledge and ideas, thus restricting job and career prospects to labor market entrants. On the other hand, employee discrimination occurs when employees, for example, refuse to work with minority workers, demanding real compensation. Regulated labor market structure is, most notably, a cause of employee discrimination since workers possessing more bargaining power tend to discriminate workers with weaker concentration of bargaining power, thus requesting higher premium enabled by the formal (trade union) or informal (intra-market nets) monopoly of existing labor supply. Nonetheless, the attempt to exterminate labor market discrimination by the exercising regulation results in information asymmetry, giving privilege to inside workers' privileges such as seniority and their bargaining power over the medium term (see: Lindbeck, Snower 2002).

Competitive Markets, Economic Freedom and Flexibility

For example, in the old American south, African Americans were often discriminated by local employers (link). Thus, the old South was put in a comparative disadvantage in comparison with Northern and Western states which faced higher productivity growth rates and profits. The situation led to a gap between northern-western and southern states; the latter having lower living standards because of the productivity lag as a partial result of labor market discrimination. The deregulation of labor market is essential to less discrimination since economic freedom such as freedom of trade, enterprise and labor, leads employers to relatively less beneficial discriminatory hiring preferences unless employers prefer lower profit. In Europe, where labor markets are more regulated than in countries such as the United States, Singapore, Denmark and Australia, regulated labor markets lead to lower productivity performance, except that age and experience-based discrimination substituted racial or sexual discrimation at the workplace. Consequently, the standard of living in European welfare states is significantly lower than in the United States. For example, cost decreases in child care, as a result of competition, put more mothers into the labor market in the United States and Canada (link) while the percentage of mothers in the labor market, while having child-care liabilities, is significantly lower in Europe, reflecting regulated and rigid labor market designed by the intervention of trade unions. In freer labor markets where employers have fewer discrimination preferences, firms score higher on productivity, human capital and profits, advantaging employers with non-discriminatory hiring practices while putting employers with discriminatory hiring (related to race, skin color, religion, sex or any other characteristic) in a serious relative disadvantage.

Wednesday, September 24, 2008


Art Laffer and Stephen Moore offer a brilliant evidence on how lower tax rates expanded income increases (here):

"The new Census Bureau data on income and poverty reveal that many of the economic trends in this country are a lot more favorable than America's detractors seems to think. In 2007, overall real median family income increased to $50,233, up $600 from 2006. The real median income for intact families -- mother and father in the home -- rose to $78,000, an all-time high. Although incomes fell sharply in the U.S. after the dot-com bubble burst in 2000 (and still haven't fully recovered), these latest statistics reflect a 25-year trend of upward economic mobility. More important, Barack Obama is wrong when he states on his campaign Web site that the economic policies started by Ronald Reagan have rewarded "wealth not work." Based on this false claim -- that the rich have benefited by economic growth while others have not -- he intends to raise tax rates on high-income individuals. To be sure, there has been a massive amount of wealth created in America over the last 25 years. But tax rates were cut dramatically across the income spectrum, for rich and poor alike. The results?
When all sources of income are included -- wages, salaries, realized capital gains, dividends, business income and government benefits -- and taxes paid are deducted, households in the lowest income quintile saw a roughly 25% increase in their living standards from 1983 to 2005. (See chart nearby; the data is from the Congressional Budget Office's "Comprehensive Household Income.") This fact alone refutes the notion that the poor are getting poorer. They are not...Looking at the last two business cycles (first year of recovery to first year of recovery), this low-income group experienced a 10% rise in their inflation-adjusted after-tax incomes from 1983 to 1992 and then another 11% rise from 1992 to 2002). Roughly speaking, the Reagan and Clinton presidencies were equally good for them. Income gains over the last 30 years have been systematically understated due to several factors. These include:
- Fall in people per household. The gains in household income undercount the actual gains per person, because the average number of people living in low-income households has been shrinking. On a per capita basis, the real income gain for low-income households was 44% from 1983 to 2005, about 22% from 1983 to 1992 and about 18% from 1992 to 2002. These are excellent numbers by any measure. Earned income tax credit effect. The Earned Income Tax Credit (EITC) is a government payment to low income people who work. It was instituted on a small scale in 1975. In 1986, 1990, 1993 and 2001, Congress expanded the program ...Over time the EITC has multiplied the number of poor households that fill out tax forms each year and are thus counted in government income statistics. That's because to be eligible to receive the refundable EITC, a tax return must be filed ...Official tax return data show that in 1983, 19% of returns had zero tax liability; that percentage has climbed steadily, reaching 33% in 2005. (The Tax Policy Center estimates that in 2008 nearly 40% of filers will have no income tax liability.) Thus, we are now statistically counting more poorer families today than we used to. This is a major reason that median and poor household income gains appear to be a lot smaller than they have been in reality. Income mobility. In the U.S., people who had low incomes in 1983 didn't necessarily have incomes as low a decade later. People in this country have long moved up over time, and this income mobility continues to be true. While some people do remain in the lowest income group, they are the exception ...One way to quantify income mobility is to examine how many people remain in the same tax bracket over time. We compared the returns of tax filers in the lowest tax rate bracket (zero) in 1987 with their returns in 1996. Only one third of the tax filers were still in the zero tax bracket, but 25% were now in the 10% bracket, 32% had moved up to the 15% bracket and 9% were in the 25%, 28%, 33% or 35% brackets. And that was following them for a decade, not a generation ... From 1996 to 2005, we have the income mobility data for income quintiles. Of those filers who were in the lowest 20% in 1996 and who also filed in 2005, 42.4% remained in the bottom 20%, 28.6% were in the next highest quintile, 13.9% were in the middle quintile, 9.9% were in the second highest quintile, and 5.3% were in the highest quintile ...What is also striking about the data is that the poor today are, in general, not the same people who were poor even a few years ago. For example, the new Census data find that only 3% of Americans are "chronically" poor, which the Census Bureau defines as being in poverty for three years or more. Many of the people in the bottom quintile of income earners in any one year are new entrants to the labor force or those who are leaving the labor force. Obviously, there is also a significant core of truly poor people in this group, but that core is drastically less than 100%.
The data also show downward mobility among the highest income earners. The top 1% in 1996 saw an average decline in their real, after-tax incomes by 52% in the next 10 years.
America is still an opportunity society where talent and hard work can (almost always) overcome one's position at birth or at any point in time. Perhaps the best piece of news in this regard is the reduction in gaps between earnings of men and women, and between blacks and whites over the last 25 years ...Census Bureau data of real income gains from 1980 to 2005 show the rise in incomes based on gender and race. White males have had the smallest gains in income (up 9%), while black females have had by far the largest increase in income (up 79%). White females were up 74% and black males were up 34%. Income gaps within groups are rising, but the gaps among groups are declining. People are being rewarded in today's economy based on what they know and what they can do, not on the basis of who their parents are or the color of their skin ...There are of course Americans who live in poverty, as there are very affluent Americans with $25 million yachts and $10 million homes who hold ostentatious $200,000 birthday parties. But the evidence is plain that all groups across the income distribution have made solid gains during the last generation ... Taking from the rich through much higher tax rates in order to help the poor and middle class makes no sense intellectually and has seldom worked in practice. Reducing rates, on the other hand, does increase the share of taxes paid by the highest income-earning group. For example, in 1981, when the highest tax rate on the rich was 70% and the top capital gains tax rate was close to 45%, the richest 1% of Americans paid 17% of total income taxes. In 2005, with a top income tax rate of 35% and capital gains at 15%, the richest 1% of Americans paid 39%.
We suspect that Mr. Obama will discover that when you put "tax fairness" ahead of economic progress, you produce neither."

