Monday, January 28, 2008
The central question concerning the economic policy is whether government agencies such as Enterprise Ireland really support growth and innovation or do they actually present a barrier to the entrepreneurial edge. There has been different evidence in different countries. The answer to this particular question rather depends on the size of government spending as a share of the GDP. For example, Ireland is known for restrictive fiscal policy, low corporate tax rate and low public spending while countries in continental Europe have had quite different experience. In Slovenia, public spending equals almost 50 percent of the entire output and public administration accounts for a considerable part of the GDP. In fact, cuts in public spending revived Ireland's "the-sickest-and-poorest-of-the-rich" economy to become a roaring Celtic tiger (link).
Different quantitative studies suggested that there is a positive correlation between the efficiency and quality of services provided by public administration and low public spending. The empirical evidence has confirmed that the inefficiency of services provided by the public administration strongly correlates with oversized and inadequate staff with poor track on productivity performance.
There is hardly any externality that could justify the existence of government agencies as information providers. True, the coordinative, productive and cooperative government inputs are essential to the core public products such as the rule of law, sound regulatory environment and administrative quality. New economy and the age of IT have succinctly eliminated a large slice of the information asymmetry and markets can successfully provide the needed information to entrepreneurs and start-up companies.
Should government agency support R&D activities at the university and at the company level. Again, it depends on behavior. Cooperative behavior may definitely enhence the efficiency of such incentives while rent-seeking behavior may definitely provide political incentives to manipulate with the information resulting in a growing rate of inefficiency.
The question is to which extent can government agencies such as Enterprise Ireland promote the entrepreneurship. First, it is important to rely on private-decision making instead of the enhencement of government ownership and intervention. Second, competitiveness is a microeconomic phenomena that emerges from the product and service quality of the companies competing on a rock-bottom incentive to provide the largest possible quantity and the lowest possible price. Third, the ultimate way to promote the entrepreneurship is the economic policy. Restrictive fiscal policy, lower public spending, product market deregulation, administrative reforms, tax cuts and the liberalization of the productive capacity, the rule of law and efficient institutions provide important incentives to launch the productive behavior such as saving, investment, labor supply and entrepreneurship nonetheless.
There is also a doubt whether public funds are truly as efficient as the conventional wisdom claims. Honestly, the best and most attractive R&D projects are privately funded. Google Inc. has been started by Sergey Brin and Larry Page. Apple was started by Steve Jobs, Jerry Yang started Yahoo.com and Pierre Omidyar succeeded with eBay without government funds and public R&D programs. Also, cutting-edge innovation in pharmaceutics and life sciences is usually pioneered by providing private funds.
Rok SPRUK is an economist.
Copyright 2008 by Rok SPRUK
Thursday, January 24, 2008
Tomaž recently published a beautiful post discussing judicial claims over wage increases:
"The announcement of the strike on behalf of Slovenian Judicial Association is an unusual step, knowing that not all Slovenian judges are not the members of the Slovenian Judicial Association. Even local fireworkers cannot announce a general strike of all fireworkers in Slovenia. That's why, Slovenian Judicial Association does not and cannot have a legitimate right to announce a strike on behalf of all Slovenian judges.
The use of means regarding general strike opens the essential question: against whom shall Slovenian judges announce a strike? From a historical perspective, "strike" has emerged from the individual rather than collective initiative of employees against the employer. By definition, trade unions are workers' associations. Later in the course of time, trade unions launched widespread initiatives as a form of political pressure against government authority as Solidarity did it in Poland in late 1980s."
Source: Tomaž Štih, When Government Announces a Strike (and almost realizes it), Libertarec, January 22, 2008 (link)
Wednesday, January 23, 2008
Tuesday, January 22, 2008
The Meaning of Economic Freedom
Innumerable empirical investigation has confirmed a positive correlation between economic freedom and sustainable economic performance. Gwartney, Lawson and Holcombe (1999) have explored the relationship between economic and economic growth (link). They concluded that an environment with a high degree of economic freedom is essential to sustainable growth performance. As an ingredient of general prosperity, high level of economic freedom is impossible without a firm role of institutions whose aim is to protect private property from expropriation and to enforce the rule of law. Institutions are defined as the rules of the game and interaction between individuals. Institutions are a set of formal and informal rules that define the scope and shape of behavioral limit in private contracts. Inevitably, the aim of institutions is to minimize the transaction cost through codified arrangements and the respect for individual liberty and a limited role of government. The pursuit of institutions to minimize the transaction cost is, of course, essential to sustainable economic performance. Douglass North, the father of new institutional economics once wrote:
"The inability of societies to develop effective, low-cost enforcement of contracts is the most important source of both historical stagnation and contemporary underdevelopment in the third world."