Monday, September 22, 2008


In Sunday, voters in my native Slovenia elected left-leaning political party that will presumably hold the majority in the national parliament, given favorable majority conditions for left-leaning political parties as well as the distribution of votes and preferences of political agents. Political analysts and comments have said that Slovenian voters now turned to the left. Aside from political populism of welfare state, it is time for a brief economic view on the future of Slovenian economy and consequences that left-leaning economic policy may induce.

Some Facts about Growth

In 2007 and 2008, the output of Slovenian economy grew by historically high rates, averaging around 6 percent. Economists have different views and analytical opinion what pushed growth onto such high rate. One group of economists believe that output increase is a consequence of demand boost through government spending on infrastructure that boosted economic growth, bringing demand-pull inflation as a consequence while another group of economists believe that Slovenia's economic growth is a result of higher investment rates, favorable global economic conditions such as lowering interest rate and tax cuts. After reviewing the data and forecasting assumptions, I analytically believe that the phenomena of economic growth in recent years in Slovenia has mainly been the outcome of robust investment, reductions in marginal tax rates on labor and capital, and low interest rate. However, given the state of low interest rate, capital deepening is not a key to aggregate productivity growth. What Slovenian economy experieneced was surging investment and small supply-side tax cuts that boosted output growth. In the long run, the growth of productivity is essential to economic growth. Without it, the output growth would slowly diminish in relative terms since a continious lowering of interest rate would lead to deflation trap such as experienced by Japan in 1990s. As first, I would like to refer to the pioneering work of professor Moses Abramovitz on economic growth and output trends (here, here and here). Professor found out that there are huge growth residuals in the measurement of economic growth. For example, when the emergence of new economy propelled innovation, the latter was perceived as an exogenous shock, leaving a huge part of economic growth unexplained. While the static measurement of growth was an empirical practice as long as measuring samples of output growth were based on simplified input assumptions, dynamic advancement of innovation into production, at first, seemed as a measure that is decreasing productivity growth. However, productivity paradox revealed that assumptions in the measurement of economic growth are not a static experiment but rather an experiment that needed empirical renewal. Today, we measure economic growth through endogenous growth model where engines of growth do not come from the "outside" (exogenously) but from the "inside" (endogenously). An advantage of the endogenous model of growth is that, in general, there are not many residuals since shocks are already entailed into the model of growth. However, economic policy can significantly affect the economic performance over the future horizon.

The Greed of Political Agents

In the political market, political parties are utility-maximizing agents that seek anticipated rents through time and power they aim to achieve in the political arena. Therefore, their existence depends entirely on the distribution of economically absurd promises to different interest groups and stakeholders. In Slovenia's pre-election period, political parties delivered countless promises about the prospects of economic development, inflation and other economic issues. If there's a widespread virus of economic illiteracy, then the ideas such as "inflation is a fiscal phenomena" and "government is to be blamed for poverty" can really stick to the conventional wisdom.

Economic Scoreboard

In the fiscal year 2006-2007, the Ministry of Finance launched the first tax reform in the history of independent Slovenia. Top tax rate on personal income was reduced from 50 percent to 41 percent. Also, the entire tax code was gradually reduced from 5 tax brackets to 3 tax brackets with progressive income tax structure - 16 percent, 27 percent and 41 percent. Although tax burden remained high, consuming approximately 47 percent of the GDP, there was an intial supply-side effect on jobs, investment and tax revenue that reached historic highs after tax reductions were imposed. Also, budget deficit (in percent of the GDP) has been reduced and public spending (in GDP's share) reduced as well. Some economists blame tax reductions for poverty. In Slovenia, there is a wrong perception of poverty. The latter cannot be defined by confusing income and net wealth. Using Gini coefficients, the income inequality in Slovenia is among the lowest in the EU, just behind Sweden and Denmark. Also, using Eurostat data (here) as an analytical source, the risk of poverty in Slovenia is among the lowest in the world. Also, Slovenians owe the highest share of owned tangible households in the world. Thus, the rate of poverty in Slovenia is approximately 3 percent of the individuals above the age of 15. In the last four years, the rate of economic growth reached historic highs. Even though Slovenia is a transition economy, output growth throughout transition period was among the lowest in Eastern Europe. However, in the last four years, output growth exceeded 5 percent; the most rapid economic expansion in the economic history of independent Slovenia. Unemployment shrank sharply with its natural rate averaging 4 percent. Although "higher wages" are a popular manifest nowdays, it must be recognized that, in the long run, wages and productivity correlate. In the short run, it is evident that wage growth is behind the productivity growth. Recently published data by the Eurostat have shown that Slovenian economy has not completed the convergence of productivity relative to EU27. Today's level of real labor productivity in Slovenia is 84 percent of the EU27 level, and between 60 and 70 percent of the EU15. Estonia is the regional leader in productivity convergence from 1997-2008, while Slovenia is a regional laggard. From 1997 to 2008, the overall productivity improved by 12,5 index points. For example, in 1997, the relative level of real productivity in Estonia was 38,7 percent of the EU's. In 2008, today's level of real productivity in Estonia compared to the EU is 65,4 percent. Not surprisingly, there is an obvious empirical relationship between bargining power of the unions and slow productivity growth since economies with higher bargaining power of the unions tend to have lower productivity growth. Social democrats, the winners of the election, pledged to raise taxes on productive behavior. In that case, the growth of productivity would reduce to at least 2,5 percent in the medium run. In that case, Estonia's standard of living would catch-up Slovenia's standard of living in 13-14 years, assuming Estonia's 4,5 percent average productivity growth over the medium term. Unfamously, Slovenia is known for the highest rate of inflation in the EMU. Neither the introduction of euro, neither "fiscal impulse" are the flames of inflation which is (by the way), monetary phenomena True, lower interest rate in previous periods by the ECB may have boosted output activity and, at the same time, boosted the level of prices but, in retrospect, high rate of inflation is a consequence of rigid market structure that spills supply shocks into higher prices either because of oligopolistic market structure that imposes mark-ups on input prices, spilling it into consumer prices.

Looking to the Future

After the political turmoil, it is likely that left-leaning political parties will continue the statist course of economic policy with high tax burden in the share of the GDP, hostility towards financial markets (with enormously high tax rate on derivates) and foreign direct investment, postponing privatization with political management and meddling of inefficient state-owned companies. Tax rates will likely remain the highest in the region and Slovenia will, after Hungary and Croatia, remain the only country without flat-rated income tax. As in previous periods, there is little prospect for labor market deregulation that severely hampers productivity growth. In the long run, productivity is everything. After decades of market socialism, Slovenia's unique gradualist approach to economic reform, there is still much to be reformed immediately. Without tax cuts, market liberalization, reduced public spending, the economic growth, and consequently, the standard of living, would decline. Economic theory and practice teach us that there's no better welfare state than high economic growth, enabled by economic and individual freedom.

Rok SPRUK is an economist.

Copyright 2008 by Rok SPRUK


Cato Institute has just published recent report on the state of Economic Freedom in the World, measuring the level of economic liberty in each country (link). The freest economies in the world are: Singapore, Hong Kong and New Zealand. Slovenia, ranked 88th, performed poorly, scoring significantly low on the size of government, freedom of labor market and the security of property rights.


World Bank has issued the recent report Doing Business 2009, comparing countries throughout the world regarding the ease of doing business and entrepreneurship (link).

Saturday, September 13, 2008


Professor Glaeser of Harvard University wrote an interesting article, addressing the issue of importance of human capital for economic growth, income and welfare (here):

"Also since the mid-1970s, America has become much more unequal. Not all inequality is bad. I wouldn't mind if the guys who gave us Google earned even more, given their contributions to society. I do, however, care deeply that millions of Americans seem to have reaped, at best, modest benefits from the past 30 years of technological change... By contrast, investing in human capital offers the potential for permanent increases in earnings that encourage work. Education increases the ability to deal with innovation, so that investing in skills today will make Americans better able to weather the storms of future technological changes."

Sunday, September 07, 2008


Donald Boudreaux recently published an article where he discusses the emergence of prosperity (here)


Tom Wilson, a British speechwriter, wrote an opinion (link) in Wall Street Journal, showing incredibly similar parallels between Obama's economic agenda and the economic agenda of Britain's Labour party in Pre-Thatcher years, that turned British economy into the sick man of European economy.

Wednesday, September 03, 2008


Forbes reports (link) that Hungarian Prime Minister announced the abolition of 4 percent solidarity tax, a unique layer of tax on company profits that used to finance government's welfare expenditures. In addition, the government announced a decrease in corporate tax rate from 18 percent to 16 percent and payroll tax rate by 10 percentage points. However, after Slovenia and Croatia, Hungary is among the last remaining economies in Central-Eastern Europe without flat-rated income tax (link) that would boost economic growth, investment and job creation. Surprisingly, Greece introduced a gradual reduction in corporate and individual income tax by 5 percentage points over the next five years (link).

Thursday, August 21, 2008


Kenneth Rogoff of the Harvard University, former chief economist at the IMF, has drawn a perspective on current financial crisis (link) that boosted macroeconomic instability in the U.S and the rest of the world, facing surgining inflation rates (link), asset bubbles and declining output growth.

Monday, August 18, 2008


Inside Higher Ed published an interactive article about political correctness by discipline. The article can be read here.


Martin Feldstein (link) and Barry Eichengreen (link) offer a closer perspective on the comparison of the state of monetary policy at the beginning of the Great Depression and in the light of recent frictions in financial markets.

Saturday, August 16, 2008


I recently listened the serie called "Intelekta" (link) on Radio Slovenia. The topics of the talk was classical liberalism and its direct and indirect effects on economic growth and development. Nobel laureate fromm 1973 and an imminent philosophical and economic thinker, Friedrich August von Hayek once famoulsy noted that society's course will be changed only by the change in ideas. Once ideas meet the minds of the individual initiative, the politico-economic measures will follow. Slovenia, still the wealthiest post-communist economy, enjoys moderately high standard of living while the future prospects of economic development are hampering the growth of output and productivity. My research (link) has shown an alarming evidence of Slovenia's score on economic growth and development: back in 1991, the relative gap in terms of standard of living between Slovenia and Estonia stood at 35-41 years, taking purchasing power parity and current prices into account. In 2007, the gap between Slovenia and Estonia reduced to 13 years. In simple terms, this implies that in 13 years, the level of living standard in Estonia will surpass the standard of living in Slovenia. In this briefing paper, I intend to draw a perspective on Slovenia's economic development and empirically alternatives to statist economic policy and Bismarckian welfare state.

The Empirical Side of Economic Policy

Back in early 1970s, David Nolan of the MIT, composed a chart, showing how each political ideology is derived from the mathematical treatment of marginal changes in two variables - personal and economic freedom. Today, this matrix is called Nolan chart (link). The usefulness of this matrix is of the high purpose since it can show revealed preferences of political parties as vote-maximizing agents in an oligopolistic political market. Kenneth Arrow, a Nobel-winning economist, devised an impossibility theorem, the assertion of which is that it is impossible to devise a constitution or voting system which offers more than two reasonable choices to the individual, or that will guarantee to produce a constant set of preferences for a group which correspond to the preferences of the individuals making up that group. Hence, the paradox of voting is that it is impossible to have rational and at the same time egalitarian choice. Assume a two-agent utility-maximizing model in the political market where both agents strive to maximize election output. Because both groups face a monotonic utility function, which means practically the same preferences under different set of policy measures, the empirical intuition is under what rules the agents will react. In Social Choice and Individual Values, Kenneth Arrow, proposed the rules of social choice (link). Unless clear rules are given in the game of economic policy, limiting the scope of government action, the use of discretion would always arise and be made permanent. This simple theorem referes to Arrow's general impossibility theorem and to the rules determining social choice. The behavior of utility-maximizing political agents is shown in the graph. The utility function y = u(x) is downward sloping. This movement reflects the fact that the first choice done by a political agent will inherently reduce the utility his competitor. It means that the support for one measure, say tax reform, will not be strong enough to pass it through. Each utility-maximizer in the political market will inevitably seek to maximize the utility sum of each square by reducing the utility of the competing agent per se. What determines the voting outcome is the rule of the margin - meaning that higher majority rule of one group will entail greater feasibility of social choice. From an empirical point of view, that could be the reason why political system with smaller number of utility-maximizing political agents tend to score higher on the scale of political freedom and quality of governance. In theoretical terms, the paradox of voting is that higher majority rule implies the full-scale fluidity of individual preferences transmitted into the machine of collective choice. Notably because individual preferences of choice can be fully processed only by the market mechanism, the collective choice always entails a contradiction in terms. Instead, it should be noted that transitivity and non-coercion are the main determinants of the welfare choice, not the aggregation of preferences.