Source: Douglass North; Institutions, Institutional Change and Economic Performance, Cambridge University Press, 1990 (link)
The quality of the business environment regarding creativity, innovation, financial markets and free exchange, is a set of components that determine the rank of economic freedom in a particular country. By the logic of the common sense, economic freedom is a necessity for both human and political freedom. Economic control is not only the control of economic transactions. It is the control of the means for all individual ends. And whoever has the control over the means must also determine which values will rate higher and which ends shall be served. The following relationship has been succinctly explained by Friedrich August von Hayek who once wrote:
"Even striving for equality by means of a direct economy can result only in an officially enforced inequality - an authoritarian determination of the status of each individual in the new hierarchical order"
-- Friedrich August von Hayek
Top 10 - The Champions of Economic Liberty
In this year's index, economic freedom in only seven nations was distributed as free. The distribution of economic freedom is officially shaped in six different categories. Again, Hong Kong remained the freest economy in the world, scoring very high on each component of economic liberty. In the group of free economies there are also Singapore, Ireland, Australia, United States, New Zealand and Canada. Those countries scored very high in monetary freedom, business freedom, private property rights, labor freedom and financial freedom. Among top 10 there are three countries left: Chile, Switzerland and United Kingdom. Sound regulatory environment, efficient judicial system, deregulated product markets, liberalized financial sector and low exchange costs reflect the ranking of countries among top 10. Among them, only Chile is a middle-income country but economic reforms in the past decade such as the privatization of the pension system boosted growth performance of the Chilean economy and contributed to Chile's high score in economic freedom. In 2008, the overall economic freedom of the world has not increased, but some countries progressed dramatically well while some other countries diverged. For example, Mauritius and Denmark performed a continued improvement from previous ranking while Russia's ranking decreased substantially.
Economic freedom in Nordic countries
The proponents of the so-called Nordic model argue that it is possible to combine sound economic performance and an unlimited welfare state. At this stage, they cite the example of Nordic countries. It is somewhat of a paradox to speak of the Nordic countries as they notably differ in several aspects. Therefore, it is actually impossible to speak about the Nordic model in general. Nordic countries score very well in the area of the quality of the business environment, having created one of the freest business areas in the world. Nordic countries also score very well on freedom to trade internationally, open investment environment, non-existent corruption, flexible financial environment, and independent judiciary. But Nordic tigers score quite badly in the areas of fiscal burden and government size. However, each Nordic countries has its own features. Iceland has been very successful in tax reform, entrepreneurship and competitiveness, Denmark has reformed its labor market towards far greater flexibility, Finland is known for the highly rated elementary and secondary education system, Sweden pioneered voucher system and the privatization of health-care and pension funds. Norway, the least free Nordic country, is known for rich natural resources, enabling both generous welfare system and impeding structural environment.
Slovenia - Subalpine Jail
This year's rank of Slovenia in terms of economic freedom has not improved substantially. Officially, economic freedom in Slovenia improved by 0,4 percentage point reflecting a cautous approach to pro-growth economic reforms. However, Slovenia is ranked as 75th freest economy in the world. A growing number of former communist countries has overtaken Slovenia such as Albania, Macedonia, Romania, Bulgaria. Even Lebanon has surpassed Slovenia. The country scored well on trade freedom and monetary freedom. Poor quality of the business environment reflects the overburden and failure of the regulatory environment. Slovenia lacks the privatization of banking and insurance sector. Also, the judicial system lacks the independence from political influence and it is known for substantial court delays, inefficient staff and slow procedures. Halted privatization programs have been a wish of political aim to control particular sectors of the economy. In addition, minor tax reform slightly cut tax rates on productive behavior. However, tax rates remained steeply progressive and high. Public spending has not increased substantially but the level of public spending is still very high accounting for 47,2 percent of the GDP in recent year.