Picture No.1: Political Competition and the Public Choice

Economic Theory and Policy: The Failure of Statism in Slovenia

After 17 years of transition from state-controlled to market-oriented economy, Slovenia is still the strongest economy in Central and Eastern Europe. A detailed view on the scoreboard of economic growth shows that throughtout 1990s, the overall growth of real productivity per head stagged compared to other countries in Central and Eastern Europe. The real reason for rachitic growth of factor productivity is not the insufficient amount of working hours in the market but the size of tax burden. Until the latest minor change in tax rate structure, top marginal income tax rate was 50 percent. Even now, when the top rate on earned income is 41 percent, the rate structure is not inclined towards the growth of productive behavior such as investment, entrepreneurship and labor supply. Additional tax burden levied on workers and entrepreneurs, such as employee social security contribution and mandatory employer social security contribuion, has downsized the potential growth of overall productivity - which is, in all empirical and theoretical aspects, the main determinant of wage level. The unparalelled growth of the corporate state triangle of government, employer associations and trade unions - initiated a collective bargaining which still attempts to determine wages via central-planning mechanism that is not based upon market-clearing price system. The overall consequence of collective determination of wages is that the relative price of labor services is mis-allocated, causing labor shortages and surpluses. At the same time, that is the reason why real private-sector economy in Slovenia is facing labor shortages of skilled labor supply. True, brain-drain is another consequence of labor shortages because of high tax rates that hinder productivity growth and human capital utilization in the real sector. The lack of privatization is reflected in the fact that state control in the Slovenian economy is at the same share as Soviet Union under Lenin when the latter launched New Economic Policy (link). Considering the data, the share of private sector activities in the GDP is, in Slovenia, the smallest in the region. When the last comparison was published, public sector activities composed 35 percent of the GDP compared to the regional average of 20 percent. The most alarming threat to Slovenia's macroeconomic stability is the expected increase in net financial liabilities and transfers into inter-generational accounts through pension and health-care system. From a rational and sustainable perspective, capital market is the best guarantee of savings utilization for the old-age as the long-run sustainability of the rate of return on portfolio investments determines the level of old-age income, not transfers such as "pay-as-you-go" or income distribution that skews the productivity of the labor supply. When all aspects of statism are taken into the empirical and methodological account, it does not seem surprising why Slovenia's comparative economic performance stalled while other economies in the region, such as Slovakia and Estonia, faced significant rates of output growth. If Slovenia's long run output growth rate increased from 3,0 percent to 4 percent in the long run, the gap in the standard of living between Austria and Slovenia would shrink from 58 years to 22 years, ceteris paribus. Perhaps that is the best possible evidence that stable and free institutions, pro-growth economic and tax policy, limited government spending, free world trade, the absence of government intervention is superior to cradle-to-grave welfare state and economic policy based on government intervention. Adam Smith once wrote that "...the highest level of prosperity occurs when there is a free-market economy and a minimum of government regulation." So true.

Rok SPRUK is an economist.

Thursday, August 14, 2008


Edwin M. Truman highlighted the revealed preferences of sovereign wealth fund establishment. The article can be read here.


German GDP contracted by 0,5 percent as reported by Financial Times (link):

"Germany’s economy contracted less than feared in the second quarter but the underlying pace of activity has still dropped sharply... Gross domestic product in Europe’s largest economy declined by 0.5 per cent in the three months to June, the country’s statistical office reported on Thursday. A fall had been expected after a surprisingly robust first quarter – when GDP rose by 1.3 per cent, according to the latest revised figures. But leaks from Berlin had suggested the drop could be as large as 1 per cent... Still, the underlying slowdown highlighted the impact of soaring oil prices in curbing global demand for German exports and reducing consumer spending. The latest contraction was the first for almost four years, the statistical office said... Germany’s weak performance is expected to drag down eurozone GDP figures due later on Thursday and which are expected to show the first quarterly contraction in the 15-country region since the launch of the euro in 1999. Concerns about recession – two quarters of negative growth – are now widespread across the eurozone. Earlier this month, Jean-Claude Trichet, European Central Bank president, warned that the second and third quarters would be “particularly week” and this week, Lorenzo Bini Smaghi, an ECB executive board member, said the period of weakness could be “protracted”. However some analysts warned against excessive pessimism. “The German economy is not likely to fall into recession in the third quarter. We expect a small rise in GDP with a rebound in private spending after the sharp decline in oil price,” said Sylvain Broyer at Natixis in Frankfurt."


EU Observer has recently quoted (link) the study conducted by a team of British scientists showing that, each year, farm subsidies on behalf of EU's common agricultural policy cause strong heart diseases and stroke-related deaths as a consequence of too high nutrition values per se, given the amount of fat that farm producers can use to produce food. This is an additional sign why EU's common agricultural policy is a roadmap in the wrong direction. Taking some basics of the microeconomic theory into account, we can see that EU farm subsidies lead to massive overproduction of milk and diary products simply because producers do not meet a sufficient amount of market information as a consequence of subsidy distortions. Again, subsidies can be attributed only if there is more negative neighborhood effects that the amount of positive ones while agricultural sector is a case study that would suffice the criteria for subsidy giving as there is a market-clearing price mechanism. World Health Organization revealed that EU's annual milk production subsidies amount 16 billion EUR, including a 500 million EUR butter consumption stimulus.

The EU Observer noted (link):

"Looking at the 15 EU states before the 2004 round of enlargement, the annual "mortality contribution attributable to CAP was approximately 9,800 additional CHD deaths and 3,000 additional stroke deaths within the EU," the study says, with France, Germany, Italy, Spain and the UK seeing the highest numbers of excess deaths."

Market liberalization and an immediate end of subsidizing agricultural production would certainly boost the shift towards consumer choice and demands. In turn, that would also bring positive neighborhood effects since producers' prices would be closer to marginal cost level which means that the severity of heart diseases and stroke-related deaths and consequences would disappear faster and easier. Frankly, it's about time to end the tyranny of EU's agricultural subsidies and CAP. The effect of farm subsidies revealed by British scientists are another strong argument and evidence of the mischief of subsidy-giving.

Thursday, July 17, 2008


Allan H. Meltzer explains why Fed should be taken away from investment banks (link):

"So what can taxpayers expect from an increase in the Fed's discretionary authority over investment banks? The likely answer is rescues, delays and lax supervision – followed by taxpayer-financed bailouts. Throughout its postwar history, the Fed has responded to the interests of large banks and Congress, not the public. Investment banks don't need the Fed to regulate them. Some clear rules on capitalization would suffice."

Thursday, July 10, 2008


One of the most interesting discussions among the economists and policy experts is a debate about the role of tax havens and offshore destinations that compete with other nations in the areas of taxes, regulation and investor protection. The opponents of tax havens believe that tax havens cause an enormous damage to the economies on the other side of the world since (in their opinion), tax havens are the fundamental reason for the lack of reinvestment and capital flight in onshore economies. The real reason why tax havens are prosecuted by governments is that governement agents seek the highest possible utility from tax revenues in the form of rent-seeking that would yield more power and revenue.

Taxes and Regulation

There are two reasons for high tax rates. One is that in case of high government spending, the structure of tax rates must be high enough to avoid excessive deficit spending that could impair domestic macroeconomic stability. First, the real threat to macroeconomic stability is not deficit but the size of government spending. Also, excessive deficit spending is a threat to domestic macroeconomic stability because of the so called crowding-out effect where high government spending crowds out investment in the private sector. The net outcome is higher interest rate that arises from an increased scarcity of investment that is caused by budget deficit and high government spending. Second, the basic assertion of the Laffer curve is that high tax rates produce a bulk of negative effect. For example, when Sweden had the highest marginal tax rate in the world excessing 80 percent, the net result had been a decreasing tax revenue and when marginal tax rate were reduced, tax revenue soared. However, the real aim of tax rate reduction is not the growth of government revenue but welfare and the right of taxpayers to use the disposable income they earn. Empirical evidence suggests that prudent macroeconomic discipline such as principles of low tax burden, limited spending and adherence of price stability by the central bank result in the improvement of conditions for economic growth and stabilization process regardless of asymmetric shocks. What about regulation? Government regulate for two reasons. First, to remove the negative effects of market imperfections and second, to insure public goods. However, predatory tax rates, the growth of tax burden and the regulation of the private sector are designed seek monopoly rents in an unregulated way. While sound regulation can certainly offset the sideblocks of negative externalities such as free-riding, excessive regulation is hampering the growth of real productivity which is essential to the standard of living and the quality of life.

Tax Havens

Dan Mitchell recently explained (link) the positive role of tax havens in a global economy. From a basic perspective, minimal tax burden in tax havens is a liberalizing force in the world economy since, given capital mobility and the fluidity of knowledge, destinations with higher corporate and personal income tax burden have no choice but to reduce tax rates on productive behavior. Flat tax revolution, that was initiated by Estonia in early 1990s, also helped reduce corporate tax rates in continental Europe and Scandinavia. Given the lack of data, there are hardly any empirical studies researching the impact of tax rate reductions on tax revenue. When Swedish economy faced an onerous macroeconomic instability marred by high inflation, low output growth, declining productivity growth and a sudden dramatic increase in the interest rate (to 500 percent overnight) by Riksbank, top marginal tax rate was 84 percent. Consequently, economic growth decline and public spending grew and shrank into deficit, pushing the real interest rate up, as explained by crowding-out effect (link). When the economy is on the line of potential output, expansionary fiscal policy boosted money demand which, in turn, induced the increase in the real and nominal interest rate. As a consequence, Swedish economy faced a declining investment. Firstly, because corporate tax rate was excessive and secondly, because crowding-out effect took place. Regarding tax havens, supply-side economic and tax policies induced the trend of lowering tax rates on all sources of productivity ranging from investment, savings and entrepreneurship to labor supply. Concerning regulation, high corporate tax rate and excessive regulation usually go hand in hand since the regulation of the private sector is mostly an implicit insurance against the loss of control and - hence - the loss of tax revenue that is needed to finance government spending.
Empirical observation

I took a closer view on the comparative analysis of tax havens and onshore jurisdictions that impose higher mandatory tax rates on corporate and personal income tax as well as more excessive regulation. I downloaded the data from World Bank's Governance (link) and used a correlation analysis tool to analyze related motions of corporate tax rate, the rule of law and regulatory quality on each of these variables. An important note is that it depends on what is meant by 'regulatory quality' since World Bank oftenly criticizes tax havens. Concerning governance, tax havens scored lower than Germany and Austria - countries with high and almost punitive corporate tax rate. Despite a shaddy and imperialist fiscal agression on Liechtenstein, Germany still enjoys an enormously high score on the rule of law and regulation. However, I did not take a detailed look at methodological details even though I can say that there are extreme bias towards what regulatory quality really is.

This chart, for instance, shows a log-linear relationship between corporate income tax and regulatory quality. Considering trend line - estimated by a polynomial of second degree, countries with higher corporate income tax also have sounder regulation. But, if you take a closer look, it can be seen that trend line declines slightly in the area where there is a high concentration of countries (France, Spain, Belgium, Germany...). From WB's data, a curious reasearcher would conclude that higher taxes are good and tax havens have a tighter regulatory quality. However, the relationship in the chart is intuitive since R-square is 0,0436 which means that the variation of the independent variable explains only 4,36 of the variation of the dependent variable.

This chart(log-linearization of the relationship between corporate tax rate and the rule of law) shows that countries with high corporate income tax rate also have comparatively decreased rule of law. Again, it all depends on what is meant under the rule of law. For example, if offshore services are legally recognized in Cayman Islands, and if World Bank's governance methodology treats that as irresponsible, then Caymans will receive a lower score on the rule of law. As you can see, Iceland has the highest rule of law and a modest corporate tax rate (16 percent down from 18 percent). Interestingly, Netherlands Antilles are a tax haven more in terms of regulation and information disclosure than in terms of taxes since 34 percent corporate tax rate seems to be highly sensitive to the rule of law. In fact, many so-called tax havens have a higher rule of law than continental countries. For instance, Cayman Islands have a higher rule of law than Spain, Singapore has a higher rule of law than Germany, Belgium and France etc.

As a conclusion, tax havens are the force of liberalization in the global economy and when surveys (such as WB's) are conducted, it's good to review the methodology and measurement of particular indicators. There are bias everywhere.

Rok Spruk is an economist.

Sunday, July 06, 2008


Institute for Economic Research in Health Care (INERHC) issued a thorough economic analysis and review of Slovenian health-care system (link). Previously, the institute issued a publication in which institute's experts analyzed the financial sustainability of government-mandated health-care system in Slovenia (link).

Wednesday, July 02, 2008

BEST PLACES FOR DOING BUSINESS recently published its annual global research (link) on the attraction of particular countries on doing business from macroeconomic and microeconomic point of view. According to Forbes, the best place for doing business is Denmark, followed by Ireland, Finland, United States and United Kingdom. Among top 10 there are also Sweden, Canada, Singapore, Hong Kong and Estonia.


In Forbes, there is a brief article (link) on credit default swap in Iceland in the wake of credit crunch and external shocks that affect macroeconomic stability.

Monday, June 23, 2008


Credit Suisse recently published a research paper (link) where it's been shown that Swiss cantons with lower tax burden and improved regulatory environment are therefore more attractive as locations for doing business (link). Cantons Zug, Zurich and Obwalden got the highest score. Although tax rate structure in Zurich is not among the lowest in entire Switzerland, Zurich's high score can be explained by the fact that there's a high-quality access to demand linkages that certainly boosts the quality of Zurich as business location despite relatively high personal and corporate tax rates. In more distant cantons, tax competition certainly plays a bigger role since creating a business environment friendly oriented towards incentives to work, save and invest is a primary tool that boosts the locational quality of the region regarding economic outlook and the quality of the particular environment for doing business.