Trade Unions as Means of Coercion
The most significant obstacle to higher level of economic freedom is Slovenia's highly regulated and rigid labor market that hinders productivity growth and job opportunities. Without a radical deregulation of the labor market, productivity growth could slow substantially. Flexibility is a key feature of the labor market, brining generous effect on labor supply. In fact, the power of labor unions is the greatest obstacle to the strength of economic freedom in Slovenia.
Rok SPRUK is an economist.
Copyright 2008 by Rok SPRUK
Thursday, January 17, 2008
Recently, trade unions in numerous fields demanded a collective wage increase that would, in their opinion, boost the growth of welfare. If those demands are not fulfilled by the government in the process of collective bargaining, trade unions promised to launch demonstrations on the streets of Ljubljana. Not surprisingly, the majority of demands come from the public sector.
In Slovenia, inflation rate is currently above the EU average and is also the No.1 political issue in the public debate.
The question is whether suggested wage increases would really boost the growth of purchasing power or broader negative consequences are inevitable, following wage increases.
Collective bargaining is a zero-sum game
In the long run, wage rate is moving together with the productivity growth. Wage increases are justified only if the value of marginal product of labor is above the actual wage rate. The value of marginal product of labor is, of course, determined by the market value of labor unit. A sudden shock such as an inconsistent wage-increasing claim would leave disastrous consequence to the output activity. If wage claims are above the productivity growth rate, then a private sector would face a significant loss and cost pressures that would be further transformed in higher prices and a decreasing probability of creating jobs in the future. In the absence of perfect competition, price increases would go above the marginal cost. Such a complex situation, does not yield an optimal outcome as firms in imperfect competition create a deadweight loss. Given the conditions of global economy such as an increasing demand for commodities in China and India, the pressure on prices would inevitably be intensified. Consequently, mark-ups on current prices would eliminate the positive effect of wage increases on the purchasing power considerably.
Sudden wage increases tend to make the price elasticity of demand more inelastic. Usually, the elasticity coefficient is between 0 and 1. For example, if price elasticity coefficient is 0,31, it means that given a 1 percent increase in the price of product A, the demand for product A decreases by 0,31 percent. In this, the company has an incentive to raise the price of A, given the gain of price increase. If wage increases and productivity evidence are mismatched, the effect of wage growth on purchasing power is a zero outcome, whereas higher price level reduces (!) the overall capacity of purchasing power and therefore consumer choice and welfare.
Game theory and collective asymmetry
Distinguished economists such as John Nash successfully attempted to derive an equilibrium in non-cooperative games. In the so-called Nash Equilibrium, changing strategy is the best response in non-cooperative games with n-players. Nash equilibrium also became universally applied in national labor relations. The question is what are likely to be the preferences and strategic behavior of trade unions in the collective game. Trade unions can choose the negotiating strategy that aims to stimulate job growth. In this case, wage rate temporarily falls below the equilibrium floor, but only in the short run. Also, union's prime joker can be the maximization of wage fund for all employees. In this case, wage increase is much more sensitive to the level of productivity than in the previous case. The third option is the worst one. Under its circumstances, trade unions can move up the curve of marginal revenue, reducing labor supply and increasing labor demand. This step is called rent-seeking as union's negotiating strategy attempts to bargain the maximization of an economic rent for union members. Aftermath, the analysis of labor market shows that the overall level of welfare has not been increased after union's claims were realized. The wage rate of labor supply in non-unionized sector, is below the equilibrium line while unionized sector's claims reduce the level of employment and the pace of job creation.
How wages affect output and inflation?
In Slovenia, a sizeable proportion of the labor force is employed in the public sector. If trade unions in the public sector claim unjustified and illogical wage increases, the latter could seriously boost inflation pressures. In the negotiating circle, trade unions obviously neglect the principle of budget constraint. In Slovenia, robust economic growth originially based on diseconomies of scale, produced a positive output gap where aggregate demand raised the level of prices. By the fundamental laws of macroeconomics, the difference between potential and real GDP converged into an additional source of inflation. Employment in the public administration is funded through annual budget. Additional wage increases, of course, would have to be conducted by an increasing public spending or by an undisciplined fiscal stimulus that would infuse wage fund. In turn, an increase in aggregate demand would further raise the price level and, again, the effect of wage increases on purchasing power would disappear as the inflation rate would rise.