Thursday, June 19, 2008


Here is how JFK explained the benefits of tax reductions that he implemented in 1960s.

TAX RATE REDUCTION IN GIBRALTAR recently reported that Gibraltar's government eventually decided to slash the corporate tax rate from 33 percent to 12 percent by the beginning of 2010 (link).


From FT:

"Argentina’s debt levels are now higher than they were when it crashed into the biggest sovereign debt default in history in 2001, and a worsening crisis of confidence in the government has brought the spectre of a new default closer, a report to be published next week says. Despite a radical restructuring just three years ago, public debt has reached $114.7bn (€74.4bn, £59bn), or 56 per cent of gross domestic product, compared with $144.2bn, or 54 per cent of GDP, in 2001 – at a time when Argentina’s economy was much larger – according to the paper. Martín Krause and Aldo Abram, directors of the Argentine Institutions and Markets Research Centre at Eseade business school and the report’s authors, also found that if the amount owed to bondholders who did not accept the 2005 restructuring and are suing to recover their money is included, Argentina’s overall debt rises to $170bn, or 67 per cent of GDP. “We’re not teetering on the brink of default but if we continue down this path, with this level of [social] conflict, we could get there,” Mr Abram told the FT. Many developed countries, including Italy and Japan, have higher ratios of debt to GDP but Argentina’s higher borrowing costs and rocky institutional record make it harder to secure credit. “The worry is not the amount, it’s that we won’t have access to credit,” Mr Abram said. The six-month-old government of Cristina Fernández, the president, has been struggling to resolve a conflict with farmers after it imposed a sliding scale of export tariffs on key agricultural exports in March. The unrest has spread to truck drivers, who have mounted roadblocks to demand an end to the farm dispute, which has disrupted grains transportation. Their action has caused fuel shortages and will put further pressure on inflation, which the government is widely accused of trying to conceal with doctored data. Meanwhile, the government must this year find $14.6bn for debt servicing, plus $11.8bn next year and $10.5bn in 2010. However, the threat of legal action by bond holdouts bars Argentina from international capital markets whilst it remains in default with the Paris Club of creditor nations, to which it owes $6.6bn. Argentina has increasingly turned to Hugo Chávez, the Venezuelan president, who has bought $6.4bn in bonds in the past three years. But its international financial isolation is costly – Buenos Aires has had to pay Venezuela interest rates of up to 13 per cent, yet it cancelled its low-cost International Monetary Fund debt and the Paris Club debt only costs 5.3 per cent, Mr Krause said. By contrast Brazil, which had a far worse debt profile than Argentina in 2001, recently achieved investment grade and sold a 10-year bond at 5.3 per cent."


Financial Times reports that Mexican government decided to impose food price controls in response to an increase in food prices. It will be interesting to see the situation when the laws of supply and demand take place.


Financial Times has a brilliant analysis regarding inflationary pressures and the surgence of macroeconomic instability in Asian export-driven economies (here).

Wednesday, June 11, 2008


Kevin Hassett of the American Enterprise Institute recently published in article (link) in which he explained why there is a negative correlation between high regulation of entry and entrepreneurship. Two economists, Silvia Ardagna and Annamaria Lusardi examined survey data collected from 150,000 individuals in 37 different countries and showed that the amount of opportunity entrepreneurs is the highest in countries where there is less regulation of entry. For example, the United States has the highest share (8 percent) of opportunity enterpreneurs and the fewest regulatory entry barriers, after Canada and Denmark. On the other side, Spain, France, Belgium and Slovenia have the lowest share of opportunity enterpreneurs and unsurprisingly many regulatory barriers of entry.

Wednesday, June 04, 2008



In the latest quarter, Australia's economy grew 0,6 percent - twice as fast as the economists forecasted - continuing 17 years of rapid economic expansion. Economy's growth records may force the central bank to raise interest rate to curb inflationary pressures (link).


Bloomberg discusses how emerging markets would survive an economic crisis (link).


From WSJ's Real Time Economics (link):

"Japan’s finance minister, Fukushiro Nukaga, suggested a way to alleviate the country’s strained finances as its population ages rapidly: Work till you’re 70. Japan is already the world’s oldest big nation, and between 2005 and 2020, the number of Japanese aged over 65 is forecast to rise to about 36 million from 26 million. Meanwhile, the number of working age Japanese will shrink to 74 million from 84 million. That is already hurting economic growth, and is expected to have an even greater effect in the future. Japan’s productivity — a measure of how much each worker produces — will rise a healthy 2.2% a year between 2009 and 2013, according to a forecast by the Organization for Economic Cooperation and Development. But the shrinking workforce will strip 0.7 percentage point from that, leaving the country with just 1.5% annual growth. “We are at a historic turning point,” Mr. Nukaga told a news conference Wednesday. While output growth is slowed, more people are living off pensions. Japan over recent years has already introduced some changes designed to make its pension system workable. Between 2000 and 2025, the age at which men can receive their full pension is being raised from 60 to 65. (The changes affect women five years later.) Pension premiums paid by workers are rising. This still isn’t enough however. Other ways to alleviate the problem, he said, could include allowing a greater number of foreign workers in Japan, which has traditionally not allowed large-scale immigration."


Greg Mankiw (link) recently wrote an article (link) published in The New York Times (link) discussing the possibility of a cut in the corporate tax rate as recently proposed by the economic advisers of John McCain. While John McCain has some doubtful and economically questionable proposals, such as the extension of gas-tax holidays, his economic advisers recently proposed a cut in the federal corporate tax rate from 35 percent to 25 percent. While the suggested proposal has been harshly criticized by economists such as Brad DeLong (link), the proposal deserves an open discussion about the consequences of the corporate tax rate.

The most frequent mistake that has been grasped repeatedly by the mainstream media and intellectual elites is that corporate tax is actually paid by the corporation itself. Despite the soundness of the argument, it is false. Corporations are likely to be tax-collectors than taxpayers. Why? For example, if you own equities and securities, than corporations shift the burden to consumers, hired labor and stockholders. An increase in the corporate tax rate potentially reduces capital investment. In turn, a corporation levies the burden by cutting total costs of labor and services. Consequentially, corporate equities and stocks are hampered by a higher relative weight on potential returns. Also, a significant amount of empirical research, including Randolph's 2006 study (Congressional Budget Office), has confirmed that the major share (70 percent) of the corporate tax burden is beared by the labor force. Researchers at Oxford University (Arulampalan, Devereux, Maffini) examined the effect of the corporate tax in 50,000 European companies in nine European countries. They found that, in the long run, a $1 increase in the tax bill reduces the real wage at the median by 92 cents.

The opposition to the cut in corporate tax rate often includes arguments such as the loss of tax revenue and the reduction of real wages. However, none of these arguments is based on empirical observations. In the short run, there are numerous static assumptions claiming that the revenue may fall precisely. However, the reduction in corporate tax burden would result in a stronger and less volatile stock market. In turn, that would boost capital investment respectively which would lead to higher productivity growth. A basic consequence of productivity increase is the increase in real wages and a drop in consumer prices. True, part of rhe revenue loss may be covered by an increase in other taxes such as gasoline taxes. But have there been any confident estimates showing that the revenue may really decline?

An additional and truly important measure to decrease the corporate tax burden is lowering government expenditure, both in absolute in relative terms. According to experience, the net effect of lower government spending is an increase in the growth of real productivity as well as stronger stock market that would boost investment and reduce volatility of the stock market itself. Also, lower government spending would result in higher output growth as well as it would have significantly positive welfare effects on prices, wages and employment.

Wednesday, May 28, 2008


This article was written by Martin Rojko, a real estate analyst and frequent guest writer at Capitalism & Freedom.

According to indicators used for measuring a housing price bubble, residential property values were inflated last year in many european countries. Morgan Stanley´s and Global Property Guide´s data indicate, that market distortion is in Spain, Ireland, Baltic states, Netherlands, Denmark, Czech republic, Great Britain. As these data were gathered in 2006, it´s more than probable more markets join now a bubbled group including Slovakia.

According to TREND calculations the price of mostly selling apartment (one-bedroom, 60 m2 livable area) were equaled to eight-year disposable household income in Bratislava area. Although numbers (not only) such these should be counted carefully, sticking out income and price is a matter of fact. Also another indicator of rental property yields signals the bubble. While a few years ago an owner in Bratislava could make 10% or more from an apartment, now it is approximately 5% (less than mortgage interest in banks). It is the result of doubling apartment prices and stabilising rents.

A long history of western developed markets suggests a normal yield of around 10 – 12%. Property gets cheap when yields approach 15 – 20%. Numbers lower than 6-8% mean overvaluation. According to ECB note house prices in euro zone are overvalued by 15 to 25% by this indicator from their historical averages.

The second indicator, price-to-income ratio, tells how many years of pretax annual earnings are necessary for a household to purchase a house. The historical rule of thumb is that one annual income indicates undervalued properties, two and three annual incomes normal valuation, and four and more annual incomes overvaluation and bubble territory.

This situation has clear solution. To bring the ratio of prices to rents and incomes back to fair value, both must rise sharply or prices must fall. Housing prices now fall in Ireland, Latvia, Estonia, Spain and Great Britain.

We can often hear some experts said that european countries haven´t so crazy lending standards as in the USA and that´s why there´s no danger to afraid of a bubble. It´s a clear misunderstanding. Subprime mortgages don´t create a bubble although it can boost it. Look at Great Britain, Ireland or Spain. There haven´t been much relaxed bank´s lending conditions (especially comparing to the USA), so why the current turmoil? Because home prices are not justified by fundamentals – income, and rents. The bubble is reality.

Now the question stands whether it will burst and harm the whole economy or slowly blowing-out. Considering three mentioned countries I see the greatest danger in Spain. First, there is a huge home supply at prices which people simply can´t afford to pay. Currently cca 650 000 unsold units. Developers will be forced to decrease price maybe 30% down to sell them. But in the meantime many firms get to financial problems and go bankrupt. Second, Spain has the highest construction sector share on GDP in Europe (nearly 18 %). When developer, building firms have troubles, banks and whole economy have also. Of course, government interferes and pumps subsidy package to the economy, but this step only postpones clearing of the market.

There´s another (empirical) point we must be aware of. It is a tight correlation between US and euro area housing prices. The latter following the former with a lag of about two years. US started to decline in 2006, so maybe this year eurozone is in order.

But what about emerging euro countries? Well, as mentioned above the bubble exists in many of them. One thing is clear. Prices are rising slower than in previous years, in some markets (Estonia) they are heading downward with mild heavy impact on a part of mortgaged buyers. They have stabilized in polish Warsaw (been for 9 months cca on the same level) and start to stabilize in Bratislava. While up to day growth was driven in most part by foreign investors, they are now (also due to so called “mortgage crisis”) away. Developers thus hope domestic buyers will continue, but prices are too high for middle classed society (as largest pool of potential clients), because they are set-up still for wealthy and investors.

Now the question is whether incomes will rise so quickly that homes will sell at this level or prices should go down. I think second alternative is the most probable (and not because of I´m not living in my own). And the sooner sellers realize this, the lesser will be impact of bursting bubble in later times. The opposite side of a coin is firms are misguided by monetary policy of central banks, which manipulate interest rate according to their needs, while a real value of the money (or better said the means of payment) can be much higher (see US). And another question here arises (when not talking of abolition), whether one central bank for many differently phased markets is the best way to cope with problems.

Martin Rojko, author is a reporter in (real estate server of business weekly TREND) and runs a blog

Monday, May 26, 2008


Gary Becker (link) and The Economist (link) recently discussed the surge in commodity prices and inflation that has driven inflation rates in emerging markets as well as in high-income economies to historic highs. For example, China's official rate of consumer price inflation is at 12-year high of 8,5 percent. Unofficial estimates have shown that Argentina's inflation rate has peaked 23 percent in 2008. Also, inflation rate in Russia has trimmed up to 14,5 percent, up from 8 percent annually. Central banks in emerging markets have repeatedly faced significant inflationary pressures. In world market, the price of oil barrel has climbed over $120 USD which gave speculators a boost in inflating the expectations that the world price of oil barrel will reach $200 percent and more.

Using the data and some basic tools of economic analysis, it is easily shown that the real price of oil per barrel in relative terms, cannot reach $200 USD unless terrorists attack or a sudden attack on oil fields in the Middle East impairs production abilities of oil producers in that part of the world. Commodity market analysts repeatedly analyze the spillover effects of the regulation of production in oil-exporting economies that generates upward changes in the world price of oil. One reason is that OPEC is a cartel of countries whose profit-making point rests on the real assumption that price elasticity of oil demand is very low which means that there's an inelastic demand for oil. In that case, producers choose to allocate relatively scarce resources by rationing the production of oil and thus increasing the price of oil which, in real conditions of imperfect competition, yields oil producers gains since inelastic consumer demand and quantity control of the production return higher profits when the price per unit of oil is increased. One of the classical solutions to avoid higher price increases and mark-ups is to shift towards the consumption of green energy that will make the demand for commodities, such as oil, more elastic and that would immediately eliminate the monopoly power of OPEC. But the shifts towards "greener energy" is a time-taking process that involves significant consumer expenditures as the price of products that are not linked to oil as production ingredient, is high. That is because, developing "green" products demands huge company expenditures in R&D, supply chains and knowledge-intensive services. Over time, the dependency on oil is expected to decline which implies that cartel stability of OPEC which controls the quantity and price of oil in the world market will decline gradually.