Proposed wage increases as a threat to macroeconomic stability
The empirial investigation has shown that an additional collective wage increase by 1 percent, would accelerate the inflation rate by 0,6-0,7 percent. Inevitably, higher inflation rate would cause an immense damage to long-term sustainable growth performance and overall macroeconomic stability.
Rok SPRUK is an economist.
Copyright 2008 by Rok SPRUK
Tuesday, January 15, 2008
Monday, January 14, 2008
Sunday, January 13, 2008
Source: Amity Shlaes: The New Deal Job Myth, AEI, Wednesday, January 2, 2008 (link)
Supply, Demand and Equilibrium
As first, prices are determined in general equilibrium by matching supply and demand. The latter are shaped in the opposite direction. Consumers want to maximize the quantity at the possibly lowest price and suppliers want to sell the products at the highest possible prices to increase total revenue. In economics, we say that demand curve is a negatively sloping price function. Individual demand curves merge into market demand curve where all individual demand curves are aggregated into a single market demand curve. On supply side, supply curve shows the relationship between two basic entities in economic analysis - quantity and price. The curve is positively sloping as supplier are willing to sell larger product quantity at higher product prices. What actually affects demand and supply?
Demand in primarily affected by consumer preferences, prices of substitutes and complements, income, population size and future price perception. On the other hand, supply is subject to production technology, prices, costs and future price assumption as well. A reasonable question is how prices emerge. They emerge from market behavior. Consumers have to give up their slice and suppliers have to give up their portion. When the anti-correlated interests come together, the equilibrium point is formed up. At that point, the interest of both sides is satisfied.
How market structure affects the level of prices?
In the course of economic theory in analysis, market structures play a fundamental role. For example, a local monopolist charges higher prices than prefectly competitive supplier. Oligopolies are based on prisoner dilemma and game theory and set implicit barriers to future market agents. In Chamberlain's model of monopolistic competition, there's hardly any entry barrier but products and services are highly differed. Every economist dreams about perfect competition. In it, the price equals marginal cost.
Often, it is said that perfect competition exemplifies social optimum. The model of perfect competition is based on four basic assumptions: (1) homogenous products, (2) prices taken as given, (3) maximum mobility of production means and (4) perfectly informed consumers. One could question what the fourth assumption really means. The answer to this question opens a new concept - elasticity of supply and demand. In the model of perfect competition we assume that consumer behavior is highly sensitive to single relative price increases. For example, if there are two local grocery stores and the first raises the prices of milk by $1 USD, a rational consumer would trade a slice of its purchasing power with the same product supplied by another company. In a discussion about perfect competitive markets, we say that prices are like information signals. They work as means of communication by sending the information to suppliers of how to coordinate the economic activity and estimate future perception about market behavior and prices.
However, if market structure is incomplete, the market behavior is different. In oligopolistic model, few companies control their real market share. Prices are therefore not the outcome of a spontaneous order of competition but the result of an incomplete market structure. In case of few companies dominating the retail market, the question of firm's price policy will produce a prisoner dilemma. In Nash equilbrium, each players sets a strategy as the best response to another player's strategy while possessing the knowledge of other players. These strategies include cost structure and all possible outcomes regarding the settlement of prices shown in the payoff matrix.
Firms always set the prices that maximize their overall utility by attempting to examine the possible behavior of competitors. Probably the most important quest in incomplete market structure is that final prices are not set on the basis of marginal cost but on the basis of marginal revenue. That is because firms in incomplete market structures are not price takers, but price makers. In this case, the price elasticity of demand is not infinite because the curves of demand marginal revenue are negatively sloping while marginal cost curve is positively sloping. In a graphical analysis, the price is settled at the point where marginal cost equals marginal revenue. And there is gap between between the point where the price is settled and the slope of demand curve. In such a situation, firms maximize their utility by raising the consumer price in a vertical line with demand curve.