Among economic analysts, the surge in commodity prices is assumed as the engine of current inflationary pressures. But world supply and demand cannot solely explain the surge in commodity product prices. Impeding price controls and export subsidies have vastly contributed to a recent surge in commodity prices. Using price controls causes disparities in quantitiy demanded and supplied which leads to quantity shortages and price accomodation in underground markets. Also, various export bans, subsidies and price controls cause significant micro-inefficiencies that raise the rigidity and potentially reduce the elasticity of demand and supply.

Another important aspect of the surge in inflation in emerging markets is macroeconomic policy pursued by central banks and fiscal policymakers. For example, China responded to inflation surge by putting up more price controls and export bans. India has suspended futures trading in particular commodity markets. In the short run, such measures can cap the official inflation but in the long run, such measures do not lead to price adjustment after the endogenous and/or exogenous shocks tranquil. One of the reasons for an obviously higher inflation rate is that households in emerging markets have higher food expenditure from their budgets which places a heavy weight on food demand, making it more inelastic. Another reason is that central banks in emerging markets such as Russia, China, India and Brasil, pursued an expansionary monetary policy in recent years. Money supply, for example, has grown tremendously. In Russia, for instance, money supply has grown by a swelling 42 percent and central bank's target interest rate (6,5 percent) is far below the official inflation rate (15 percent).

On the offset, rigid labor markets and inflexible wage determination lead to price-wage spiral. An evidence has been observed in Russia where wages are growing 30 percent annually, more than 3 times more than the growth of productivity. A combination of rigid and inflexible market mechanism and expansionary macroeconomic policy as well as supply shocks contributed to the rise in the inflation rate. Even though sound growth forecast, predict a fairly stable output growth rate in the medium term, central banks in emerging markets will have to face the fact that expansionary fiscal policy must be neutralized by a rise in the interest rates and a decrease in the growth of money supply as a neccessary measure to bring the inflation under control. Continued rapid growth in emerging markets means that relative-price shock will be temporary and the food prices will remain high. Also, exchange rate flexibility is needed to avoid intended currency depreciation which sets an important pressure on inflation expectations. Thus, without tighter monetary policy and flexibile labor markets, central banks may soon repeat the mistakes which caused the great inflation in 1970s.

Rok SPRUK is an economist.

Copyright 2008 by Rok SPRUK

Monday, May 19, 2008


Here (link) is an interesting story from The Economist which discusses huge price disparities between French and German retailers. For example, a basket of almost identical durable goods costs 30 percent more in France than in Germany.

The article reports that in many places in France there are local retail monopolies protected against domestic and foreign competition. There is also no free negotiation with suppliers, the sale of non-prescription drugs is prohibited, and the consumers do not support the new law that would deregulate the retail market to liberalize entry conditions and enforce competitive mechanism.

There is a well-known fact from microeconomic theory that consumer demand curve for monopoly firm equals average revenue of the monopoly firm and that monopoly firm will never like rigid or completely elastic demand but the elasticity of demand that will be equal to 1, given the point of the maximum profit taken by the monopoly firm. Hence, the price charged by the monopolist is P = MC/1+(1/Ex,px) which means that greater monopoly power leads to higher mark-ups. And also, the allocative inefficiency of the monopoly means that firm will set the price at the point where marginal revenue and marginal cost are crossed. Hence, higher prices and quantity regulation maximize the profit of the monopoly firm but consumers face a significant welfare loss.

In France, however, only 42 percent of the respondents favored more competitive retail market while 85 percent favored sales tax cuts and 72 percent prefered the rise in the minimum wage. Competitive market is always the only way to break the rigidity and monopoly position of the firm inparticular markets. For example, if there would be sales tax cut, that would not change the structure of the market but it would have an effect on the price elasticity of demand and since a local monopoly firm would face changes in the composition of the local demand, a tax cut would ease the prices but would still give local monopoly firms incentives to impose the mark-up. A rise in the minimum wage is a fallacy that, empirically, results in the rise of the unemployment and further labor market rigidity that hinders the growth of real productivity, decreases job growth and does not stimulate the real increase in purchasing power parity since higher prices, charged by firms to cover-up the loss from minimum wage, discourage the increase in purchasing power that is not linked to real productivity growth.

Tuesday, May 13, 2008


BrinkLindsey of the Cato Institute wrote a piece on the origins and causes of Argentina's economic crisis. The article can be read here.


From FT (link):

"Inflation has replaced unemployment as the most pressing short-term problem facing the oil-rich Gulf economies, which are reaping the benefits of record oil revenues but do not have the tools available to cap rising prices, the International Monetary Fund warned on Monday. Creating jobs for the region’s growing youth population continued to be the main longer-term challenge for Middle Eastern oil exporters, said Mohsin Khan, the IMF’s regional director, but rising prices, already a concern in Qatar and the United Arab Emirates, had now extended across the Gulf Co-operation Council members to traditionally low-inflation countries such as Saudi Arabia, where inflation is approaching 10 per cent... The IMF predicts the Arab Gulf states’ consumer price index will average 7.1 per cent this year, up from 6.1 per cent in 2007 – while the broader Middle East and north Africa region will reach 10.4 per cent this year. With many regional economies pegged to the dollar, central banks lack any monetary policy tools to tackle inflation, leaving fiscal spending, rent caps and price subsidies as the only policy tools available to policymakers. In November last year, for example, rumours of a revaluation in the UAE sparked speculative inflows of $45bn (€29bn, £23bn) in one month, almost a third of the UAE’s gross domestic product... The Middle East and central Asia, which has been largely insulated from global economic uncertainty, was set to continue its strong performance, with oil-exporting countries seeing growth pick up to 6.25 per cent, the IMF said in its biannual regional economic outlook report. The region’s oil and gas exports will amount to $940bn this year, almost $200bn more than last year, as an almost fivefold increase in the price of oil fills the GCC’s coffers. The IMF estimates that the GCC’s combined GDP will reach more than $1,000bn this year, up from $805bn in 2007. The oil exporter’s growing external current account surplus, which is expected to grow to $1,400bn for 2004-2008, signals a continuing ability to invest abroad, while coping with increasing imports and investment into their domestic economies. The GCC’s current account surplus is expected to rise to $332bn from $227bn in 2007, with the UAE’s surplus rising 58 per cent and Qatar’s almost doubling. Official reserves of oil exporters had reached $800bn by the end of 2007. Foreign direct investment into the region reached $80bn in 2007, four times as high as 2002, 55 per cent of which flowed into Egypt, Saudi Arabia and the UAE."