The question is, why demand curve is negatively sloping? It is because few companies dominate the market and the outcome is that consumer behavior is modified according to the actual choice. The price elasticity of demand varies between 0 and 1. Firms signalize this clearly. 0,81 price elasticity coefficient of demand means that if a price of A is raised by one percent, the demand for A declines by 0,81 percent. In this case, the supplier faces a 0,19 percent gain if his company raises the price by 1 percent. It is said that in such a complex situation, the price elasticity of demand is inelastic and because of an incomplete market structure, firms have a sizeable space to control price settlement as consumer lack the choice such as in perfect competition.
Monopolies, prices and welfare
One could argue that there is a tradeoff between the quality of consumer products and perfect competition. In a theoretical terminology, the higher the level of market competition, the lower is the level of product differentiation. The fact is that each price is the outcome of particular allocation of scarce resources. It is usually not difficult to answer why monopolies are bad. Monopoly companies do not produce at the lowest possible cost. They do not advance technological improvements to speed-up the growth of productivity. They also do not offer the best possible quality and do not consider the essence of succinct allocation of resources. A monopolist is a pure price maker.
He settles the price at the cross of marginal revenue and marginal cost. Given the negative slope of demand curve, he produces a deadweight loss corresponding to inefficiencies in production and his allocation mechanism. The overall outcome is that monopolies do not maximize the individual welfare. There is absolutely no exception to that rule in case of natural monopolies where average and marginal cost curves slope negatively. Policymakers are often exposed to the dilemma of how to regulate natural monopolies such as railway companies. Often they want to nationalize the company.
They also want to regulate its rate of return. If such policy decision were implemented, the monopoly would face a bottom-line pressure and zero profits. If privatization and competitive initiative were launched, the natural monopoly company would have less incentive to discriminate with the prices and its price policy would be approaching closer to the competitive model.
Competitive Markets, Elasticity and Inflation
Government policies often intervene the market to maximize the best possible outcome on the consumer benefit. For example, there are two ways to reduce smoking. (1) The first option is to launch anti-smoking campaign and try to influence smokers' decision to stop smoking. In this case, the demand curve would move left while the price of cigarettes of remain the same, ceteris paribus. (2) The second option is to impose a tax on tobacco company which produces cigarettes. In this case, the supplier would add the tax to his price and set a new consumer price of a pack of cigarettes. In this case, only the size of demand would be reduced and the equilibrium point would be changed by moving up the demand curve.
The last question is referring to the actual situation regarding food prices, demand elasticity and inflation. First, inflation is a monetary phenomena arising from the situation where money fund is larger than the fund of goods and services. The settle the equilibrium point, the level of prices goes up to catch the balance with current quantity of money circulating in the economy.
The important thing to realize in the question of how competitive market structures really are is the degree of flexibility and demand elasticity. If the demand for particular good or product is inelastic, the situation gives a sign that market structure is quite incomplete. Monopolies exhibit its market power by adding mark-ups to the marginal cost after particular shocks. The more inelastic demand, the higher the size of particular mark-up. Food market has been accountably exposed to the mark-ups. In Slovenia, the structure of supply-chains is known for a substantial degree of inflexibility.
Consequently, every single shock emerging from global conditions of supply and demand for food is transformed into the mark-up above the marginal cost. The outcome is not beneficial for consumer welfare as the combination of inelastic demand, false structural policies, incomplete market structures and non-competitive supply-chains is abused for the escalation of prices. That is why various cosmetic attempts do not reduce the extent of paricular shocks. In sum, the principles of competition codified in the competitive law are the only possible way to prevent the abuse of market power that stakeholders possess.
Rok SPRUK is an economist
Copyright 2008 by Rok Spruk
Saturday, January 12, 2008
Monday, January 07, 2008
Source: The American (link)
Sunday, January 06, 2008
Slovak government soc-storm brigade doesn't come to halt anything in the name of way for brighter tomorrows and achieveing of promises from the dreamland. It wants to connect by highway capital city Bratislava with second largest city Košice (on the other side of the country) till the year 2010. Recently passed law by the parliament should give a hand this aim, which as they say will enable to accelerate highway construction in areas, where an owners don´t want to sell their property at price the government says. Yes, they want to march on even at the expense of total blatant derogation by a private property. But finishing highway construction in this deadline is as real as building of broad-gauge railway to east part of Slovakia (to join railway to Moskva).
Legislative act or rather mafia´s ultimatum on non-resisting allows planners building roads on private land plots without agreement with the owners. If these people won´t consist with own property sale for government´s offered price, the state will simply steale it (they call it eminent domain). And to compensate still rightful owner will suffice as far as a road will pass just under his own window. Joke? Scarcely!
If the state should indicate a public interest (what a specific notation) of a kind up to this day, tomorrow it won´t have to. When government simply decides that your house with land plot stands in the way of highway, which pay every taxpayer in the country including those who don´t ride a car, you just drop it. With any immediate and adequate compensation. Better variant is that you learn of it from an official bulletin hanging in front of a local authority building, worse one is you wake up one day on a surprising noise of digger in your living-room.
Bolshevistic bashaws built roads for forty years in such a way. They weren´t interested whose a house, cottage or piece of farmland is. And not a bid any fair compensation. The same communists want now to steal people´s property and they don´t bother about some meaningless private property. A fundamental thing is they are building and giving out. And when the court will confirm the passed law as unconstitutional in a few years? It doesn´t matter, they tried. Government and parliament officials maybe already won´t seat on their chairs by that time and a huge financial compensation to the owners and PPP concessionaires will pay all taxpayers.
Appeal on virtue and conscience of parliament´s or government´s members is like to expect from a thief that he satisfies at a visit of your house with it´s visual inspection. A state constitution is not a contract. It doesn´t oblige anyone for any particular action. It is only a piece of unvalued paper document. The government and parliament simply confirm it by their action.
Thursday, January 03, 2008
"...the EU as it is today, is definitely not sustainable. Slovenia integrated into the union of nations instituted upon market capitalism. Regarding the negative experience we had with previous regimes of dictatorship, rational voters would agree that the only positive feature of current Slovenian government is that the latter attempts to pursue the agenda over democracy and market capitalism. Everything else is a zero-sum game as it was in Habsburg Monarchy, Kingdom of Yugoslavia and Tito's communist Yugoslavia. That's why, bluffing with all sorts of speech, banquets, inaugurations and fantasies about the relevancy of Slovenian Republic in foreign policy, will nevertheless be a clear signal, that Slovenian government has absolutely no idea what is it doing in the European Union. Nonetheless, given the current state of political and economic climate, Slovenia could easily be integrated into the African Union, leaving behind local monopolies and nation-wide cartels."
Source: Rado Pezdir, Croats and Banquets - The Radius of Janez Jansa's Government, Finance, July 9, 2007 (link - subscription required).
In 1991, Slovenia emerged as the wealthiest former communist state with the highest GDP per capita in Eastern Europe. That was a sign that Slovenia's socialist politico-economic system allowed some (!) private initiative. For example, manufacturing companies were allowed to operate with private means of production, but only if there were five or less employees. However, the entrepreneurship under production means of private property and ownership was strictly prohibited. The manufacturing sector was hardly seen. Later, the hope of the most successful economy in Eastern Europe suddenly disappeared.
Slovenian politicians quickly embraced the idea that the country must progress gradually by a beguiling path of non-reform. The consequences were terrible. The mainstream economists embraced the idea that foreign direct investment must be highly limited and prohibited in some sectors. Therefore, the privatization was delayed. By 2005, Slovenian government ownership share in major Slovenian companies was 35 percent of the GDP; the highest share in Eastern Europe.
Government ownership can be seen everywhere, managed by para-government funds - in Krka (pharmaceutical company), Triglav (insurance company), NKBM (banking company), Nova Ljubljanska Banka (banking company), Gorenje (household appliance producer), Petrol (oil company) etc. Slovenia has an unreasonably high tax wedge, among the highest in the EU. Taxes levied on labor supply and productive behavior negatively affect economic performance. High tax burden in the share of the GDP does not stimulate productivity growth and the growth of GDP.
There's a dozen of empirical arguments in favor of private ownership. Capital management under private ownership is better at approximizing the information and seeking cost-efficient solutions needed for a successful investment and return on equity as well as for other parameters of the firm. At the same time, looking at the productivity data, Slovenia hasn't yet reached a convergence of the productivity in line with EU15, EU25 and EU27.
The political map of Slovenia is perhaps the most terrible saga that has been continuing in historical cycles. Currently, there is no political party that would launch reform agenda to boost an ambitious political program in favor of higher and stable growth in the long run. Slovenia's economic policy is based on Keynesian ideas such as heavy public investment, inefficient public administration and government intervention into the free market. Each year, the World Bank composes a ranking of countries in accordance with the ease of doing business. This year, Slovenia was ranked as 55th most friendly environment for doing business.
This year's rank has arrived from 53th place last year. For example, in Iceland (link), the enforcement of commercial contracts is easy and payment disputes almost do not exist. In average, it takes 393 days to reach a full enforcement of commercial contract until the actual payment. In Slovenia, it possibly takes (link) 1350 days until the commercial contract claims and obligations are fully enforced after dozens of lawsuits and payment disputes. A research by Slovenia's Office for Macroeconomic Analysis and Development has shown that the major obstacle to starting a business is weakly protected rights of entrepreneurs regarding payment disputes.
Slovenia's Balkan ethics lies firmly into its unique political culture. Recently, Johnny Munkhammar wrote a book entitled Guide to Reform (here and here), where he showed how policymakers can achieve great results and win re-election by implementing long-range economic reforms. Slovenian political parties, whether they are left or right, always opposed full privatization, pro-growth tax policy, labor market deregulation, the rule of law and reductions in public expenditure.
Instead, interest groups control all types of decision under public policy. Trade unions, for example, roared against tax reform, denied labor market deregulation and stood firmly against education reform. Urban planners have controlled nearly every possible instrument that could enable the liberalization of housing sector. The ongoing consequence is that the prices of urban flats, housing and land are stratospheric. Slovenia's agricultural lobby can easily be compared to the "state-within-the-state".
Besides holding a complete control over land resources, they boost artificially high land prices, given a flat downward sloping curve of land supply. Protectionism has arrived at the cost of enormously high consumer housing prices. In addition to the pedigree of central planning, Slovenian Apartment Fund, under government control, runs a policy of full price control. Nevertheless, price controls fail sooner or later.
Slovenia's political system is marred by dusts of old-style protectionism and anti-competitive mentality. State Council is holding an enormous power of public decision-making. It can simply block the decisions which have been democratically approved by the parliament. State Council is a symptom of Mussolini's idea of the corporate state where the interests of stakeholders are firmly protected in the economic system.
In addition to obscure institutions such as State Council, there is also an ESS, which could be called Economic Schutz Staffel. It is a cooperative body called Economic Social Council where employers, government and trade union impose wage-control policies. This particular council indeed has terrible consequence for the growth of living standards which are, by the wisdom of economic theory, determined by productivity. In the long run, productivity is everything.
At last, Slovenia's blurred image is further degenerated by the inefficient and cumbersome judicial system. Property rights are very weakly protected. According to Heritage Foundation's 2007 Index of Economic Freedom, Slovenian courts are inefficient and procedurally slow with a bulwark of reports about legal corruption. The latter is widespread. It enables everything what is legally prohibited under the rule of law.
In Balkan region, Slovenia is the most developed country according to official parameters. Its eastern neighbors call it "Slavic Switzerland" or "Balkan's Germany" as Der Spiegel wrote in the abovementioned article. The reality is quite different from official reports of a happy sub-Alpine nation enjoying an ever-lasting prosperity.
This myth has been erased when Slovenia entered the European Monetary Union when country's inflation skyrocketed because of structural inflexibility. But nevertheless, depression, anti-competitive mentality, status quo, degenerated legal system, slow economic progress, violence against intellectual and productive individuals, psychological torture, public unsafety and spurring corruption are the best signs of country's international rank. However, structural misery cannot escape the pen of history.
Rok SPRUK is an economist.
Copyright 2008 by Rok SPRUK
Wednesday, January 02, 2008
Source: Yahoo News (link)
The major reason for imposing an internal tax on grain exporters has been argued by the attempt to develop an explanation for a surgining inflation in China. Previously, the Ministry of Finance imposed a 13 percent rebate on China's grain producers in a move to increase domestic supply. In November, the inflation hit 6,9 percent accordingly.
China's consumer inflation is driven by food prices which rose 18,2 percent recently. The reason for high food prices is determined by global conditions of demand. China has been facing significant GDP growth.
The growth has been driven by a surge in domestic and global demand which put a cyclical pressure on commodity prices. The fundamental law of economics is the scarcity of resources. Each event that affects the behavior of supply and demand, also affect the equilibirum where the prices are set. In previous year, there have been particular shocks that relatively affected the behavior of world prices. For examples, natural droughts and harvest shortages reduced the supply and lifted input prices respectively.
Though the proposed tax on grain exporters is only temporary, it could hardly be supported by sufficient arguments. There will definitely be an upward pressure on prices unless the exporters give up the marginal gain. Chinese grain market is marred by subsidies and regulation. The additional taxation would further distort the allocation of scarce resources. The producers would harder find the information needed for the free production of goods where different types of grain are included as an input resource.
Given the current analysis of the behavior of food price, higher food prices which caused a surge in inflation, are temporary (link). Various attempts to influence the prices by subsidies, regulation and food quotas are economically irrelevant for two reasons: (1) such incentives cause the lack of information about the production and (2) policy-induced incentives increase the marginal cost of production. Given the conditions of perfect competition, prices equal the marginal cost.
China also proposed a 25 percent fuel tax to limit domestic consumption. Ceteris paribus, fuel prices would increase. However, there are various incentives to introduce a tax on fuel consumption. The most significant argument is that fossil fuels cause a negative effect on global warming and that therefore, fuel tax is justified. Despite the fact that China is world's No.1 air polluter, the reduction in the dependency on fossil fuels takes time. In this case, car producers will face a significant cost-induced shock because of changes in the pattern of production and technological restructuring.
The use of alternative means of energy will induce cost distortions given the magnitude of relatively high fixed costs subject to production plants and technological equipment. Chinese authorities reported that one of the major sources of inflation were higher oil prices. The answer to the question how to curb oil prices and therefore an important inflation pressure is not government intervention and various incentives such as subsidies to oil companies, oil quotas and protectionism. The fact is that oil demand is highly inelastic and that only a shift in demand will calm oil prices.
If the price coefficient of demand for oil is situated onto the interval between 0 and 1, then price increase maximize the intended utility of oil producers, because an increase in the price of oil by about 1 percent, increased the income of oil producers. China is a current leader in global economic growth. It's GDP per capita is growing rapidly, after being adjusted for inflation. A decade of high growth rate invisibly modified the conditions of oil demand. Driven by optimistic estimates and assumptions, the demand for oil became quite inelastic and there each price increase, does not reduce the welfare of oil producer. If the oil demand were prone to relative price changes and elastic, oil producers would have less manoeuvre to lift the price at the margin since such a step would inevitably reduce their income.
Chinese central bank lifted baseline interest rates six times in previous year. Such steps were normally expected due to the need to normalize the magnitude of particular shocks such as rapid economic growth which is highly related to the surgence of inflation. Keeping oil prices artificially low, and providing subsidies to oil refiners to compensate for losses due to global oil prices, is quite risky. Such a move would be justified if there were particular externalities and positive effects but in China's case, the protectionism arrives at the price of market dynamics and holding-back everyday shocks that are quite common in market economy.
Taxing grain producers, imposing tax rebates, giving subsidies to farmers and oil refiners is an inadequate measure to curb the inflation. The flexibility of domestic market to balance the signals of production, prices and consumption is an essential tool as a response to sudden shifts and macroeconomic shocks. Also, regulation makes information asymmetric, making the supply side of the economy worse-off. Subsidies to farmers distort the free mechanism of price establishment.
Inevitably, there is a negative dash on consumer prices. In economics, there are different judgements of subsidies, temporary taxes and tax rebates. Each one of those measures is mismatched by the information signalized by the producers. Fighting the administrative barriers, the establishment of competitive law, deregulation of all sectors of the economy and market liberalization are, by historic and current evidence, the best way to fight the temporary shocks and pressures as well as inflation which is a monetary phenomena.
Rok SPRUK is an economist.
Copyright 2008 by Rok SPRUK